In [yesterday] morningâ€™s Wall Street Daily column, I shared an attractive takeover target for investors to consider. But it doesnâ€™t make sense for conservative, income-oriented investors to chase after these returns. Not when thereâ€™s a way to profit from takeovers in a much more reliable and safe manner.
Iâ€™m referring to the strategy known as merger arbitrage, whereby we wait until after a takeover announcement is made.
In fact, itâ€™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 remindersâ€¦
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 itâ€™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 companyâ€¦ and wait. When the takeover closes, the cash equivalent to the full offer price appears in our account. And weâ€™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 thereâ€™s a credible concern about the takeover being completed.
Take energy company, Venoco (NYSE: VQ), for instance. Itâ€™s trading about 15% below the $12.50 per share offered by the companyâ€™s CEO, Timothy Marquez.
Itâ€™s not a fluke, though. Doubts remain whether or not the CEO can secure the financing to close the deal. And when deals donâ€™t close, we donâ€™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, letâ€™s move on to two merger arbitrage opportunities worth your considerationâ€¦
Two Ways to Pocket An Extra 6% (or More) Before Yearâ€™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 companyâ€™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 thatâ€™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 Indiaâ€™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 worldâ€™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, Iâ€™ll be in touch with more compelling opportunities as they materialize.
Source: Dividends and Income Daily