Financial researchers have convincingly shown that companies which are taken-over outperform the general market in terms of share price. These companies see their share price rise substantially after the acquisition announcement – the rise may be instantaneous or may occur over a few days or weeks. This rise in most cases is about 30% to 40% during this short period although the rangemay be much higher. To benefit from this insight:
Identify fragmented industries that are beginning to consolidate.
- A fragmented industry always has many players; each player is typically smaller than the correct size; and often some players are not meeting cost of capital. One major player will try to buy up some of the others.
- Sometimes an industry needs to consolidate because these businesses are much smaller than their customers and are thus ‘bullied’. After consolidation, these players usually increase price and are able to reduce cost through economies of scale.
In these situations, buy the financially weaker (or smaller player), as it is more likely to be taken over. If the player is both small and making a loss, the likelihood of a takeover is even higher.
Be patient. It might take months or years before a wave of takeovers starts.
Caveat: For investors, it is usually too late to buy in once a takeover announcement reaches the public.