Now, that is a real surprise.

WSJ reported today in a feature on M & A that an independent study (by someone from academia) has found that the top people at companies about to be sold were willing to settle for a lower buyout premium (i.e a worse deal for shareholders) in exchange for sweetened personal payouts/option grants and lifelong pensions.

While it is hard to grudge the windfall for someone who has turned around a Gilette or smartly grew Guidant, in most cases loyal shareholders just got the equivalent of a middle finger!

Give them an inch and they go crazy.

It is just amazing how human emotions, as seen through investing/economic articles, swing from one extreme to another. Just 3 weeks ago a number of columnists were crying wolf (or is it bear!).

A week of heightened M & A, and these same people are bringing out the bull****! After all the manic pieces in the last 2 days on the coming M&A boom, I hope they are let down. I have still a year or more of accumulation to do and I want them cheap:-)!

Hit #31

I have already written enough about it, so this will be short. AT&T (T) is being acquired by SBC for $16 billion, in a stock and cash (in the form of a tax-free one-time dividend) deal. At around $19.7/share this is a 20% premium over my average cost of $16.4/share.

This one probably is a hit for practically anyone who ever bought shares given that AT&T is so widely-held. But the real question is whether the transaction is profitable i.e did you buy it at a reasonable price ?

I will be holding onto my SBC shares that I get as part of this deal. The current valuation and yield are very attractive.

The Rockies are still active.

No, I am not talking about seismic activity here! This is a follow up to a couple of earlier posts on M&A among the oil/gas majors in the Rockies.

Just last week, Magnum Hunter was acquired by Cimarex at a healthy premium.

Among the public offerings in the last few months were 2 Colorado based oil/gas explorers/drillers - Bill Barrett (BBG) and Warren Resources (WRES). I bought a few shares of WRES recently since they looked attractive though a near-term buyout is unlikely here.

I missed one company in my earlier posts - Delta Petroleum (DPTR).
This looks fairly valued now and worth adding.

Ma Bell to be adopted!

No surprise to anyone following the sector, but SBC's reported bid to buy AT&T (T) is a symbolic undoing of the '84 breakup forced by trust-busters. The big crunch theory on how the universe will end may be real after all!

I have been a AT&T buyer in the last few months, especially after the yield crossed the mouth-watering threshold recently. It has been a takeover target all along, which was my initial reason for buying. At its recent closing of $19.7/share, it is now 22% above my average cost of $16.4/share. The final offer may be in the mid-twenties.

While Verizon sat on the sidelines during the Sprint/Nextel merger, it now has a chance to respond, by either outbidding SBC or going after the only other business-customer heavy player, MCI (MCIP). I own a few of MCI, added as a buyout and dividend play.

A few other mergers will happen in the next couple of years. A SBC - BellSouth combination has been talked about a few times in the past; they already jointly own Cingular wireless.

Someone will go after the remaining smaller/rural players like Qwest (Q), Rural Cellular (RCCC), Talk America (TALK), Dobson Cellular (DCEL) and Centennial Communications (CYCL). I own a few of Qwest, and waiting for a good pullback on the others.

Instinet up for sale ?

Reports indicate that Instinet (INGP) may be acquired by Archipelago (AX). While I am not marking this as a hit, I bought and sold (at a price higher than the current value, even after the runup following the rumors) Instinet shares after a sharp short-term spike earlier last year.

This is just the beginning of electronic markets / exchanges. If you are willing to buy and hold for a decade buy into stocks of all the players that have been going public lately - Archipelago (AX), MarketAccess (MKTX), Arbinet (ARB), Espeed (ESPD), Nasdaq (NDAQ), OptionsXpress (OPXS) (to go public in a week or so ).

The middlemen have been allowed to go on for too long in this business, adding to costs and leading to inefficient execution, not to mention all the possibilities that human-intervention brings along with it. The major specialist firms, Labranche (LAB) and Van Der Moolen (VDM), are the losers in the long term, but both do represent value plays in the short term and will likely be looking to sell themselves soon.

I own Archipelago and Labranche stock.

Digital River buying ?

Digital River (DRIV) announced last week that it is raising around $200 million. This will end up being used for a buyout soon. Who is likely to be the target ?

Assuming that the target is a public company and a decent premium will be paid, I think Zomax (ZOMX) makes for a good fit. It complements Digital River's electronic delivery with the regular shrink-wrap delivery method which will take a while to disappear completely.(I own a few shares of Zomax).

Other possible targets include Aladdin Knowledge Systems (ALDN) for enhanced license/copyright protection solutions, Programmer's Paradise (PROG), Tucows (TCOW).

