RIYADH, 6 December 2004 — In order to survive in the long-term, companies need to continuously grow their business. Beyond a certain size, companies find it difficult to grow from within, instead they do so by acquiring or merging with another company. The outcome of a successful merger or acquisition (M&A), results in an extension of the product line, expansion of the customer base, and most of all revenue and profit increase. Some mergers or acquisitions, defensive M&A, protect a companies’ weakness-deteriorating position, and provide them a better chance to survive.
In order for an M&A transaction to be approved by the “seller”, the buyer has to pay a premium of around 25 percent to acquire the “target” company. Many investors buy shares of companies that are potential acquisition target, and make a quick profit by selling them shortly after the acquisition announcement is made. In general the buying company experiences a short-term price loss, since it pays a premium to buy the target company. The above dynamics create short term trading opportunities for many investors.
For better clarity about such recurring M&A opportunities, let us look at two real life examples — Pfizer and Mylan Laboratories, based on my personal experience with both companies. Pfizer is the world’s largest and fastest growing pharmaceutical company, with a solid balance sheet. Around July 10, 2002 they announced that they will acquire Pharmacia Corp., a leading pharmaceutical company with a complimentary product line. As in most acquisitions, Pfizer agreed to pay a premium to Pharmacia owners of around 25 percent. Immediately after the announcement Pfizer share price tumbled from $32.5 to $25.2, a loss of 22 percent over a span of few days. Pharmacia shares jumped during the same period to reflect the premium offered by Pfizer. Historically around two thirds of the acquiring companies, in a merger or acquisition transaction, loose market value.
A closer look at Pfizer revealed that in addition to its leading position, it had a strong sales force, and ranked second on a Fortune 500 list of “The Smartest US Companies”. Their revenue was around $35 billion, their net income was healthy and growing at a double digit rate, and their R&D budget was in excess of $4 billion. In addition they controlled seven of the world’s 25 largest-selling pharmaceuticals. They were also in the middle of a plan to purchase up to $5 billion worth of their own common stock. In addition they have completed a successful acquisition of Warner Lambert less than three years earlier.
For the subject deal, there were clear synergies of cost savings, advantages from using a bigger sales force, and the ability to spend more on consumer advertising-a key driver to revenue growth. Based on the above, I was convinced that the downside risk is much smaller than the upward potential. So I bought Pfizer shares at $26.5 around mid July.
The share price bottomed at $25.13 and started to climb few days later. In fact the stock regained all the loss that it had encountered due to the above announcement, in less than two weeks. Since it is a leading company, I was in no hurry to sell prior to achieving a good profit of 25 percent. In the second half of August it hit $35 and I was able to sell my shares on their way up at $33.5. In total I made 26 percent in one month, trading a solid low risk company under difficult market conditions.
Mylan Laboratories, the world largest maker of generic drugs, announced on July 25, 2004, that they will acquire King Pharmaceuticals for $4 billion. The deal came at a time when all generic makers were switching their focus toward the branded drugs to bolster their margins. Although each company had its own challenges, however they had clear synergies that the combined company can capitalize on.
Mylan paid 40 percent premium for King’s shares, and immediately its shares went down by 16 percent, to $15.2. Both are solid companies with good fundamentals, so after a quick evaluation I purchased Mylan shares on July 27.
The following week the share price went down further, so I purchased more at $14.8. Since this period was dominated by difficult market conditions-war in Iraq, oil prices at new highs, terror warnings, I decided to get out quickly after a modest profit of around 20 percent. On Sept. 13, I sold my shares at $18.5 for a 22 percent profit in less than two months. Similar company specific M&A opportunities are available all the time-few every month, which investors have a chance to benefit from.
(Salim J. Ghalayini, [email protected], is the author of “Stocks for the Practical Investor”. He manages several investment accounts.)
