Remember that Merger Rumor? Yeah, About That….

Bloomberg has an interesting article. It turns out that a fairly large percentage of mergers don’t work out:

The surest way to profit from takeover speculation in the stock market is to bet it’s wrong.

Electronic news services, brokerages and newspapers reported at least 1,875 rumors about potential buyouts of 717 companies between 2005 and 2010, according to data compiled by Bloomberg. A total of 104, or 14.5 percent, were acquired, the data show. While stocks that were the subject of takeover speculation initially jumped 2.9 percent, betting on declines yielded average profits of 1.2 percent in the next month, an annualized gain of 14 percent.

Opportunities to employ the strategy are increasing as mergers recover from the worst recession in more than 70 years, data compiled by Bloomberg show. After bottoming in 2008, the number of unconfirmed stories about possible mergers surged 71 percent to 611 last year from 2009, data compiled by Bloomberg from more than 50 news providers and brokerages show.

“Sell into the strength,” said John Orrico, who focuses on mergers and acquisitions at New York-based Water Island Capital LLC, which oversees about $2.2 billion. “We see it as an opportunity to sell if we think the rumor is false or ridiculous, which in most cases they are.”

Short selling to speculate on declines on supposed takeover targets produced more than twice the average return generated by U.S. stocks, data compiled by Bloomberg show. At the same time, companies in the Russell 3000 Index had the same chance of being acquired in any 12-month period since 2005 as those that were the subject of merger stories, the data show.

So betting against the rumor is the sounder strategy. Or, at least, it has been for the past few years. That’s one of the red flags I have about this study — the time period is very short.

I’ve always been very skeptical of investing in a company because others think it might be bought out. The problem is that you’re adding other variables to the mix that you can’t control.

The better way to invest is to think that you’re making the buyout offer. Then, every once in a while, some large investor agrees and you get a nice premium. That’s happened to us twice on the Buy List in recent years. Biomet was bought by a private equity firm, and Golden West Financial was bought by Wachovia (which was later bought by Wells Fargo).

Posted by on January 11th, 2011 at 9:21 am


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