M&A Is Back—And May Bring Big Opportunities for Investors

After missing in action for much of this year's stock rally, mergers and acquisitions are making a big comeback.

A New York Stock Exchange trader.
Oliver Quillia for CNBC.com
A New York Stock Exchange trader.

On Monday alone, Xerox announced plans tobuy Affiliated Computer Servicesin a deal valued at $6.4 billion. And Abbott Laboratories agreed to buy the drugs unit of Belgian conglomerate Solvay for $6.6 billion in cash.

Kraft also is reportedly poised to launch a hostile bid for Cadbury valuing the British confectionery business at around 11 billion pounds ($17.6 billion).

On top of that, Disney agreed earlier this month to buy Marvel and eBay is moving ahead with plans to sell a majority stake in its Skype unit.

Stocks opened sharply higher Monday as investors cheered the growing wave of M&A activity.

"It reflects an improvement in investor psychology," says Curt Lyman, managing director at HighTower Advisors in Palm Beach, Fla. "For investors, it gives them hope that the world is not coming to an end, businesses are still in business to make money."

As strong sentiment persists that the market is due for a substantial correction following its six-month rally, the resurgence in M&A activity could counter that trend and help the rally continue.

As for specific M&A deals, analysts see energy as a sector most likely to benefit, while materials, consumer staples and health care also could be active.

The key will be value, with acquirers trying to find companies whose shares remain beaten down from the bear market that destroyed 50 percent of Wall Street's worth from October 2007 until March 2009.

"This is an extraordinary opportunity for combinations of businesses at prices that make sense," says Peter J. Tanous, president and director at Lynx Investment Advisory in Washington, D.C. "There was a period of time when acquisitions were based on exuberance, but the numbers didn't quite work. The numbers work a lot better now. I think we're going to see a lot more M&A activity and this time it's going to be a lot better thought-out and more sensible."

Another factor that could spur M&A is the market's performance since reaching the March lows.

Stocks have regained half those losses, and buyers looking to snap up smaller companies will be compelled to do so in case the market continues to rise, Tanous says.

"I have never seen such unanimity of opinion among professional investment people that we are going to have a major correction," he says. "The rationale for that is very compelling, but I am concerned that everybody expects it and that usually is a contrarian bullish sign."

As economists continue to see the US recession coming to an end that would further stimulate buyouts, particularly of companies not sensitive to the buying power of US consumers, who are likely to continue to face difficult times until unemployment subsides.

"Companies are looking forward and beginning to pull in some of their missing links," says Peter Cardillo, chief economist at Avalon Partners in New York. "The more consolidation and more mergers we see suggests that corporate America is certainly much more enthused about the global economic rebound as opposed to consumers."

To be sure, investors looking to time M&A activity and buy companies that appear to be in line for such moves are playing a dangerous game. But market experts say there are flags for companies that seem ripe on both sides of the equation.

The simplest view is to find companies with strong assets and low debt against companies laden with leverage and not much access to credit markets.

"It's fair to say that the strong probably stay status quo," Lyman says. "But those companies with weak balance sheets heavily reliant on leverage and credit and difficulty obtaining that are now weakened. It's a perfect opportunity for companies to exercise financial Darwinism. It's survival of the fittest."

"I would never recommend to a retail investor as a matter of strategy to try and play it, because you'll lose," Tanous adds. "But the way to improve your odds is to buy beaten-down stocks that have value primarily in terms of undervalued assets. That's the typical value-investor thesis."

For those who are fortunate enough to get in on a deal, the rule of thumb is that short-term investors benefit from owning the acquiree, while long-term investors will want to own acquirers.

"Investors in companies that are taken over will do well," Tanous says. "But I do not expect lush premiums. I think those days are probably behind us, and the effects of the M&A activity will be much more focused on the synergy of the combined company rather than on a huge premium to the acquired company."

Besides, if the trend holds up then those holding a broad market focus could be biggest beneficiaries of all.

"For this (rally) to have legs you're going to have to have some M&A," says Uri Landesman, head of global growth strategist at ING Investment Management in New York. "I don't think this level would be substantiated without it. If we're going to see a much higher market, M&A is going to have to be a part."