On the surface, 2016 hasn't been much of a year for capital gains so far, but that doesn't tell the whole story. You see, while the big S&P 500 index is hovering around a 3% loss year-to-date, merger and acquisition deals (better known as M&A) have been heating up.
M&A activity is up 13.4% from this time last year, with more than $1.1 trillion in deal volumes in North America alone.
That's not surprising. With record cash on corporate balance sheets at the same time that interest rates are skittering along record lows, companies are trying to figure out a strategy to earn meaningful returns on those piles of cash. One big solution to that problem has been M&A activity. By buying other businesses, management gets to justify holding on to those record cash reserves. So big M&A deals have been getting more frequent -- and more lucrative for investors.
Here's the thing: Contrary to popular belief, you don't need to have a crystal ball and get in ahead of the next big acquisition announcement to profit from the M&A trend.
In fact, some of the biggest deals on Wall Street are currently pricing in hefty premiums for investors getting in right now.
Today, we'll take a closer look at five of them.
Up first is computer storage stock EMC (EMC) . EMC is one of the biggest companies in the enterprise computer storage business, and it's about to get bigger with its upcoming merger with privately held Dell. When the $67 billion buyout was announced back in October, it represented a 31% premium to EMC's closing price. Thing is, almost 12% of that premium is still left in shares right now.
Dell is set to pay EMC shareholders $24.05 per share in cash, plus tracking stock that's tied to the company's 80% stake in VMWare(VMW) - Get Report . That brings the deal's total value to $29.48 at current market prices, a meaningful premium to EMC's $26.35 closing price yesterday. Much of that risk premium has to do with the relatively complex structure of the deal; 2016's 13.5% decline in shares of VMWare and worries over Dell's financing have scared investors away from bidding EMC up to the full deal price.
The (unlikely) worst-case scenario is that Dell's bid for EMC falls through. In that situation, EMC shareholders are left with a tech giant that has 16% of its market capitalization paid for by net cash and investments on the books.
On the flip side, if the deal closes, EMC investors get to collect a nearly 12% premium over the next six months or so.
The energy sector hasn't won many friends in recent months, and that's playing into the 11.76% premium left in shares of pipeline giant Williams Cos.(WMB) - Get Report right now. Last fall, Williams agreed to be acquired by Energy Transfer Equity (ETE) in a then-$36 billion deal. A free fall in Energy Transfer's share price has more than halved that acquisition price tag, and it's actually leaving Williams with a bigger merger premium than shares had when the deal was initially announced.
Energy Transfer is paying the equivalent of $19.28 per share in a cash and stock deal. Despite the rout in energy infrastructure stocks, both companies are holding their line of wanting the deal to close -- which means that it may leapfrog the concerns investors are voicing and make the deal go through. The important wild card in the Williams/ETE deal is the rebound in the energy sector that's been happening for the last few weeks. Both stocks are up around 30% since mid-February, and a continued rally in share prices in 2016 greatly increases the likelihood that the deal gets done and that investors collect more than their 11.76% merger premium.
Obviously, buying Williams Cos. here isn't without risk. There's a good reason that other market participants are pricing a premium into this merger right now. That said, the underperformance of the energy sector is likely clouding the story. For investors who can stomach the risk, it's a merger arbitrage trade that's worth a closer look.
Healthcare giant Cigna(CI) - Get Report tips the scales as one of the largest managed care organizations in the U.S., boasting more than 14 million medical members. And Cigna also tips the scales as one of the biggest buyout targets right now, thanks to the firm's pending $50 billion purchase by Anthem(ANTM) - Get Report . Anthem's offer pays Cigna shareholders $103.40 per share in cash, plus 0.5152 shares of Anthem, for a combined value of $171.65.
That represents a huge 22.68% premium to Cigna's $139.92 closing price on Tuesday.
Regulatory risks are the black clouds that are scaring investors away from the marriage between Anthem and Cigna. While the combination makes a lot of sense from a business standpoint (it's estimated to produce $2 billion in cost savings, mostly from overhead), the chances that the deal won't clear antitrust regulations are resulting in the huge premium right now.
Like with EMC, the Cigna deal is a good example of a great opportunity if it closes -- and an otherwise attractive stock to hold if it doesn't. Cigna currently trades for just 17 times earnings right now, a substantial discount to most peers. Meanwhile, if Anthem is allowed to buy Cigna by year-end as planned, investors get to book a 22.68% return at current price levels.
Williams Cos. isn't the only energy sector M&A deal that's offering investors a double-digit premium right now. Another comes from the pending purchase of oilfield service stock Baker Hughes (BHI) by Halliburton(HAL) - Get Report . The Baker Hughes buyout is the biggest oilfield service provider acquisition in history, valued at $34 billion when the deal was announced. Halliburton will pay shareholders $19 in cash, plus 1.12 shares of Halliburton for every BHI share owned. That adds up to a $57.62 deal value at current price levels and a 30% merger premium.
Here again, weakness in the energy sector is to blame for the enormous differential between Baker Hughes' share price today and the price Halliburton is willing to pay this spring, when it's scheduled to close. Plummeting energy prices give both firms fewer options and hike the costs if the deal runs into any issues. For instance, while the firms have made it clear that they're willing to sell off assets if required by regulators, those sales are likely to be costly in this environment.
Even so, the sheer size of a deal like this at a time when nobody wants to own oilfield service stocks makes it worth a second look from a contrarian standpoint. The 31% merger arbitrage premium left in Baker Hughes' stock right now is the biggest in the large-cap space -- and would represent a very large annualized return if management teams can get the deal closed before the summer, as hoped. There are certainly risks in buying BHI right now, but the rewards are substantial.
Last up on the M&A list is Rite Aid(RAD) - Get Report . Back in October, Walgreens Boots Alliance(WBA) - Get Report announced a deal to buy the smaller drug store chain for $16.7 billion. Rite Aid investors will collect $9 in cash if the deal closes as planned. But investors are still leaving money on the able in the Rite Aid trade; this stock's premium currently weighs in at 12.5%.
Walgreens has been a voracious acquirer in recent years. The firm's buyout of Swiss drug chain Alliance Boots at the end of 2014 was transformational, and the Rite Aid acquisition will transform the firm again with another 4,750 retail locations. The question now is whether regulators will consider Walgreens' reach too big already to absorb Rite Aid. That seems unlikely, especially after rival CVS Health(CVS) - Get Report passed the hurdles to take ownership of Target's(TGT) - Get Report in-store pharmacy business.
With the Rite Aid deal expected to close in the second half of 2016, there's still a dollar per share in premium left on the table. And shareholders look likely to get paid.
Disclosure: This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.