10 Top Hedge Fund Buys Show M&A Tilt

NEW YORK ( TheStreet) -- An examination of the stocks that attracted the most hedge fund interest during the quarter showed managers had a taste for mergers and acquisitions.

TheStreet's look at hedge funds' top stock buys, ranked by market value of purchases, suggested that merger-arbitrage deals were the name of the game in the third quarter. A merger arbitrage deal typically involves buying the target's shares and shorting the stock of the acquirer, soon after a deal is announced, in order to take advantage of the premium between the offer price and the prevailing market price. However, in the case of all-cash deals, it could just mean taking a long position in the target, without a corresponding short position in the acquirer.

With deal activity seeing a significant revival in the third quarter, the strategy proved to be popular with hedge funds. Six out of the top ten stock buys during the period were targets of M&A activity.

The merger-arb strategy is not without risks in this bearish environment, where deals are taking longer to execute as acquirers and targets haggle over pricing terms. Last week, BHP Billiton ( BHP) withdrew its nearly $40 billion hostile bid for Potash ( POT) after it failed to win approval from the Canadian government, putting an end to a three-month long takeover battle.

Stronger fundamentals may be helping to support the stock price of Potash, despite the failure of the deal. But in most cases, the shares of the target will retreat back to pre-offer levels if the deal fails, so the event risk is high.

Investors may want to view the buildup of hedge fund interest in some of the stocks in the list below with caution, as it could represent a speculative bet on a deal taking place, rather than a directional view based on fundamentals.

Tech and healthcare stocks also figured prominently in hedge fund purchases during the quarter. Hedge fund titan David Tepper bought several large-cap tech stocks even as he cut back on financials, according to the latest regulatory filing.

Our shortlist excludes the iShares MSCI Emerging Markets ETF ( EEM), which also saw considerable inflows from hedge funds, as money chased higher yields overseas. The SPDR S&P 500 ETF ( SPY) was also popular. Big traders tend to use ETFs for hedging strategies, rather than as investment vehicles.

Read on to check out which stocks attracted the most hedge fund interest during the third quarter, ranked in descending order of market value of purchases.

10. Alcon

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Alcon ( ACL), which develops, manufactures and markets pharmaceuticals, surgical equipment and devices targeting the eye care market, attracted over $1 billion of hedge fund purchases during the third quarter.

Steve Cohen's SAC Capital Advisors and John Paulson's Paulson & Co were the biggest buyers in the stock. Highbridge Capital, Farallon Capital, Och Ziff Management and D.E. Shaw were other prominent hedge funds that bought into the stock.

Earlier this year, swiss drug-maker Novartis ( NVS) completed its acquisition of a 77% stake in Alcon from Nestle ( NEST). Since then, Novartis has offered to buy out Alcon's minority shareholders to secure 100% ownership, but has been rebuffed on the grounds that its offer was too low. Novartis is offering 2.8 shares of Novartis for each share of Alcon, which values the shares at $156 per share, according to a Reuters report. That is lower than the $180 per share shareholders are looking for.

Novartis said last Wednesday that Swiss laws prevent it from making an all-cash offer, but reiterated its intent to acquire a 100% ownership in the company.

9. Anadarko Petroleum

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Anadarko Petroleum ( APC) topped the buy list of hedge fund titan John Paulson during the quarter. Paulson & Co bought 13.4 million shares for nearly $850 million in Anadarko. In total, hedge funds poured $1.2 billion into the stock between June and September.

Interestingly, Carl Icahn's Icahn Capital made a complete exit from the stock during the quarter, selling 2 million shares.

Anadarko figured in TheStreet's top ten most volatile large-cap stocks in 2010, as it became embroiled in the BP ( BP) Gulf of Mexico oil spill disaster.

>>10 Most Volatile Large-Cap Stocks

With a 25% stake in the ill-fated Macondo well project, Anadarko was hit hard in June as concerns mounted that it will be held liable for legal compensation damages for the Gulf of Mexico oil spill.

The stock has nearly doubled from its June lows, as those worries abated and hedge funds piled into the stock. 17 out of 27 analysts rate the stock a buy.

Recent investigations into the oil spill concluded that none of the parties involved in the Macondo project put money before safety, absolving BP of the charge that it had taken undue risks to cut costs. While the government's findings have no legal applications including questions of negligence, Anadarko might now have a harder case to make to escape damages.

Unlike BP, the company has so far not taken any charge in its books for potential legal expenses it may face because of the spill. Any recognition in the upcoming quarters could be a negative surprise for investors.

8. Valeant Pharmaceuticals

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Mid-cap drug company Valeant Pharmaceuticals ( VRX) figured among the top purchases of hedge fund manager John Griffin's Blue Ridge Capital during the third quarter.

Valeant develops, manufactures and markets a broad range of pharmaceutical products primarily in the areas of neurology, dermatology and branded generics.

