3 sectors for deal-making's golden age

The stars are aligned for billions in deal flow. Here's where to invest before then.

By StreetAuthority May 8, 2014 8:52AM
Droplet Falling from Pipette into Test Tube © Andrew Douglas, Radius Images, Getty ImagesBy David Sterman

When Merck (MRK) announced plans this week to sell its consumer products business to Germany's Bayer (BAYRY) for $14 billion, industry watchers may have merely shrugged.

After all, Novartis (NVS) and GlaxoSmithKline (GSK) only recently agreed to a $20 billion asset swap. And Valeant Pharma (VRX) is dangling $45 billion in front of Allergan's (AGN) shareholders in a deal that has yet to be consummated.

Why are these firms now throwing around such big money? Two reasons.

First, the global economy is growing at a sufficiently slow pace that companies must seek deals to shake up their portfolios to boost profits.

Second, most major economies are now healthy enough to avoid the risk of a fresh economic slowdown or crisis. Companies don't like to do deals when the economic environment is uncertain. Those two reasons add up to a Goldilocks scenario for deal makers, operating in an economy that is neither too hot nor too cold.

As long as we remain in this middling growth phase, look for many more deals in coming quarters. Here's a look at the industries and types of companies that will be on the buying and selling ends of transactions in coming quarters.

One of the key themes playing out among drug companies is a desire to streamline their business models.

The process began a few years ago when Abbott Labs (ABT) decided to spin off its biotech unit, AbbVie (ABBV). It's not that Abbott's executives had a disdain for biotech, it's just that they realized that the parent company needed to more squarely focus on fewer core strengths. Merck's move this week to unload its consumer business, while simultaneously making a $1 billion investment in Bayer's drug development business, signals a desire to double down on drugs.

These moves come at a curious moment. Smaller biotech firms have been subject to massive sell-offs this spring, which has surely caught the attention of Big Pharma. Analysts are already starting to identify the new core strategies of the big players, and identify which younger firms might fit well with their plans.

As an example, Novartis decided to wind down its investments and cooperation with RNAi drug firm Alnylam Pharmaceuticals (ALNY) back in 2010, citing a desire to focus its research resources elsewhere. Yet in early 2014, Sanofi (SNY) embraced Alnylam with a $700 million investment.

Most of the time, Big Pharma will only consider acquisitions of drugs that are at least in Phase II clinical trials. Patience is in short supply these days, and early-stage drugs hold less appeal to Big Pharma right now. Biotech firms with promising drugs in Phase II and Phase III trials include Derma Sciences (DSCI), Threshold Pharma (THLD), Synergy Pharma (SGYP) and Insmed (INSM).

New tech m​eets old tech
Deal-making in the tech sector has been fairly quiet thus far in 2014.

That's likely due to wildly swinging share prices, which create an uncertain sense of appropriate valuations. But many young tech companies have stumbled so badly that their bigger peers must now be looking at them quite closely as prospective acquisition targets. I recently took a look at a wide variety of tech stocks that have shed billions of dollars of collective value. The key here is to find companies with solid niches that can help bigger firms gain rapid traction in a new tech segment.

Take CommVault Systems (CVLT) as an example. The company is a well-respected mid-tier operator in the field of network optimization. CommVault has boosted sales at least 15% every year for a decade but has recently begun to see extended sales cycles.

About a month ago, Bloomberg suggested that IBM (IBM) or EMC (EMC) would be a logical buyer of CommVault. Shares of CVLT have fallen 25 percent since that article was published.

CommVault has ample company. Digital advertising firms such as Rocket Fuel (FUEL) have fallen sharply and may hold great appeal to firms such as Facebook (FB) or AOL (AOL).

Regional banks
The recent regulatory overhaul of the banking sector has created a new set of deal-making dynamics. The largest banks, which are still seen as "too big" in the context of a potential failure, are likely precluded from making any growth-inducing deals. Meanwhile, the smallest banks are struggling with huge reams of paperwork as they comply with new regulations.

That puts regional banks into the sweet spot. They need not worry about buying competition from their bigger peers, and they can entice smaller prey with the proposed cost savings that combined regulatory filings can bring. This industry is just too vast to name targets, and perhaps the best way to profit from banking industry consolidation is through the SPDR KBW Regional Banking ETF (KRE) or the iShares Dow Jones U.S. Regional Banks index Fund (IAT).

Risks to consider: You should never buy a stock simply on the hopes of a buyout, as many rumored deals never come to pass. Instead, the stock should hold appeal on its own, with any buyout merely providing upside.

Action to take:
Active deal-making can be healthy for the broader market. Each new deal establishes a fresh baseline of what companies are with in the eyes of deal makers. Rival companies often see their shares move up as well as a new higher valuation gets established. Conversely, if a stock you own has been bid up sharply after a rival was acquired, that may make it a good time to sell, since a subsequent deal is unlikely to follow.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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May 9, 2014 10:15AM
This scumbags did not wait long this Friday morning, came out of the gate doing their thing early and often, why? Because they can, because they know they can manipulate and cheat at will and get away with it....We have a long day ahead of us and will try to make things look respectable although many times this is easier said than done....Be very cautious today, crooks are again doing their thing....More later.
May 8, 2014 9:16AM
"Will today be the day the Dow finally does it?"

YES. It WILL crash to ZERO today. Same answer I'll give everyday until it does. I won't have to wait long or at all. Nothing good comes from Inflationists except fertilizer. 
May 8, 2014 9:15AM
The stars are aligned for billions in deal flow? Get your head out of your azz. The stars are aligned for catastrophic failure and an END to financial tyranny. Key suckers are making for the exits leaving only the DUMBEST of Kool Aid addicts to pay the tab. YES, the tab WILL NOT be paid by the global masses, JUST the financial azzes. 
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