Steve McDonald: Hi, everybody. I’m Steve McDonald. This is your Market Wake-Up Call. The focus this week is on M&A activity ­– mergers and acquisitions – and the ungodly amount of money they make for their shareholders. The SunTrust (NYSE: STI) and BB&T (NYSE: BBT) deal announced earlier this month put M&A activity back in the headlines. It created the sixth-largest U.S. bank and highlighted the return potential these deals can produce. But the dollar amounts and market pressures these deals generate are greater than most realize.

In the first three quarters of 2018 alone, there were 8,683 buyouts, mergers and takeovers completed, for a total of $1.5 trillion. That’s a lot of money in flux, and 9 out of 10 of the deals were done in North America. The BB&T merger was worth $28.2 billion. The highly publicized AT&T (NYSE: T) and Time Warner deal that cleared its regulatory hurdles last year topped out at an amazing $85 billion. Pfizer (NYSE: PFE) has had three deals that total a combined value of $240 billion. But the largest acquisition ever was the 1999 takeover of Mannesmann by Vodafone (Nasdaq: VOD). It topped out at an inflation-adjusted $297 billion.

Now, the folks who are hired to run and complete these monster deals – the bankers – expect tax reform, a more relaxed U.S. regulatory climate and growing cash reserves to drive even more deals in 2019. And the recent uptick we’ve seen in the size and return of the deals show no signs of slowing down. With the exception of Europe, deal activity is expected to continue to increase across the globe, and the dollars these deals will mean to stockholders will be stunning. The IBM (NYSE: IBM) and Red Hat (NYSE: RHT) deal – the largest acquisition in IBM’s 107-year history – drove Red Hat’s stock to a 63% premium. The Amazon (Nasdaq: AMZN) and Whole Foods deal drove Whole Foods’ stock up 27%.

And keep something in mind – these were instant, deal-only-driven, almost surreal run-ups in stock prices. Leveraged buyouts (LBOs), buyouts, mergers, takeovers – call them whatever you will – have been the market norm for decades and have made many people uber-rich. During the internet and dot-com booms, files were almost daily occurrences and created a class that we now know as dot-com millionaires. The only problem with these money-printing phenomena is, how do you get in before the deals are announced and the stock goes crazy?

Well, to answer that and other questions about mergers and acquisitions, we have with us today one of the best market analysts I know, Chief Income Strategist Marc Lichtenfeld. He says there is a way to know when a company is a target of the dealmakers. Marc is the dividend-and-growth end of The Oxford Income Letter and Editor of Stock Sequence Trader. He’s a multidecade veteran of the market and has his hands in one of the hottest areas of M&A – pharma. My God, when those pharma deals used to go through in the ’80s and ’90s, they were monsters. They were amazing.

All right, one negative about M&As before we talk about the money: Every time a stock is taken over, bought or acquired, another company isn’t being traded on the exchange. Is that a good or a bad thing?

Marc Lichtenfeld: I think it’s a neutral. You also have initial public offerings (IPOs) happening all the time. You have companies spinning off divisions. So in a perfect world, we’d like to have lots and lots of stocks to be able to trade and invest in, but it’s not a real problem at this point, certainly not. There are still thousands and thousands of stocks out there.

Steve McDonald: Now, I read something recently where there were about 8,000 stocks on the New York Stock Exchange at one time, and now we’re down to around 4,600.

Marc Lichtenfeld: As you mentioned, we are seeing a declining number of stocks. More companies are staying private a little bit longer or not going public at all, but still there’s still 4,600 stocks to choose from.

Steve McDonald: That’s a lot of stocks. Hell, I own half of them.

When there’s a deal in the works, there’s a quiet period. And for those who don’t know what a quiet period is, you can’t say anything. That’s the shortest distance to a white-collar prison, talking about that.

So how do you know when a company has a target on its back? What do you look for? What kinds of signs does it give off?

Marc Lichtenfeld: We are looking for certain financial metrics, basically. We’re looking for companies with certain cash flow growth and rock-solid balance sheets. It doesn’t mean that a company that has lots of debt can’t be acquired – that does happen. But when you think about this, it’s not just a stock acquisition, this is a business acquiring another business. If you were going to buy a business – let’s say you wanted to buy the diner down the street – chances are you would look for one that’s performing well, that’s generating cash and that doesn’t have a ton of debt. And if you had your choice between two diners – one with tons of debt and one without debt – you’re probably going to go for the one that’s financially healthy. So it’s a lot of those same things. And we’ve narrowed it down to a screen, and we’ve back-tested some things. So we have some very specific metrics that we are looking for as far as cash flow growth and balance sheet metrics.

