M&A: No Play for Small Investors

The recent spate of mergers makes exciting headlines, but those making financial home runs on the deals are mostly heavy hitters

By Amey Stone

In the business world, few events are as exciting as the megadeal. Billions of dollars are exchanged, epic brand-name companies are suddenly poised to disappear, jubilant chief executives grin and slap each other on the back, and lots of people get rich.

Actually, scratch that last point. Only a few top executives, investment bankers, and lucky stock market speculators get rich. Academic research shows that the majority of big deals don't create any long-term shareholder value. And while plenty of arbitrageurs on Wall Street structure complex investing strategies around playing both sides of a merger, that's sophisticated stuff individuals best not attempt.

Barry Ritholtz, chief market strategist at Maxim Group, compares the average investor trying to profit from a merger with himself stepping onto the gridiron at the Super Bowl. "You'd need six different stretchers to carry me off the field," he says.


  Face it, even as merger mania ramps up with the announcement of Procter & Gamble (PG ) buying Gillette (G ), SBC Communications (SBC ) snapping up AT&T (T ), and MetLife (MET ) purchasing Travelers Life & Annuity from Citigroup (C ), the average investor has no smart way to get in the game. Here's why.

Big deals rarely generate long-term gains. Integrating two companies often takes longer than expected, yields fewer benefits, and causes more disruption than anticipated. "A merger is kind of like a marriage," says Pat Welch, an economics professor at Saint Louis University. "Some of them work better than others." And there's no way you can tell at the outset how they'll turn out, he adds.

Plus, if a company has a solid strategy for organic business growth, it won't need to go out and buy another company, observes Ritholtz. That's why the stocks of acquirers typically trade down on the announcement. P&G, for example, fell 3% the day the deal was announced. Michael Farr, president of investment firm Farr, Miller & Washington and a P&G shareholder, says he isn't excited about the deal. "It will take some work and time for all the benefits to show up, but I think patience will be rewarded."


  Another reason that little guys don't win in the M&A game is that by the time you've heard about the deal, it's too late to buy the target. The problem: Stocks react immediately to the news, climbing close to the deal price within minutes. The way average investors make money in a merger is by owning the stock of the outfit before it's acquired. If you don't already own it, you're not going to get in after the announcement.

What about buying companies next up to be acquired? It sounds good in theory, but the stocks of obvious targets get immediately bid up on the announcement as well. "At this point the professional investors have figured out all the angles," says Peter Cohan, an author and investment strategist in Marlborough, Mass.

It's easy to get caught up in acquisition mania. Mergers beget more mergers, whether they make sense or not. Even though the latest megamergers seem to be priced at reasonable levels, that won't last if a feeding frenzy develops. "Once the merger ball gets rolling, everyone else decides they need to do one," says Cohan. Egos get in the way, he says. "That's when prices get a little hysterical." As investors learned in the late 1990s, overpaying in a period of dealmaking fever can lead to getting badly burned.

Merger arbitrage works, but those strategies are best left to the pros. An arbitrageur makes money by shorting the stock of the acquirer and simultaneously buying the stock of the company being acquired, hoping to make some money when the deal actually closes. These aren't big bets, and they're low risk when done right.


  Unfortunately, they're hard to do right. "It's very difficult to do and is certainly not something individuals should try to do on their own," says Todd Trubey, a mutual-fund analyst at Morningstar. A few funds pursue merger-arbitrage strategies, but the best ones -- Merger Fund (MERFX ) and Arbitrage Fund (ARBFX ) -- are both closed to new investors.

"It's an interesting strategy that could be a small part of a portfolio, but there aren't any attractive funds out there right now," says Trubey. His overall take on mergers: "It's exciting, interesting news, but it's not something that individual investors need to act on or should act on."

The best news for investors about merger mania is that many pros believe it signals that chief executives have the confidence to invest in the future and that they see good value in the stocks of their competitors. "I see it as a very positive sign" for the broader market, says Farr. If you invest in stocks, you've already got a seat at the table. Just sit tight and enjoy the ride.

Stone is a senior writer at BusinessWeek Online and covers the markets as a Street Wise columnist

Edited by Beth Belton

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