This is a guest post from Tusk Trader (check out the newly launched site: www.TuskFund.com), an experienced Bay Street trader who will be writing here until Tusk’s own blog is set up. Tusk had a front row seat to the twists, turns, and almost collapse of our capital market systems a few years ago and provides a unique perspective you won’t find anywhere else. For most people, financial literacy is the elephant in the room. Let Tusk Trader help change that. If you are on twitter, make sure to follow Tusk at @TuskTrader
I can always tell when pieces of financial news are permeating the mainstream media by the conversations I hear in line-ups at coffee shops and on the subway during my commute. (I don’t mean to eaves drop, I just can’t help it when living in a dense city.) I learn a lot about what news needs to be explained better to the public and what news actually excites people. Lately, I hear people talking takeovers. From the fight for Hathor to the now standard bi-monthly Rim rumours, takeovers are back to making headlines. In our Canadian markets there are many junior oil, gas and metal firms that fuel this fire for investors. Traders who like to trade junior commodity companies are often on the hunt for the next takeover target. They trade in and out, day after day, comparing news to rumour, managing risk and subtly trying to hook that big fish.
In the back of a trader’s mind when a sector gets hot, is takeover. They want (and often dream) that they will come in to work one morning to find the stock they have a position in with a bid 50% higher than the close the day before.
Takeover targets can occasionally be easy to spot. Bids start to get very big and very aggressive, rumours start to get whispered, the stock opens high and keeps moving higher all day. The hardest parts of trading takeovers are timing and takeover prices, especially in the juniors area. Those two elements are hard to predict and make it tough to manage risk. Timing is often about having a crystal ball. Personally, I feel some traders are lucky more often then they are right when holding a takeover at the prefect time. Rumours are actually a good starting point for price. Price is tough to predict because the issues, parameters and constraints of potential acquirers are different. It is not just about the asset being purchased, but also about who is doing the purchasing. You need to remember that different assets hold different values and opportunity costs for different acquirers.
Think of a bar of gold. Whether you have one bar in a hidden vault in your house or whether it is sitting on a stool in a pub in Whistler, it is worth the same dollar value to most people. The only cost that needs to be accounted for is acquisition…. going to pick it up.
To contrast a gold bar, think of a house for sale. The amount you will pay for the house has just as much to do with the location of the new house as it does to your current location and income. The house and land cannot be moved so your perceived value involves your ability and desire to move to the new location. If you find the perfect house in Red Deer but currently live and work in Halifax, it will change what you are able to and what you are prepared to pay for the property.
The same is true for a company bidding for a junior firm. The information about the price the acquirer is prepared to pay is found just as much on their own balance sheet than on that of the target company. Companies are looking for that magic element of synergy when making acquisitions; when two $3 items are worth $8 together over time. How much the companies seem to fit together will give you the best indication about how high the price of the target company could go. Compare some rumours, keep an eye out for big consistent bidding, manage risk and happy takeover hunting.