In September, the company merged with Biovail ( BVF) to form Valeant Pharmceuticals International. Shareholders of Valeant received 1.78 shares of Biovail and special premerger dividend of $16.77 per share. Valeant also announced a $1.5 billion buyback when it declared its latest quarterly results in early November.

The fourth quarter results will likely give a more complete picture of the financials of the merged entity, as the merger was effected only towards the end of the third quarter. Management said in its conference call that it expects to report a combined revenue of approximately $500 million in the fourth quarter and adjusted cash flow from operating activities of approximately $200 million in the fourth quarter.

Valeant recently settled three lawsuits launched by Biovail, including one against Steve Cohen's S.A.C. Capital, which it estimates will cut its legal costs by $10 million a year.

Out of 18 analysts covering the stock, 12 rate it a strong or moderate buy, while 6 have a hold rating on the stock.

7. Motorola

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Carl Icahn continued to step up investments in Motorola ( MOT) during the third quarter, snapping up another 12 million shares to raise his stake to 8.5%. Motorola remains Icahn Capital's top holding, accounting for about a third of the fund's nearly $5 billion portfolio.

Highfield Capital and Bridgewater Associates were other prominent hedge fund buyers.

Investors are betting that Motorola will benefit from its plans to split into two businesses -- Motorola Mobility, which will sell mobile phones and television set-top boxes and Motorola Solutions, which will sell wireless gadgets and walkie-talkies to government organizations and businesses.

Last week, Motorola said it would spin off its handset unit as early as January 2011. The company had indicated the first quarter of 2011 as a likely timeframe for its restructuring initiatives. Motorola announced its plans to spin off the handset business in March 2008.

Motorola Solutions will be headed by co-CEO Greg Brown while Motorola Mobility will be led by co-CEO Sanjay Jha. Motorola Solutions is likely to grow 4% to 5% in 2011 and 5% to 8% in the long-term, Brown said last Monday, in the company's first investor conference.

Motorola Solutions derives 65% of its revenues from government contracts. Markets have been worried about government spending on tech after Cisco ( CSCO) blamed weak public spending for its poor revenue outlook. But management reiterated in its conference call that its outlook was positive as spending on public safety remained strong.

Jim Cramer said in an interview with TheStreet, the sum of Motorola's parts may be greater than the whole and that the stock should be on investor's radar.

6. Aon Hewitt

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In another example of a merger story at work, insurance and risk-management firm Aon ( AON) found favor with a number of hedge funds. Larry Robbins' Glenview Capital bought an additional 4.4 million shares in the company. S.A.C. Capital, Citadel and Renaissance were other notable funds that increased their stake in the stock.

In July, Aon announced that it would buy out human resources firm Hewitt Associates (which traded previously under the ticker HEW) in a $4.9 billion cash-and-stock deal. Hewitt stockholders received $25.61 in cash and about 0.64 percent of a share in Aon stock per Hewitt share.

The addition of Hewitt, the world's largest human resource consulting outfit, is expected to triple Aon's consulting business.

Aon's third quarter profit disappointed expectations, with earnings per share coming in at 61 cents per share against estimates of 66 cents. The company said it was on track to meet its long-term margin target of 25% as it benefits from cross-sell opportunities through its Hewitt acquisition.

Analysts have remained skeptical on Aon's ability to generate higher margins. The upside potential in cross-selling is more toward Hewitt, Stifel Nicolaus analyst Meyer Shields told Reuters. "It's always been a disappointing area across insurance brokerage. The whole cross-sell argument has never got any traction."

5. McAfee

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Intel ( INTC)'s $7.68 billion all-cash acquisition of security software maker McAfee ( MFE) shook up the tech sector, spurring a wave of M&A activity as companies sought to fill gaps in their hardware and software portfolios.

Shortly after the Intel-McAfee deal, Hewlett-Packard ( HPQ) announced a $1.5 billion takeover of security firm ArcSight. Other big deals during the quarter include Intel's buyout of Infineon and HP's purchase of 3PAR ( PAR).

Consolidation hopes may have been one factor that drew hedge funds to tech stocks during the third quarter, especially since cash-rich acquirers were willing to pay premiums for their targets.

Intel offered to acquire McAfee at $48 per share, a whopping 60% premium to its then prevailing market price. That prompted a rush of money into the stock, with Paulson, Eton Park, Farallon Capital and S.A.C Capital among the prominent hedge fund buyers.

McAfee comfortably beat estimates in the third quarter, reporting revenue of $523 million, an 8% increase on the same period last year, and well above analysts' forecast of $514.2 million. Excluding items, McAfee earned 67 cents a share, a 9% hike on the prior year's quarter, against estimates of 64 cents a share.

"The public sector is very strong for McAfee around the world, particularly in North America," CEO Dave DeWalt told TheStreet. "Our vertical industries have been very strong of late."

But the company issued a more cautious guidance for the fourth quarter as a result of foreign exchange pressures and the impending acquisition of Intel, which still requires regulatory approval.

