How to Find the Best Potential Profit Plays in the Resurgent M&A and IPO Markets

When Xerox Corp. (NYSE: XRX) yesterday (Monday) unveiled plans to pay $6.4 billion for outsourcing specialist Affiliated Computer Services Inc. (NYSE: ACS), it was just one of four major financing deals with an aggregate value of more than $14 billion announced on the day.

And that wasn't all. Newegg Inc., a well-known computer and electronics e-tailer, announced plans to raise $175 million via an initial public stock offering (IPO) - and intends to use some of the proceeds to expand its already-growing operation in China.

Welcome to merger-mania Monday, which delivered a highly bullish message to investors: Although U.S. stocks have surged 57% from their March 9 lows - creating a strong belief that a correction is overdue - a frenetic burst of mergers-and-acquisitions (M&A) activity and a growing number of IPO deals could mean that U.S. stocks still have room to run.

And it also points to some lucrative profit plays for investors who know where to look.

"For this [rally] to have legs you're going to have to have some M&A," Uri Landesman, head of global growth strategist at ING Investment Management in New York, told "I don't think [stock prices at] this level would be substantiated without it. If we're going to see a much higher market, M&A is going to have to be a part."

If that's what's needed to fuel the market rally, there could be some very bright days ahead.

After all, don't forget that it was an explosion of M&A deals two years ago that helped propel the Dow Jones Industrial Average to its Oct. 12, 2007 record of 14,093.08. This time around, Corporate America has an estimated $700 billion in cash on its collective balance sheet - more than enough keep the M&A market humming, said Howard Silverblatt, an analyst for Standard & Poor's Inc. (NYSE: MHP).

The M&A market is clearly healthy again.

And it's not just M&A. With eight stock-offering deals raising more than $3.5 billion, last week was the biggest for the U.S. IPO market in two years. And there are more IPO deals in the hopper, including several companies with household brand names.

Investors can also take heart that the dealmakers aren't the only market catalyst at work right now. There's also a pile of cash on the sidelines - including $3.5 trillion parked in no-yield money markets alone. That's enough to keep the current rally going for some time to come.

But something's needed to draw that cautious money back into the stock market. The flurry of deals could be just the ticket - especially if investors can understand just what is driving this dealmaking.

Increased investor confidence has certainly helped, since the rebound in stock prices has given companies more "currency" - enabling them to use their higher share prices as part of the of deal payment. Corporate balance sheets are stronger than they've been in awhile, too. During the worst of the global financial crisis, companies slashed payrolls to cut costs and to build up cash cushions.

Louis Basenese, a noted M&A and IPO expert who is the editor of The Takeover Trader investing service, said the global financial crisis and ensuing recession and credit squeeze prompted many companies to hoard cash. Some wanted it as a buffer. Others simply refused to reinvest their profits until they could combine that cash with leverage to effectively buy more.

But "that much cash doesn't sit idle forever. Not when it earns a paltry 1% interest in a bank account," Basenese told Money Morning. "In fact, the longer it sits, the more executives will be itching to put it to work to earn higher returns. After all, it's their responsibility to maximize shareholder wealth."

Some of the same factors that jump-started the M&A market are now also helping to drive new stock offerings, Basenese said.

"The best cure for an IPO lull is a bull market," he said. "Companies want to tap into the enthusiasm. And a 50% rebound [in U.S. stocks] certainly qualifies. So it's no wonder we're witnessing an uptick in recent weeks."

Kraft Bid for Cadbury Ignites Zeal For Deals

M&A deals and IPOs have traditionally been among the stock market's top headline grabbers. And with good reason - both are major wealth creators for investors, offering the potential for windfall returns.

Buyout offers - especially those that are unsolicited, or even hostile - tend to feature a hefty premium over the target company's previous trading price. As for IPOs - well, though it's not as common as it was during the dot-com heyday, who hasn't heard the stories about companies that went public at $12 or $14 a share, only to have their newly minted shares zoom up past the $200 a share level?

With this latest flurry of M&A deals, the buyout play that caught the imagination of investors was the $16.7 billion unsolicited takeover bid that Kraft Foods Inc. (NYSE: KFT) launched for Cadbury PLC (NYSE ADR: CBY). Not only was it the most significant deal in 10 months, it was yet another sign that the next round of mega-mergers will have a global face.

