by Louis Basenese, Advisory Panelist
Friday, September 11, 2009: Issue #1090

Trying to call market tops and bottoms is a foolish and fatally flawed endeavor.

However, we all know the mergers and acquisitions (M&A) market is notoriously cyclical. And deal volume picks up coming out of recessions.

And if the last 10 days are any indication, we might have hit the turning point. Let me tell you why. And more importantly, the best way to play it…

Corporate America is Finally Dipping into its Massive Wad of Cash

The economic slowdown and credit freeze prompted many companies to horde cash. Some wanted it as a buffer. Others simply refused to reinvest their profits until they could use leverage to effectively buy more.

Regardless of the reason, an arsenal of cash sits on the balance sheet of corporate America.

In fact, the latest tally of corporate cash available pegs it at roughly $700 billion, according to S&P analyst, Howard Silverblatt.

Keep in mind that this figure excludes the financials, utilities and transportation sectors. These companies generally carry lots of cash as a normal part of business. And it also doesn’t include the nearly $1 trillion in cash in private equity funds, according to London-based research house Preqin.

Here’s the big whoop: That much cash doesn’t sit idle forever. Not when it earns a paltry 1% interest in a bank account.

In fact, the longer it sits, the more executives will be itching to put it to work to earn higher returns. After all, it’s their responsibility to maximize shareholder wealth.

Well, last Monday, they started scratching…

August 31 Was “Merger Monday”… and the Trend is Continuing

On Monday, August 31, the newswires lit up with merger activity.

• Baker Hughes and BJ Services….
• Disney and Marvel Entertainment….
• Kinder Morgan and Crosstex….
• And of course, the credible rumors that materialized involving E*Trade Financial.

In the end, it was the busiest day of deal making in almost three months.

But it wasn’t a fluke. It happened again this week!

Despite the market holiday, Kraft Foods went public with its $16.7 billion takeover offer for British candy maker Cadbury PLC. And Deutsche Telekom’s T-Mobile announced plans to merge with France Telecom’s Orange subsidiary.

All told, more than $40 billion worth of deals were announced over the past 10 days.

So is this just a short-term spike that won’t be sustained?

Loads of Cash + Cheap Takeover Targets = A Boost in M&A Activity

Not according to investment bankers and M&A attorneys. They confirm that more deals are in the pipeline. For example…

• “There is a lot of activity behind the scenes,” says Andy Levine, a partner at M&A law firm Jones Day.
• Paul Parker, head of global mergers and acquisitions at Barclays Capital concurs: “Given that this down period was an extended one, there is a lot of pent up demand.” He adds, “They [CEOs] are no longer worried about catching a falling knife and are now worried about getting left behind.”

Clearly, the stage is set for a revival. There’s ample cash to fuel it. And the longer we go without a market correction, which would put buyers on guard again, the quicker I expect M&A activity to perk up.

If you want to capitalize on it, focus on the sector chock-full of cheap targets and buyers flush with cash.

A Perfect Storm for Technology Takeovers

Even after this year’s rally, prices for many small technology firms are down significantly, below cash in some instances.

Meanwhile, the titans of technology are cash heavy. If you take the collective balance sheets of Oracle, Cisco, Microsoft, IBM, Google, Apple, Intel and Hewlett-Packard, these big boys are sitting on $158.1 billion in cash.

And since they don’t suffer from huge debt burdens or enormously unfunded pensions, get ready for them to spend it. But don’t just take my word for it…

• Over the past 18 months, Oracle made several impulse buys, scooping up 10 smaller firms for a combined $750 million. CEO Larry Ellison is an unashamed takeover addict, not interested in quitting, even after gobbling up Sun Microsystems for $7.4 billion.
• Over at Cisco, CEO John Chambers believes, “Cash is king, queen and the royal family” in a recession. By his own admission, he doesn’t intend to let the company’s $36 billion sit idly on the throne.
• Then there’s Microsoft executive Chris Liddell. He thinks the buying opportunities have “probably never been better.” Not a comment one makes unless they’re out shopping.

Bottom line: Thanks to low prices for takeover target companies and historically high cash balances, the deal machine in the technology sector is well greased and primed for action.

Here’s how to tilt the odds in your favor…

Let the $2 Billion Mark Be Your M&A Yardstick

Although the M&A pace is quickening, the credit markets haven’t completely thawed. So we shouldn’t expect the mega deals we witnessed in 2007. In fact, July marked the first month in six years without an announcement of a deal worth $5 billion or more.

Deals for small companies, however, are plentiful. The bulk of all announced transactions in the last two months were for $500 million or less.

So I recommend that you focus on all-cash deals – takeover targets with valuable assets that can be purchased for $2 billion or less.

Once such opportunity is Trident Microsystems (Nasdaq: TRID), which I’ve covered in Investment U issue #1076, Buying Low Density Stocks.

And if you want more, I’ve revealed two others in the latest issue of The Oxford Club Communiqué.

• One is a $110 million high-speed networking specialist whose technology is used in almost 25% of the fastest 500 computers in the world.
• The other is a $444 million data storage provider with a valuable niche focus on small- to medium-sized businesses

To learn more about The Communiqué, click here.

Good investing,

Louis Basenese