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Where There’s Smoke, There’s Fire

Where there’s smoke, there’s fire: On Feb. 13, the British Times reported that BHP Billiton and Rio Tinto were eyeing Alcoa. On Feb. 26, there was a story in a British paper speculating that Dow Chemical could be a private-equity target – and the offer would make it the biggest ever.

There was a lot of smoke in these two stories. It was like these potential takeovers were practically etched in stone. And there’s no question that both Alcoa and Dow are takeover targets. But are they worth speculating on? Yes, because they fit the Mad Money criteria for takeover speculation: the fundamentals are good.

Apparently, BHP Billiton and Rio Tinto each separately consider Alcoa a good target, but neither has approached the company’s board yet. Estimates put the valuation at $40 billion, and the deal makes sense both because they’re in aluminum – Alcoa’s business – and they could use the extra smelting capacity. The bids would put a price of about $40.86 on Alcoa, way up from the $33 and change where it is now.

As for the fundamentals, aluminum has been a real dog, mostly because the Chinese expanded their capacity and became net exporters. But that trend will probably reverse as demand catches up with supply and China controls the expansion of its aluminum smelting capacity. That would turn China into an importer again, raise aluminum prices, and make Alcoa’s shareholders very happy.

The Dow Chemical rumor involves KKR, Blackstone and Carlyle – the big boys in private equity. The speculation is that they might take the company out for as much as $60 a share. That’s almost 17 points up, or 39%, from where it is now at $43 and change.

On top of all this, the chemical stocks are seeing better pricing and bigger margins, especially on polyethylene, where price increases are just starting to take hold. At the same time, there were dramatic declines in the price of feedstock back in January – they're lowering their own costs and raising price – it's the best of both worlds. The stock's got a 3.5% yield, which gives you a great cushion in case the buyout doesn't happen. And if management tries to fight the takeover, a great analyst over at Merrill Lynch said they'd probably raise the dividend, buyback more shares or sell their AgroSciences business – all things that would take the stock higher. Dow has pulled back over 9.1% from its intraday high on Feb. 26, so you're getting a great deal here, too.

Bottom Line: Where there’s smoke, there’s fire. Believe the rumors and make Alcoa and Dow Chemical your speculative plays.

Questions? Comments? madmoney@cnbc.com

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