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Merger mania adds twist to stock-picking

March 2005

Merger mania adds twist to stock-pricing

By Andrew Leckey
Tribune Media Services columnist
March 6, 2005

A story about legendary mutual fund manager Peter Lynch tells how he shrewdly and profitably invested in the stock of Hanes Corp. after his wife praised its L'eggs pantyhose sold in grocery stores.

In the 15 years since Lynch stepped down as Magellan Fund manager, however, there has been such a rush of mergers that it's increasingly difficult to tell who owns what. We live in a nation of increasingly bigger corporate fish swallowing other fish--such as Hanes' purchase in 1979 by the predecessor of Sara Lee Corp.

If, for example, you've managed to keep telecom companies straight amid their 2005 merger mania, good for you. There's been SBC Communications Inc.'s proposed acquisition of AT&T Corp., the Verizon Communications deal for MCI Inc. that was contested by Qwest Communications International Inc., and Alltel Corp.'s agreement to buy Western Wireless Corp.

There is relentless talk of synergy, such as the ability of Procter & Gamble Co. to market the products of its proposed acquisition Gillette Co. Or MetLife Inc. selling insurance more efficiently thanks to its planned purchase of Travelers Life & Annuity Co.

Yet synergy to many buyers simply means the ability to fire lots of employees whose responsibilities overlap.

Merger deals too often are about empire building, rather than intelligently expanding product lines. The corporate culture and products of two firms may fit awkwardly, as in the Hewlett-Packard Co. and Compaq Computer Corp. merger or the America Online Inc. and Time Warner Inc. combination. When cultures and products are compatible it can work, as with merged oil giants ChevronTexaco Corp. or ConocoPhillips.

Keep potential merger industries and targets in mind this year because the deals may continue to go down hot and heavy. Individual investors make money by owning shares of the acquired company in the deal, not those of the buyer. Shares of the buyer may decline in value, because not everybody's sure the deal is worth its cost.

Specialty retailers, department stores, airlines, banks, pharmaceutical firms and energy companies are all considered fair game.

This stage was set by factors such as consolidating industries, a strong economy, confident CEOs, hostile intentions, cheap financing, cash and reasonable deal prices.

"The merger and acquisition activity now going on is an indication that corporate purse strings are loosening," observed John Caldwell, chief investment strategist with McDonald Financial Group in Cleveland. "Companies of the Standard & Poor's 500 are sitting on $750 billion in cash, which gives them the wherewithal to make deals that have cash components."

A portfolio of companies with solid fundamentals is "the cake," said Caldwell, while "the frosting" is when some are taken out in generous acquisition deals.

Among companies that may be acquisition candidates, Caldwell likes the stock of Inc. (PCLN) because its unique online travel niche features earnings growing at a 25 percent annual clip, and FirstMerit Corp. (FMER), an Akron, Ohio, firm whose quality financial-services franchise could be useful to a firm looking to enter its northeastern Ohio market.

"Companies have been rewarding shareholders with dividend hikes and share repurchases, but now that they've seen all these mergers, animal instincts kicked in," said Richard Cripps, chief market strategist with Legg Mason Wood Walker in Baltimore. "Consolidation makes sense financially if one company thinks another is undervalued and it is likely to make money on the deal, or strategically if the company being acquired fits in with the buyer's long-term plans."

Attractive financial-services firms that might be acquisition candidates, Cripps believes, include Regions Financial Corp. (RF) in Birmingham, Ala., with 1,400 branches in 15 states; SunTrust Banks Inc. (STI) in Atlanta, with 1,201 branches in five states and the District of Columbia; and Compass Bancshares Inc. (CBSS) also in Birmingham, with 375 branches in six states.

In pharmaceuticals, some acquisition targets could be Watson Pharmaceuticals Inc. (WPI) and Forest Laboratories Inc. (FRX), both of which are successful at selling brand-name and generic drugs, he said.

"Favorable economic and regulatory environments, positive buyer psychology and the seller's expectation of a decent price will drive an increase in merger activity," explained Ken Marlin, managing partner and founder of Marlin & Associates in New York. "We focus on smaller $50 million to $500 million deals, and in that segment we currently see a lot of strength."

His rule of thumb is that the top three companies in an industry are acquirers, while the next three down are often those acquired.

Whatever deals actually go down this year depends on stock valuations and the inner workings of the CEO mind.

Both have proven somewhat unpredictable, so try to own a good stock in the first place so that it will hold up whether merged or not.


Andrew Leckey is a Tribune Media Services columnist.

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