5 M&A Deal Stocks to Watch for Premium Gains

BALTIMORE (Stockpickr) -- Forget about earnings season. M&A season is providing a far more exciting ride this summer.

2014 has been a big year for mergers and acquisitions so far. Year-to-date, deal volume is up 72% to $2.5 trillion. In the U.S., where equity markets have been on fire for the last two years now, M&A volumes are up a whopping 85.3% since the calendar flipped to January. A lot of that huge transaction volume has to do with the fact that suitors don't have many options to deploy their cash right now.

Even though the broad market has rallied hard in the last year, there are still pockets of value, particularly in some individual small-cap stocks. Likewise, with low interest rates and more cash than ever before parked on corporate balance sheets, large companies are in search of ways to earn meaningful ROI on that $1.25 trillion mountain of corporate cash.

So as management teams come to the realization that they need to either put money to work or hand it back to investors, acquisitions are looking a whole lot more appealing again. Mergers and acquisitions can provide amazing value for purchasing firms' balance sheets -- and they can provide instant gratification for shareholders in the target firm.

Too often, investors think that there’s no money to be made once a deal has been announced, but that’s just plain wrong; between merger arbitrage opportunities and value creation for acquiring firms, it’s worth paying attention to Wall Street’s deal book. So that's exactly what we're doing this week.

With that, let's take a look at four M&A deal stocks worth watching right now.


We'll start things off with grocery giant Safeway (SWY), a name that's been selling itself off as fast as it could for the last year. First, the firm spun off its Blackhawk Network (HAWK) gift card subsidiary and its Canadian businesses last summer. Then it announced that it would unload its Dominick's stores in the Chicago back in October. Earlier this year, Safeway cut to the chase with the announcement that it would begin to explore selling itself.

A month later, Albertsons (backed by Cerberus Capital Management) announced that it would purchase Safeway for $9.4 billion -- a deal that will pay Safeway shareholders a total estimated value of $36.15 per share. $32.50 of that comes in the form of cash from Cerberus. At current price levels, that means that there's a 4% risk premium still priced into shares of Safeway today.

Basically, that 4% payout translates into the risks of the approximately $3.65 per share from Safeway's Mexican business not being paid out. For investors willing to take on a more speculative merger arbitrage opportunity, there's still some cash left in the deal.


Satellite TV carrier DirecTV (DTV) is another high-profile merger name that's still providing investors with an arbitrage opportunity this summer. Back in May, news hit that telecom giant AT&T (T) had bid $95 per share for DTV, a move that would dramatically increase AT&T's presence in the television business. The combined firms estimate that they would capture approximately $1.6 billion in annual cost savings by joining forces -- justification for the lofty price tag AT&T is putting on DTV.

Even if AT&T is overpaying for DirecTV, the $66 billion purchase price is peanuts compared to top rival Verizon's (VZ) $130 billion deal to purchase Vodafone's (VOD) 45% stake in Verizon Wireless (a glaringly overpriced deal that destroyed shareholder value). More important, the move makes sense for AT&T. The firm needs to build out its "triple play" offerings, and purchasing satellite infrastructure that it can simply tuck-in to its existing networks is logical.

But the opportunity comes on the other side of the deal right now; DTV trades for a whopping $9 discount to the deal price, a 10% premium at current levels. That big risk premium accounts for lots of regulatory pieces that could come into play between now and next May, when the deal is scheduled to close. That's a meaningful return in a market that many investors believe to be top-heavy, regulatory hurdles included.

As of the most recently reported quarter, DirecTV was one of Warren Buffett's holdings.

Time Warner Cable

DirecTV isn't the only video provider that's getting in on the M&A game. There's another pricing disconnect happening this summer with shares of Time Warner Cable (TWC). In February, cable behemoth Comcast (CMCSA) announced that it would offer $156.37 per share for TWC, a deal that would expand the reach at the cable industry's biggest operator by another 30 million households.

As I write, that price tag leaves a 5.4% premium priced into shares of TWC. The deal is slated to close at the end of 2014.

Like other heavily regulated M&A deals, the Comcast/TWC marriage needs to pass through several gauntlets of regulatory scrutiny before it can be completed. So far, however, the firms have had little trouble with the process. Whether or not you'd want to continue to hold on to shares of the combined entity is debatable -- each firm has a huge contingent of unhappy customers who would be likely to jump ship as new alternatives emerge, and the merger of giants is only serving to sway consumer sentiment away from the combined company. That said, the 5.4% premium in shares is worth tuning in for.

Time Warner is one of John Paulson's top holdings as of the most recently reported quarter.


Earlier this month, Reynolds American (RAI) announced that it was planning on acquiring tobacco peer Lorillard (LO) in a deal valued at $26 billion. The deal gives Reynolds almost 15% more of the U.S. cigarette market, including a whopping 40% of menthol cigarettes thanks to the flagship Newport brand. Surprisingly, the sale doesn't include Lorillard's Blu brand of electronic cigarettes, the sole category in the tobacco industry that's actually seeing growth in 2014. That's going to Imperial Tobacco.

Reynolds is paying approximately $67 in stock and cash for shares of Lorillard, an offer price that leaves another 10% on the table at current price levels. The deal isn't set to go off without a hitch just yet. Investors are suing to halt the deal, arguing that RAI and Imperial are underpaying for LO's assets.

Frankly, they're probably right, but that only serves to make this merger trade a no-brainer for investors today: If the deal goes through, investors collect a 10% premium a year from now. Otherwise, if it's blocked, LO shareholders end up with a valuable high-yield tobacco play or a fatter offer price. Either way, there's considerable profit opportunity left in shares of Lorillard this week.


Medical device maker Covidien (COV) is up almost 30% since the start of 2014, thanks in no small part to a buyout offer from $62 billion medical technology firm Medtronic (MDT). As of recently, the deal would pay shareholders $95.32 in cash and stock.

For Medtronic, buying Covidien gives the firm access to a broad portfolio of medical devices (and their associated IP), and it also provides MDT with the ability to switch its tax domicile to business-friendly Ireland. That facet of the deal has been getting the most attention this week, as investors duke it out over the politics of dodging the IRS through a tax inversion. But the real attention should be on the 8.6% premium that's left in shares of Covidien right now.

While the added scrutiny from the political arguments about tax inversions certainly add to the risk premium in shares of Covidien right now, it's unlikely to have ill effects on Medtronic's ability to close the deal. After all, COV's product portfolio is the biggest reason for the $47 billion price tag on shares.

To see these M&A plays in action, check out the M&A portfolio on Stockpickr.

-- Written by Jonas Elmerraji in Baltimore.


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At the time of publication, author had no positions in stocks mentioned. Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation. Follow Jonas on Twitter @JonasElmerraji

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