Like the $52 billion buyout of U.S. brewer Anheuser-Busch by Belgian-Brazilian brewer InBev in July 2008 (creating Anheuser-Busch InBev NV (NYSE: BUD), now the world's biggest brewer), the proposed Kraft-Cadbury merger involves companies that are based on opposite sides of the Atlantic Ocean.

But the driving reasons for Kraft's interest in Cadbury is due chiefly to the target company's strong presence in India, South Asia and the former British Empire than it does on its.

This deal, which Kraft says it intends to pursue no matter how sternly its British target tries to rebuff it, raised hopes of a new wave of mergers and acquisitions - just as 2009 seemed to be headed for a record for futility in the M&A market.

But the wheeling and dealing had actually started the final day of August. And while the corporate financing frenzy that ensued was initially very domestic in focus, it would ultimately take on a decidedly global flavor as it unfolded.

On Aug. 31, The Walt Disney Co. (NYSE: DIS) said it would buy Marvel Entertainment, Inc. (NYSE: MVL), creator of more than 1,500 superheroes and other comic-book characters, for $4 billion, while Baker Hughes Inc. (NYSE: BHI) offered $5.5 billion for its fellow Houston-based energy-services firm, BJ Services Co. (NYSE: BJS).

Disney's offer represented a 29% premium to Marvel's market price, while Baker Hughes' bid for BJ represented a 16% premium. Those premiums become a key reason investors get excited whenever a clear takeover frenzy emerges.

The next day, eBay Inc. (Nasdaq: EBAY) sold a 65% stake in its Internet-phone unit, Skype, to a group of private-equity investors for $1.9 billion.

Within a few days of each other in early and mid-September, Deutsche Telekom AG (NYSE ADR: DT) and France Telecom SA (NYSE ADR: FTE) said they would merge their British mobile-phone operations - T-Mobile and Orange, respectively - to create a new market leader.

During that same stretch, France's Vivendi SAS (PINK ADR: VIVDY) bought GVT, a Brazilian mobile-phone firm, for $2.9 billion.

Other activity followed well into late September, including the $626-million bid for New York-based Parsons Brinckerhoff  Inc., by U.K.-based engineering giant Balfour Beatty PLC  (PINK: BAFBF).

Except for the fact that it's not a public company, Parsons Brinckerhoff may well be the prototypical global buyout target. A leading transportation engineering firm, Parsons focuses on infrastructure projects in 80 countries, and has 150 offices globally. An employee-owned firm that was founded in 1885 - and whose claim to fame is that it designed the New York City's first subway - the firm's real value is that it it's a major emerging markets infrastructure play: It does work in the environmental, water, energy, urban development, and telecommunications sectors.

Like the Balfour/Parsons link-up, the Kraft/Cadbury deal very likely points up the type of M&A deal that investors are most likely to see in the months to come - strategic deals.

Companies will look for targets that are complementary, that fill out a product line, or that add a distribution channel that would be too costly to develop from scratch. Strategic deals are far more likely to allow real synergies than the seemingly random buys of the megadeal era.

"There were more distressed situations last year, a different type of M&A," Patrick Lee, joint head of investment banking for Nomura Holdings Inc.'s (NYSE ADR: NMR) Southeast Asia unit, told The Straits Times. "In this market, you'll see more normal types of M&A deals, where deals are more strategic in nature."

Indeed, the Cadbury deal's far-flung attractions suggest that some of the most compelling deals - and IPOs - will involve companies whose headquarters are far from Wall Street or London's City.

For instance, Shanghai-based Shanda Games Ltd. has filed to go public. Founded in 2001 as a division of Shanda Interactive Entertainment Ltd. (Nasdaq ADR: SNDA), Shanda Games is a big player in the fast-growing space of massively multi-player online role-playing games.

The company has 18 of these in its portfolio (as well as 11 advanced casual games). It follows the IPO in April of Ltd. (Nasdaq ADR: CYOU), an on-line gambling company based in China. Since then, Changyou's stock price is up an impressive 138%.

The strong regional appetite for gambling and gaming has also shored up interest in the pending IPO of a major stake in Las Vegas magnate Steve Wynn's Wynn Macau Ltd. casino operation. The Hong Kong flotation, set for early October, could raise more than $1.5 billion.

Similarly, the proposed U.S. flotation by AEI rests on its geographic diversity: it operates energy-generating facilities in 19 developing countries. AEI, interestingly, is formed from the remnants of the Enron empire.