Steve McDonald: Back in the ’80s, there were some very highly publicized leveraged buyouts, which is a different kind of an animal. They were running up all kinds of debt just to buy the company, and then they put the debt on the company. It’s the craziest stuff I’ve ever seen. But you can make a ton of money on them because they’d come out with an offer, the company would throw up its defenses to try and block it, and then they’d come out with another offer. It goes back-and-forth. I remember Nabisco was one of these – the price went crazy on the stock. Are these things still happening?

Marc Lichtenfeld: Not so much the leverage buyouts. It happens, but certainly not the way it did in the ’80s and ’90s. But we are seeing hostile takeovers for sure. One that didn’t go through because the president stopped it: Broadcom (Nasdaq: AVGO) was trying to take over Qualcomm (Nasdaq: QCOM) last year as a $117 billion acquisition. It was going to be a huge deal. Qualcomm tried to fight it every step of the way, but its shareholders wanted it because it was an elevated price and Qualcomm hadn’t been performing well.

So it does happen, and when there is a hostile takeover, that can be a situation where if the company is fighting back, the acquiring company has to raise its price to get shareholders on board, or it could get competing bids. So a hostile takeover can actually be very, very lucrative for the companies, depending on the situation and their shareholders.

Steve McDonald: I know activist investors – when they take over a board – it is a takeover, but it’s not a buyout.

Marc Lichtenfeld: Right, right.

Steve McDonald: What’s been the track record? I really don’t follow them, but are you familiar with the track records of how these things have been working out? Is it good for the company?

Marc Lichtenfeld: Activist investors are usually very good for the company, especially if you have experienced activist investors who have done this before. They know whom to appoint to these boards and how the game is played.

Steve McDonald: Well, that’s half the problem. A lot of those board members have been sitting on there collecting six-digit – high six-digit – incomes, living on the expense account, using the company jet and basically doing nothing. I have friends who are on boards. Believe me, they do nothing.

Marc Lichtenfeld: And that’s exactly what happened with Amazon’s Whole Foods takeover. There were some activists involved who wanted the company sold and originally the CEO did not want to sell his baby. But they got enough of a presence on the board that they got a bid that he couldn’t or wouldn’t refuse, and the company got taken over. 

Steve McDonald: This is the obvious question: Where is the hottest area? Now, after the SunTrust and BB&T merger came out, there were all types of articles in The Wall Street Journal and Barron’s saying that we’re going to see a lot more bank takeovers because they’re all trying to make it above the asset threshold so they get more lenient regulations. Tech has been incredibly hot. Pharma is always hot. Where are you seeing it popping?

Marc Lichtenfeld: I still think tech, pharma and biotech because that’s always where the novel products, the exciting products, are and where the companies that are already trading for pretty high valuations are. I think you’ll also see some in retail. There seems to always be consolidation in retail. The big companies are always taking over the smaller companies. But I do think technology – IBM and Red Hat is a perfect example of that. And I think that’s where you’re going to see a lot of acquisitions and deal-making in the future.

Steve McDonald: You want to hear my tale of woe about buyouts? Western Airlines, you probably don’t even remember it. It was a West Coast airline. There was a buyout. This was back in the early ’90s when all the airlines were being bought out, and I had just finished flying. I knew a lot of guys flying for the airlines, and a couple of them would call me and say, “Hey, this is the price for the Western buyout.”

So I started buying it, you know? It wasn’t inside information. It was just another know-it-all pilot. I think I paid $12 a share, and the buyout was at $8.

Marc Lichtenfeld: Ooh.

Steve McDonald: So don’t ever trust “inside information,” especially when it comes from the cockpit. 

Thank you so much for being with us. 

Marc Lichtenfeld: My pleasure. Thanks for having me.

Steve McDonald: It’s a great topic – tons of money to be made here.

Marc Lichtenfeld: Absolutely.

Steve McDonald: Take a look at the link below. Marc’s got a whole report about mergers, acquisitions and how you do it right. Thanks again for being with us. 

Marc Lichtenfeld: Thanks for having me. 

Steve McDonald: And for everybody here at the Market Wake-Up Call, thank you for being a part of this. We’ll see you next week. 

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