Digital River may also go after its smaller competitor, Intraware (ITRA), though I am hoping that is not the case! Intraware is among my largest holdings, and even if it receives a substantial premium from today's price, I will barely break even. I would rather have Intraware grow slowly over the next 3-5 years and take on Digital River.

Defence targets - Part II

I left out a few areas in my earlier post. (As before, entries marked with * are companies in which I own stock ).

• Defence/government IT service providers: the 2 most interesting players here are Mantech International (MANT) * and Anteon (ANT).
  
  Mantech falls into the category of when, not if buyouts. I bought into a pullback resulting from an earnings miss. I still rate it a buy.
  
  There are literally hundreds of smaller players, some of which are public. I will attempt a later post focused on this sector.
  
  
• Border patrol and related services: Borderless world ? Dream on! If anything, borders are getting more sophisticated everyday.
  
  Having the best possible experience in this field, Elbit Systems (ESLT), is a great target. This Israeli company handles all the borders at home, as well as borders like India/Pakistan. With that kind of experience, there is really no competition. I have been watching this company for a while, but haven't yet found a good entry point.
  

A company I mentioned in my earlier post was Acxiom (ACXM), which probably knows more about you and your routine than anyone else. IBM, just last week, announced that it is acquiring Las Vegas based Systems Research and Development Inc which similarly helps track / find relationships among people/activities. SRD was partly funded by In-Q-Tel, the CIA-backed VC.

Convera (CNVR), one of the firms that I mentioned in a very early post on search, is also an In-Q-Tel backed company in the classification/relationship discovery field. I own a few shares of Convera.

Insightful (IFUL) is another interesting player to watch in this field.

Coming mergers in the defense/security sector.

Now that the expected defence budget cuts have started (finally, all that pork!), expect established defence biggies like Lockheed Martin (LMT), General Dynamics (GD), Textron (TXT), Northrop Grumman (NOC), United Defense (UDI) to start going after smaller/smarter companies catering to the new post-9/11,post-Iraq security needs.

I hope to make a longer, detailed post later on this topic, but here is a short list of targets (the ones I own have a * next to them).

• Titan (TTN) *: Expect this defense contractor (along with others) to get bids soon. Some, including Titan have been tarnished following the abuses in Iraq and the investigations that followed. In the worst case, these will get taken out by some private equity player like Carlyle Group and enter the cozy world of Pentagon/lawmakers/lobbyists/directors, away from the public gaze. Titan had an offer earlier from Lockheed, but it has been put on hold pending completion of investigation into Titan's practices.
  
• Raytheon (RTN) *: There were rumors earlier about General Dynamics being interested. I think this will happen this year.
  
• Cogent (COGT), Identix (IDNX) *, Viisage (VISG) : Have you been fingerprinted / photographed / retina imaged recently on re-entry to the US ? (I was!). Chances are that one of these 3 had something to do with the software/hardware/processing system behind the setup.
  
• Ceradyne (CRDN) *, Lakeland (LAKE), Armor Holdings (AH), DHB Industries (DHB) : Iraq has shown that the US forces are really not prepared for urban warfare, which will likely be the most common form of battle in the future. These companies have the next generation of small/smart armored vehicles / protective clothing made with new ceramic materials.
  
• Accenture (ACN) *, Bearing Point (BE) *: These are getting to implement some of the larger software projects to warehouse and process info about visitors to the US.
  
• CompuDyne (CDCY) : Niche players like this maker of (among other things) bullet/blast-proof doors for US embassies around the world will make for good targets.
  
• Taser (TASR) : Now that day-traders/momentum-chasers have ditched this stock, expect someone like Lockheed to make a move. The cozy/almost-incestous world in which these defence players live in was demostrated recently when it was revealed that Bernard Kerik, Homeland Security Secretary elect, had made a few million as a director at Taser! Expect Taser use to spread from police departments to the armed forces.
  
• Cornell (CRN), Geo Group (GGI) (formerly Wackenhut): As the country lurches towards the right, expect more states to follow progressive! California's recently announced lead in cutting benefits to elderly/low-income sections/teachers etc and building more prisons and putting more people behind bars! That should help these correctional service providers.
  
• Engineered Support Systems (EASI), Innovative Solutions and Support (ISSC) : Specialty military equipment.
  
• Hollis-Eden Pharmaceuticals (HEPH) *, BioSante Pharmaceuticals (BPA) : Bio/nuclear protection/shield.
  
• Acxiom (ACXM) *, Digimarc (DMRC) * : Background checks, Identification cards. Acxiom was among the first companies contacted by the various investigative agencies to trace back the activities of the 9/11 hijackers.
  
