How to spot and profit from potential takeover targets

- Marc Johnson, CFA

Here's a quick and easy way to spot a possible takeover candidate.

First, add the company's total debt plus other obligations that an acquiror would have to assume. Then add its market capitalization (the share price times the diluted number of shares). This is the offer price.

Compare this number to the dollar value of the firm's tangible assets. If the value of the tangible assets exceeds the offer price, the company is ripe for a takeover.

Just remember that the shares of such companies typically trade at very low prices.

This can mean that a company is in trouble, of course. So you would not buy the company on its own merits. Then again, the share price may be very low just because the shares have fallen out of favor.

In this case you could adopt a contrarian approach and buy the shares cheaply. Then you would profit if a takeover occurs or when the shares regain favor in the market.

There are other factors to consider as well. For instance, controlling companies or families of a company can block an unwanted takeover. Sometimes these controlling shareholders can buy out the minority shareholders.

Takeovers usually pay for the shareholders of the target company. That's because the buying company typically pays more than the market price for the target's shares.

A study by CIBC World Markets found that such targets beat the market by an average of 22 per cent in the month after a takeover bid. That's one reason to hold a stock after an offer is unveiled.

A second reason is that the shares often trade below the bid price. By tendering, you collect the full price and side step brokerage fees and bid-ask spreads. A third reason to hold is that a bidding war could break out if two or more companies launch competing bids.

Given high potential profits, speculators seek the next target. The trouble is, takeover candidates are often identified by rumors that may prove untrue.

Even if a takeover bid is made, it could fizzle. That's why you should buy takeover candidates based on their own merits. Here are three takeover candidates that have appeal, takeover or not.

Imperial Oil (TSX-IMO, $47.04) buys back its shares and has raised your dividend for 20 years in a row.

Exxon Mobil could buy the 30.4 per cent of Imperial Oil that it doesn't already own - as Shell did with Shell Canada. One plus for Exxon Mobil is that Canada is more stable and enforces property rights better than many other oil-producing countries.

But whether or not Exxon Mobil buys it out, Imperial Oil remains a buy for long-term gains and rising dividends.

Corus Entertainment (TSX -CJR.B, $25.72) is another potential target in the consumer goods stocks sector. It would fit nicely within Shaw Communications. This company would bolster Shaw's media assets.

Corus offers specialty TV and radio and has assets in pay TV and TV broadcasting. It will soon acquire assets that BCE Inc. and Astral Media must sell. This will let Corus enter the Ottawa radio and Quebec specialty TV markets.

So it's a hold on its own merits. Shaw may want Corus at its side to compete against, BCE, Rogers Communications and Quebecor Inc. among others. This could convince the regulator to allow Shaw to acquire Corus. The Shaw family has connections to both companies. Corus remains a buy for attractive dividends and long-term gains, takeover or not.

Open Text Corp. (TSX-OTC, $97.71) develops, licenses and supports software for collaboration and enterprise content management. This software stores, finds and distributes information across networks.

With nearly 59.1 million shares, Open Text's market capitalization is $5.57 billion. This makes its potential takeover affordable for competitors such as IBM, which needs growth.

Open Text may also hold appeal for partners such as Microsoft Corp. Open Text remains a buy for long-term gains and dividends, despite a 71 per cent jump in its shares from a year ago. These gains could come fast if a competitor makes a bid.

* My Advice: Buy potential takeover targets based on their own merits and view any takeover premium as a profitable bonus. All three possible takeover candidates above are buys, whether they're taken over or not.