Virtually every big market around the globe is getting in on the stock-offering action. Even the Middle East. One big deal is a Malaysian-Indian consortium's bid of about $14 billion for a 46% stake in Kuwait's Zain telecom. Abu Dhabi's Advanced Technology Investment Co. (ATIC) has agreed to buy Chartered Semiconductor Manufacturing Ltd. (Nasdaq ADR: CHRT) in a deal worth $5.6 billion - the biggest M&A involving a Singapore company since 2001, when United Overseas Bank acquired Overseas Union Bank.

Deals to Watch for Possible Profit

What's next? Rumors are the only certainty in the world of M&A, but persistent speculation centers on Sprint Nextel Corp. (NYSE: S), with Deutsche Telekom, T-Mobile's parent, named as the buyer. This deal would present technological challenges, but Sprint is so frequently named as a target that it merits watching.

The pharmaceutical and biotech sectors, already the arena for major deals earlier this year, are likely to see activity. A key driver: Major drug patents are soon to expire and companies are looking for assets and cost savings to make up for the lost earnings.

Between January 2007 and July 2009, pharma and biotech accounted for four of the 10 biggest M&A deals of the period. Expect more dealmaking and consolidation, especially if the U.S. health insurance industry gets reformed under "Obamacare."

Other than Sandoz Inc. - part of the US arm of Swiss giant Novartis AG (NYSE ADR: NVS) - and Teva Pharmaceutical Industries Ltd. (Nasdaq ADR: TEVA), all of the world's leading generic companies are potential acquisition targets. Shire PLC (Nasdaq ADR: SHPGY) and Elan PLC (NYSE ADR: ELN) are potential targets. AstraZeneca PLC (NYSE ADR: AZN), GlaxoSmithKline PLC (NYSE ADR: GSK) and Novo Nordisk A/S (NYSE ADR: NVO), with strong cash and low debt ratios, are likely acquirers.

In fact, Credit Suisse Group AG (NYSE ADR: CS) went so far as to predict that the U.K.-based Shire would be AstraZeneca's next target. Shire's U.S. subsidiary has a new attention-deficit-disorder drug that it believes will bring strong results, even with Shire's relatively small sales force.

Germany's Bayer AG (OTC ADR: BAYRY) is seen as an eventual takeover target, in part because of its potential-blockbuster blood-thinner drug called Xarelto. Some estimate Xarelto's long-term sales at $6.8 billion. This could be a big attraction as many drug companies will lose patents on key drugs in 2012.

Ian Ormiston, director of European equities for Ignis Capital in London, told that any possible deal would probably see Pfizer Inc. (NYSE: PFE) buy Bayer for a premium to the its $37 billion market cap, and arrange side-deals to sell Bayer's non-core businesses.

Bayer's crop-protection business alone could fetch as much as $10 billion, Ormiston said.

Tech deals are (of course) likely - spurred by September's news that Dell Inc. (Nasdaq: DELL) was to buy Perot Systems Corp. (NYSE: PER) for $3.9 billion in cash. Dell is still on the tipster's list as the acquirer of wireless-device-maker Palm Inc. (Nasdaq: PALM), but it is perhaps more likely that industry heavyweight Nokia Corp. (NYSE ADR: NOK) steps in.

Where tech blends into high finance, E*Trade Financial Corp. (Nasdaq: ETFC), the on-line brokerage firm, has long been mentioned as a takeover target. And Basenese, the Takeover Trader editor and M&A maven, thinks that the time is now for all that talk to become reality. He names TD Ameritrade Holding Corp. (Nasdaq: AMTD) and The Charles Schwab Corp. (Nasdaq: SCHW) as likely acquirers.

Big players may not be big acquirers in this market. For instance, don't expect any M&A bombshells from Internet-search giant Google Inc. (Nasdaq: GOOG): The world's largest search-engine operator is expecting to make about an acquisition a month - but all of them small, Chief Executive Officer Eric E. Schmidt said last week.

When there's word of the next wealth-creating deal, some traders and investors will doubtless get the news by way of Twitter, and that brings up another subject of intense speculation. Some see Twitter Inc., now cash-heavy, as a target for a Microsoft Corp. (Nasdaq: MSFT) buyout, though the privately held Twitter just raised $100 million in its latest round of financing.

[Editor's Note: For a sidebar to this story that addresses the strength that brand names will play in dealmaking, please click here. For a related Money Morning news story that details the merger-and-acquisition deals yesterday (Monday), please click here. For more information on Louis Basenese's service, The Takeover Trader, please click here.]

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