• Ipix (IPIX), Lojack (LOJN) * : Companies that were not doing anything with security earlier, but are now trying to get a piece of the pie.
  
• OSI Systems (OSIS), American Science & Engineering (ASIE) : cargo inspection / x-ray systems. The biggest player in this sector, Invision Technologies was acquired by GE last year, after a spectacular runup from around $2/share before 9/11 to a final price of $50!

Most of these are expensive right now, since most of the good news, whether as increased orders or as takeover targets, is priced in. But individual players suffer setbacks occasionally on contract losses/cancellations or earnings misses and that should provide for a good entry point.

If investing in these companies makes you squirm, I suggest redirecting your profits to ACLU or the Sierra Club - seriously!

As for the suggestion that investing in these companies is the same as funding them, well, guess where your tax dollars are going!

Hollywood - a happy ending ?

Hollywood Video (HLYW) has got a definite/higher offer of $13.25/share from Movie Gallery (MOVI). The market still expects a better offer (from Blockbuster ?) and Hollywood shares are trading at $14.2!

With my average cost for Hollywood shares at $13.8/share, any offer above that will make me happy - another profitable takeover!

What next ? It looks like Blockbuster is determined to kill Netflix by using its own deep pockets. Netflix (NFLX)'s only option is to branch out to real technology like delivering movies online, where it has made a move by partnering with Tivo. A 3-way merger/strong-partnership among Netflix (NFLX), Tivo (TIVO) and Real Networks (RNWK) is something these should target.

Netflix (NFLX) stock is attractive after the recent battering. A few buyers out there must be eyeing Netflix now. These include Amazon, Time Warner's AOL and Interactive Corp.. While Netflix CEO, in past interviews, had ruled out selling the company I definitely think he is considering offers seriously!

What will Blockbuster and Movie Gallery target next ? I think they will attempt to get into games more aggressively, possibly buying out Gamestop (GME) or Electronics Boutique (ELBO). Gamestop is attractive at its current price. I own a few of Electronics Boutique, and looking to add a few of Gamestop soon.

Leverage, cheap credit and the punch bowl

Now that the Fed has made it clear that it is taking away the punch bowl, it is time for me to write on a topic I have been planning on writing for a while now - leverage.

Following the market bust of 2000 and the 9/11 tragedy, the Fed reduced interest rates to historic lows. Soon after that, various credit cards started offering some unbelievable balance transfers / cash advance offers. I spent a couple of months making sure that there were no fine-prints designed to fleece me later on - and then I jumped in.

Over the last 2 - 2.5 years, I have borrowed over 150K from various credit cards and invested in companies that are potential takeover targets and have recently been hit by bad news or warnings. Most of the borrowing was at 0%, with a very low one-time transaction fee and in some cases, no fees at all. If the rate was fixed and was a sufficiently long term offering, I borrowed at 1.9%, 2.9% and most recently at 3.7%. With each borrowing I made sure that the effective rate was less than the fed rate + inflation.

There may not be such a thing as a free lunch, but this one came very close to the real deal, especially if you had a near-certain forward income stream to borrow against. With each borrowing, I made an estimate of the monthly payment and the total time needed to pay off the entire amount.

Now that the punch bowl is going away, these offers have almost completely disappeared. I have paid off 80% of my borrowing and will be done with the rest soon. I used this to fund only my takeover speculation, and did not route it to fund short-term or day trades. That would have been very risky and would not have given the peace of mind I needed.

The most generous offers were from MBNA, Fleet (now Bank Of America) and Household Bank - a big Thank You to you guys. MBNA (KRB) itself is among my takeover bets! Discover was among the stingiest cards.

With some of these the offers were so simple, you could have reaped a profit by just borrowing and putting all that money in a 1-year CD! Or, if you were ok with a slightly higher risk, you could have gone after dividend yielding stocks that were battered by the downturn.

For the first year or so, I hesitated to recommend this technique to others. I did try later on to get a few friends to do the same, but couldn't convince anyone.

It could be a few decades before such a free lunch becomes available again. But as the minutes of the December Fed meeting indicated, the rates are going up for the foreseeable future. In fact, among the clues cited in the minutes as evidence that credit has become too cheap, is the recent increase in M & A activity. Now, we have really come one full circle!

Profiting from M&A advisors.

Apart from guessing takeover targets, buying into the stock of M & A advisors also provides a way of profiting from a buyout boom. The latter strategy is less risky given the solid financials of these Wall Street majors, but correspondingly promises a smaller return since most of them are already fairly valued by the market.

Here are the players :

• Goldman Sachs (GS)
  
• Morgan Stanley (MWD)
  Goldman Sachs is the leader and should see substantial pickup in fees from deals in the coming years. Morgan Stanley could see an additional upside from divesting some of its businesses. Both pay a small dividend, but I think they will follow others in announcing increased payouts soon.
  
