As we look ahead to what 2011 holds, one of the dominant themes will be an increase in merger and acquisition activity. Already, the year is off to a great start: Deal volume has already topped $83 billion so far this year thanks to deals like Duke Energy (NYSE: DUK) snapping up Progress Energy (NYSE: PGN) for $13.7 billion and Playboy (NYSE: PLA) going private. That’s the best start in more than a decade according to Dealogic.
The trend looks set to continue since this is an extension of the shareholder wealth return thesis I’ve been talking about for months as extreme demand for corporate bonds sizable cash reserves sets the stage for M&A, dividend hikes, and stock buybacks. For more, be sure to read my MSN Money column from last May.
For investors, the way to play this is to try to get ahead of the curve and invest in companies that are likely buyout targets. The short-term returns from M&A almost always accrue to the shareholders of the target company; whereas long-term returns, if they develop, are harnessed by shareholders of the acquirer.
Since M&A is enabled by cash reserves, Morgan Stanley (NYSE: MS) equity strategist Adam Parker took a look at which sectors of the market appear to be equipped for an increase in buyout activity. Combined, healthcare and technology account for nearly 50% of overall corporate cash balances. Industrial stocks come in third with a 16% share. Consumer staples and energy stocks bring up the rear with cash balance shares of 6% and 7% respectively.
These two sectors — technology and healthcare — were flagged by Barclays Capital analysts in a recent 2011 M&A look ahead research note. Of the two, technology “appears most likely to be the breakout sector in 2011 for announced M&A.”
For specific ideas, we turn to Matthew Rothman, who heads up quantitative strategy research at Barclays Capital. Rothman recently screened for stocks that have above-average cash reserves and earnings yields higher than their borrowing costs — both of which make a company an attractive M&A target. To further sweeten the pot, he focused on names that are considered high quality based on a number of factors including spending levels, return on capital and sales growth.
The results were concentrated in the tech sector. Included on the list were stocks like IT specialist BMC Software (NASDAQ: BMC), semiconductor equipment makers Lam Research (NASDAQ: LRCX) and Novellus Systems (NASDAQ: NVLS), and memory specialist SanDisk (NASDAQ: SNDK).
All should perform well in 2011 as the great M&A boom continues.
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