4. Citigroup

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Citigroup ( C) remained a hedgie favorite in the third quarter, with funds pumping in an additional $2.2 billion in the stock.

Shumway Capital Partners bought 100 million shares in Citi, while D.E. Shaw, Maverick Capital and Citadel were also significant buyers. Long-term bulls, John Paulson and David Tepper's Appaloosa Management, however, pared exposure to the stock.

Citi has been plagued with many of the same problems facing its competitors, including uncertainty of the impact of financial regulations and issues with foreclosure procedures. However, its considerable global reach has been among its strong points.

Last week, Manuel Medina Mora, who heads Citi's consumer retail banking business, said the share of emerging markets of its consumer banking revenue was set to grow to 55% over the next three years from 30% currently. He was speaking at the Bank of America Merill Lynch Banking and Financial Services Conference.

Mora expects emerging market to lead growth in consumer banking at a compound annual growth rate of 10% over the next three years, while growth rates in the U.S. is expected to expand at a much slower pace of 5%.

He said Citi will spend $3 billion to $4 billion over the next three years toward increases in affluent customer acquisition and retention, building new capabilities to improve the customer experience, such as a common technology platform, and internet and mobile banking, and increasing its footprint in the top 150 cities of the world.

In other recent news, Citi announced that it would receive $100 million from Wells Fargo ( WFC) in settlement of a lawsuit it launched against the bank over its takeover of Wachovia.

Out of 20 analysts covering the stock, 11 analysts rate Citigroup a buy or outperform, 7 have a hold rating while 2 analysts have a sell or underperform rating on the stock, according to Reuters.

3. Apple

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Hedge funds poured more than $2.5 billion in Apple ( AAPL) during the third quarter. Shumway Capitak, Renaissance, Lone Pine and David Einhorn's Greenlight Capital were among the notable bulls on the stock.

Apple has consistently blown past forecasts quarter after quarter, even as analysts set higher and higher earnings targets. It reported a blowout third quarter in July after strong sales of its newly-launched iPad drove revenues to a record high.

Apple beat analyst forecasts yet again in the September quarter, but its guidance for the December quarter fell short of forecasts, as a shortage of parts was constraining the production and sale of iPads. Apple sold 4.2 million iPads in the September quarter.

Apple has also become the focus of M&A chatter, after CEO Steve Jobs hinted that the company would use the $51 billion in cash and marketable securities at its disposal towards "strategic opportunities."

The stock remains an overwhelming buy among tech analysts with 40 out of 44 analysts rating it a buy or outperform and the remaining 4 rating it a hold.

2. Genzyme

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Genzyme ( GENZ) and Sanofi Aventis ( SNY) have been at an impasse for five months, as they have been unable to reach an agreement on takeover terms.

Genzyme has been rejecting Sanofi's offer for $69 per share, arguing that it undervalued the company. Sanofi has for the most part been reluctant to sweeten the bid, as Genzyme has issues with its manufacturing operations. Sanofi has also argued that Genzyme is overestimating the potential effectiveness of its leukemia drug, Campath, on multiple sclerosis patients.

But ongoing negotiations between the two companies have kept hopes that the deal would go through alive.

Genzyme is currently exploring the use of contingent value rights, which give shareholders an additional benefit once the acquired company hits a future benchmark, the Wall Street Journal reported.

But while such terms may allow Sanofi to pay a lower price, Genzyme still refuses to accept a price as low as $69 per share. It also remains in talks with other potential bidders such as Pfizer ( PFE ) and Johnson & Johnson ( JNJ).

1. Potash

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BHP Billiton's $40-billion, hostile bid for Potash promised to be the biggest deal of the year but ended up being a bust.

In August, BHP announced its interest in acquiring Potash for $130-a- share in an all-cash deal. Potash rejected the offer, deeming the price -- a 16% premium to the then-prevailing market price -- as "grossly inadequate."

Hopes that BHP would ultimately raise its offer price or that Potash would be successful in getting a white knight drew substantial hedge fund interest, with JGD Management making the biggest bet with a purchase of 4.6 million shares. SAC Capital, Eton Park and Paulson were among the other prominent hedge fund buyers. Collectively, hedge funds sank $6.6 billion in Potash during the quarter.

But in the end Potash was able to fend off its unsolicited bidder. After months of wrangling for the fertilizer company, BHP finally withdrew its bid last week because of opposition from the Canadian Government.

Interestingly, Potash has held onto most of its gains since the deal was announced. It continues to trade at $140 a share, well above the offer price. That may have to do with the $2-billion share buyback program announced by Potash's management soon after the deal talks collapsed in a bid to appease investors.

Fertilizer stocks are also trading stronger as rising prices of agri-commodities are expected to improve farmer incomes and spur demand for fertilizers.

-- Written by Shanthi Bharatwaj in New York

>To contact the writer of this article, click here: Shanthi Bharatwaj.

>To follow the writer on Twitter, go to http://twitter.com/shavenk.

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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