  
• JP Morgan (JPM)
  These guys participate in M&A more directly as well, through their private equity arm. The dividend is rich and the stock itself is not overvalued.
  
  
• Bear Stearns Co. (BSC)
  
• Merrill Lynch (MER)
  These 2 M & A advisors have an additional upside in that they are themselves potential takeover targets for the likes of Citigroup and Deutsche Bank - hopefully at a decent premium. The dividend yield right now is ~1%, but an increase in payouts is very possible too.
  
  I own a very small number of shares of both and will be watching for more buying opportunities.
  
  
• Citigroup (C)
  Its M & A business is really negligible and any increase in activity is unlikely to make a difference to Citigroup's overall earnings. While the dividend is rich, there could be more skeletons in the scandals cupboard here. Still, if you don't mind holding onto the stock for 5/7 years, it is a buy right now.
  There will be additional downside pressure on the stock if Citigroup, as rumored repeatedly, tries to enter/expand into the mortgage, west coast banking or investment banking sectors via a costly acquisition.
  
  
• Greenhill & Co (GHL)
  This newly public company is another good bet. I own a few shares, and plan to buy more slowly.
  
  

What should HP do ?

HP (HPQ) revealed recently that they had seriously considered spinning off their printer business, 3 times!. What a waste of time!

HP seems to have completely lost its direction, trying to do everything, from consumer electronics to utiliy computing, but not doing anything well enough.

HP, like IBM should get out of the PC business - sell it to Lenovo's competitor! While the Compaq buyout was not disastrous, it didn't really benefit HP in a big way.

Competing with IBM head-on in the IT services area will be a good start. One way to jumpstart this would be to buy an existing player like Bearing Point (BE) or Keane (KEA) or Accenture (ACN), of which Bearing Point seems to a good-sized fit. HP is definitely moving in this area, having recently bought smaller European services companies, but the pace is snail-like.

Over the last couple of years, HP started touting its Utility Computing idea, but has scaled it down substantially recently after not being able to show any worthwhile implementation/strategy, with some observers calling it futility computing. While the goal is lofty, HP has the brains and the muscle to help companies achieve something close to the real utility computing ideal. With OpenView extensions and a couple of small buyouts last year, HP made smart initial moves, but it should now take a big leap, by buying out larger companies that could help meet the utility computing dream. HP should buy one or all of these players - Veritas (VRTS), Opsware (OPSW), Altiris (ATRS). With the obvious shareholder disappointment displayed towards the Symantec/Veritas merger proposal, HP has a good chance of winning in a bidding game.

Other possible areas include another attempt to enter the application server sector, either buying out BEA (BEAS) or ATG (ARTG) and a more serious open-source initiative by outright acquisition of Red Hat (RHAT) before somebody else goes at it.

And ofcourse, HP should spin off the printer business! While at it, it should also combine it with Xerox (XRX)'s printer business.

If HP has no plans for large acquisitions, then it should atleast announce a one-time dividend payout to disburse its cash. That will keep me satisfied for a while.

Consumers' rating of mergers

Another formal study has shown that mergers don't really mean better days ahead for customers. The study says that more than 50% of customers are dissatisfied with their service providers 2 years after a merger.

I can vouch for that - a few months into the AT&T Wireless and Cingular merger, my cellphone repeatedly switches between the 2 providers as they find ways to integrate their networks. But it gets worse - at times the cell enters into blind spots with no coverage - surely a result of the merger!

Companies still don't seem to do enough to think about and work on integration problems ahead of a merger. The synergies and cost savings that are talked about are not realized fully.

One of my early posts was on a frustrating experience at Fedex after its purchase of Kinko's. I am now prepared for worse!

More on retail ...

I wrote a bit about the retail sector in an earlier post on private equity.

Full disclosure : I am just nibbling at this sector, since I see 2 potential shocks that could make even the current valuation look extremely expensive:

• A fall in consumer confidence. The warning noises about consumer confidence have fallen silent lately, and that is worrying. Given the ever-increasing share of consumer in every sector's spending, a drop in confidence will be painful to retail. While the measured pace of interest rate hikes has so far been uneventful, combined with a fall in home prices (and the accompanying loss of the wealth effect) it could spell disaster for the entire retail sector.
  
• Overbuilding. Drive anywhere in Southern California and you feel that there is a new form of land grab out there, with every retailer mindlessly building around every new cluster of homes. Is there really a market for all of them ? I don't think so. If confidence turns south even a little bit, these places will have utility bills higher than their sales!