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Three Simple Steps To Predicting Takeover Targets

 May 30, 2011 02:58 PM

Global merger and acquisitions activity volume just surpassed the $1 trillion mark.

Not only that, the market has hit that milestone six weeks earlier than it did last year.

Why should we care?

I'll let National Semiconductor Corp. (NYSE: NSM) do the talking for me.

On April 4, Texas Instruments (NYSE: TXN) announced it was buying National Semiconductor for $25 a share – a 75% premium to the share price at the time. And look what happened…
Since nobody invests for sport, the reason to care about an uptick in mergers and acquisitions activity is easy: greed.

[Related -T-Mobile US Inc (NYSE:TMUS): AT&T Inc.(NYSE:T) Could Suffer In Wireless War]

We're in the market to make money, pure and simple – and nothing jolts a stock higher than an unsolicited takeover offer.

So far this year, the average takeover premium paid checks in at a solid 23%. But it's not uncommon for individual premiums to total 50%, 60%, or even 75%, like with National Semiconductor.

And I'm sure you wouldn't argue with single-day returns like that.

The tricky part, of course, is knowing how to identify takeover targets before a deal is announced.

[Related -Yahoo! Inc. (NASDAQ:YHOO): What Will Drive Future Revenue For Yahoo!?]

Tricky… but not impossible. And we can dramatically improve our odds of success by following three simple steps…

A Three-Pronged Approach to Predicting Takeovers

1. Consolidation is Your Friend:
Consolidation trends are a powerful predictive tool because they tend to persist.

Think about it. When your biggest competitor buys a rival firm and doubles in size overnight, there's only one way to respond: Find a suitable acquisition of your own to remain competitive. Thus, by focusing on those industries and sectors undergoing the most rapid consolidation, we can isolate high probability targets.

2. Focus on Companies With Valuable (and Undervalued) Assets:
Whether it's a new drug, a mammoth oil discovery, key market share, distribution channels, or a few promising patents, the real reason a company is acquired is because it owns a particular asset (or assets) of value to the acquirer. So it stands to reason that we should only invest in companies with such "must-have" assets.

3. Insist on Improving Fundamentals:
Takeovers take time. In fact, a buyer might spend as much as nine months conducting due diligence on a takeover target. Even then, there's nothing stopping them from walking away from a deal (Microsoft and Yahoo! ring a bell?).

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