“Merger Mania” is sweeping Wall Street. But what does it mean? And, more importantly, is there an investment opportunity here for you?
The answer in a moment, but first, let’s get a little perspective on why merger activity is heating up, and look at two big deals in the news.
Despite what many doom-and-gloom analysts are saying, corporations are awash with cash, and they are looking for a smart way to reinvest this money. Now, some corporations are using that cash to buy back their stock, while others are hiking up their dividend payments. I’m a big fan of each of these strategies. They benefit the individual investor and my palms itch in anticipation of the impact on earnings and the profits that come from it.
But there’s another very reasonable use for this cash that is becoming very popular right now and is making big splashes in the headlines: mergers and acquisitions. It seems like each day brings a new multibillion-dollar corporate bid, and investors are getting caught up in the mania.
Today, we’re going to take a look at two of the biggest deals making headlines and see if now is the time to jump in or steer clear.
Now, before you let the drama of the headlines get you too excited about any acquisition deal, you have to check the financial health of the two companies. After all, any reasonable consumer wouldn’t make a major purchase without getting his/her fiscal house in order, so why should any company?
So, today I’m going to go over two major corporate bids that still are in the planning phases, and show you how to spot red flags that should keep you from trying to catch the rallies surrounding these stocks.
Kellogg & Proctor & Gamble
First up, Kellogg (NYSE:K) announced it wants to buy Proctor & Gamble‘s (NYSE:PG) Pringles division, in a deal valued at $2.7 billion. Earlier, P&G was in talks with Diamond Foods (NASDAQ:DMND) for a possible Pringles buyout, but that plan fell through when Diamond blew up over accounting restatements and questions about fraud.
If the new merger goes through, Kellogg’s 2012 earnings per share would be reduced by as much as 16 cents, and P&G’s earnings would increase by as much as 50 cents per share. That is a big impact for both companies, but this would be the largest acquisition in the food industry since Nestle (PINK:NSRGY) acquired Kraft‘s (NYSE:KFT) pizza business two years ago.
Kellogg popped 5% yesterday on the news of the acquisition, but looking at Kellogg’s Portfolio Grader report card, I’m not overly impressed with its fundamentals. The company’s earnings and sales growth is weak enough as it is, and such a large buyout could disrupt the company’s top and bottom lines in the near term. Also, Kellogg would need to borrow about $2 billion to finance this deal, which is expected to close by summer 2012.
So although adding Pringles to its portfolio would increase Kellogg’s presence in international markets, especially in Asia, at this point, I would not recommend purchasing K shares. Wait and see if Pringles really does boost Kellogg’s business. If so, you can certainly add it to your buy list later.
But what about Proctor and Gamble?
If you have shares of PG, hold them, but if not, I would recommend looking elsewhere because despite the short-term earnings boost, I think there are stronger companies with better growth prospects.