In [yesterday] morning’s Wall Street Daily column, I shared an attractive takeover target for investors to consider. But it doesn’t make sense for conservative, income-oriented investors to chase after these returns. Not when there’s a way to profit from takeovers in a much more reliable and safe manner.
I’m referring to the strategy known as merger arbitrage, whereby we wait until after a takeover announcement is made.
[ad#Google Adsense 336×280-IA]This is, of course, a battle-tested strategy.
In fact, it’s been a mainstay in institutional and high net worth portfolios for decades.
And guess what?
As merger activity is heating up again, hedge fund managers like John Paulson of Paulson & Co. and Steven Cohen of SAC Capital Advisors are increasingly making use of it.
Yet, most investors believe merger arbitrage is a strategy reserved for the elite.
Not true. We can use it to easily boost our income, too.
With that in mind, I have two specific opportunities for you to consider today. But first, let me provide two important reminders…
1. Cash is Always King! When evaluating opportunities, we always want to focus on all-cash deals, as opposed to cash and stock or all-stock deals. The reason? Because it’s simpler and cheaper. It only involves purchasing one stock, and therefore only incurs one trading commission.
All we do is buy shares of the target company… and wait. When the takeover closes, the cash equivalent to the full offer price appears in our account. And we’ll have earned the spread in the process.
2. Pigs Get Fat, Hogs Get Slaughtered. Just like with dividend stocks, chasing yield in merger arbitrage opportunities is a bad idea. You see, the historical merger arbitrage spread is about 5%. So a double-digit spread is often an indication that there’s a credible concern about the takeover being completed.
Take energy company, Venoco (NYSE: VQ), for instance. It’s trading about 15% below the $12.50 per share offered by the company’s CEO, Timothy Marquez.
It’s not a fluke, though. Doubts remain whether or not the CEO can secure the financing to close the deal. And when deals don’t close, we don’t earn the spread.
Practically speaking, I suggest looking for slightly above-average merger arbitrage spreads of about 6% to 8%. Or more simply, be a pig, not a hog! And with that in mind, let’s move on to two merger arbitrage opportunities worth your consideration…
Two Ways to Pocket An Extra 6% (or More) Before Year’s End
In early June, Chinese biodiesel firm, Gushan Environmental Energy Ltd. (NYSE: GU), announced a deal to be acquired by its Chairman, Jianqiu Yu, for $1.62 per share.
The merger is expected to close by September 30, 2012. And based on the current prices, the spread appears to be 8.7%. After examining the SEC filings, though, a cancellation fee of $0.05 per share will be deducted related to the company’s 2007 agreement to be listed as an ADR.
If we factor this amount into our calculations, we need to purchase shares for $1.48 or better to earn at least 6%. So use a limit order if you decide to take advantage of this opportunity. And be patient.
Since I know we have plenty of Canadian readers, I also want to provide a unique opportunity for you. And that’s where coalmine developer, CIC Energy (Toronto: ELC.TO), comes in.
On July 23, the company announced it received a C$2 per share offer from India’s Jindal Steel & Power Ltd. The merger is set to close on or before October 9, 2012.
In order to earn at least a 6% yield, we need to purchase shares for $1.88 or less. So, again, use a limit order if you decide to take advantage of this opportunity. And be patient.
Bottom Line: Forget being reserved for the world’s foremost investors. With a little legwork, we can safely boost our income in this zero-interest world with merger arbitrage, too.
Gushan and CIC represent two attractive opportunities worth a look right now.
But rest assured, I’ll be in touch with more compelling opportunities as they materialize.
Safe investing,
Louis Basenese
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Source: Dividends and Income Daily