Editor’s Note: We’re always searching for ways to help you safely achieve a dignified retirement. And one of them is to use a little-known hedge-fund strategy called “merger arbitrage.”
Now, if you’re like most people, you probably don’t think the words “hedge fund” and “safe” belong in the same sentence. That’s why I contacted William Mikula, chief analyst for PBRG guru Teeka Tiwari’s Alpha Edge newsletter.
William has spent years developing a safer version of this strategy for average investors. And today, he tells me how you can use it to build your own nest egg…
Editor: Hi, William. Around the office, you’re known as our “stealth income weapon” because you’ve been quietly helping subscribers generate income for nearly six years now.
And you’ve been on a roll lately… What’s your track record?
William: As of today, my current win streak is 105 trades in a row, stretching back to January 2016.
And I’m pleased to say that since I began recommending trades for PBRG, we’ve closed 284 out of 292 for a profit. So we’re batting at a little over 97% at this point.
Editor: No wonder Teeka chose you to head up his Alpha Edgenewsletter. He often tells me if he were still running a hedge fund, he’d snap you up in a minute. That’s high praise coming from him.
So let’s get to today’s topic: merger arbitrage. What’s it all about?
William: First, thanks for the kind words. I love working with Big T. We share the same passion for helping ordinary investors. And we’re thrilled with our results.
Now, on to merger arbitrage…
I know you’re familiar with the iconic film, Wall Street. It’s one of my favorite movies.
And there’s an infamous line in the movie that goes, “Blue Horseshoe loves Anacott Steel.”
In the film, corporate raider Gordon Gekko—played by Michael Douglas—wanted to leak word that he had a company in his crosshairs as a potential buyout candidate.
Blue Horseshoe was Gekko’s code name… and Anacott Steel was his target.
Within minutes of the leak, the company started trading higher as investors snapped up shares. Gekko made a fortune.
But if you’ve seen the movie, you know how it ends: Gekko ultimately gets busted for insider trading.
Merger arbitrage works sort of like that—but legally. And the good news is ordinary investors can enjoy large returns from these types of corporate buyouts.
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Editor: How so?
William: For decades, Wall Street has used merger and acquisition [M&A] announcements to rake in billions in profits.
But you don’t need to be a rich insider like Gekko to take advantage of these opportunities.
Merger arbitrage is a simple—yet highly profitable—strategy to profit from M&A activity.
Basically, hedge funds will target a company that has received a buyout offer.
Typically, its shares trade below the offer price. And hedge funds know the price of the shares will go up by the time the deal is complete.
So they’ll buy shares in the company before the merger deal happens. That way, the fund earns the difference between the company’s trading price and the offer price.
Let me give you an example…
Say you see a book at a garage sale in Kansas for $40. And a collector at a New York bookstore is offering $50 for that same book.
You can buy the book from the garage sale for $40… sell it to the collector for $50… and pocket the $10 difference.
That’s how arbitrage works.
Editor: Are there any other ways to profit from M&A activity?
William: Yes. Another strategy we use is to look for buyout targets. They can deliver overnight gains of 20%, 30%, or even 50%-plus.
For instance, in December 2017,Hershey announced a $1.6 billion all-cash offer to buy snack maker Amplify. The buyout offer was a 71% premium to Amplify’s closing price the day before.
This means Amplify shareholders enjoyed a 71% overnight gain on the takeover announcement.
In January 2018,AIG struck a $5.56 billion all-cash deal to buy specialty insurance company Validus. The offer was a 46% premium to the closing price the day before.
So Validus shareholders locked in a 46% overnight gain.
And in July 2018,SuperValu shares rocketed 65% higher after a $2.9 billion buyout by rival grocer United Natural Foods.
Again, this translated into a 65% overnight gain for SuperValu shareholders.
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Editor: So what should our readers look for in a potential buyout target?
William: I look for companies that are growing sales, earnings, and free cash flow by double digits year after year.
They have plenty of cash in the bank and low debt levels… operate in profitable niches… and have dominant market positions that larger companies crave.
In short, I look for companies that big businesses would rather buy than compete with.
Editor: Do you think now is a good time to look for buyout targets?
William: I do. I think there will be plenty of M&A opportunities this year.
I actually have a chart I want to show of M&A activity. As you can see, merger activity remains strong and in an uptrend…
And not only are we seeing more merger activity—the returns are growing, too.
Here’s another chart I want to share of Hedge Fund Research’s Merger Arbitrage Index:
As you can see, the index is up over 200% since 1998—despite two 10%-plus corrections during the 1998 and 2008 market crashes.
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Editor: Do you have any particular companies on your M&A watch list?
William: Teeka and I have noticed strong buyout signals coming from the biotech/pharma space. Typically, we like all-cash deals since they’re clean and simple to follow.
I actually flew to Vancouver last week to do some “boots on the ground” research on a few companies we’ve been watching.
I don’t want to say too much yet; but if everything checks out, we’ll have a couple of brand-new M&A trades with double-digit profit potential for our Alpha Edge subscribers.
In the meantime, Daily readers could check out Nielsen Holdings [NLSN], Yelp [YELP], and Dollar Tree [DLTR].
But keep in mind, these aren’t official recommendations. They’re just solid companies with buyout talks swirling.
Editor: Thanks for your time, William.
William: You’re welcome.