Scouting the investment scene for lucrative takeover targets

By now, you may even know someone who bought stock in Getty Oil or Gulf Oil last fall and watched its price skyrocket in just a few months. Earlier this month, Standard Oil of California offered $80 a share for Gulf stock. At the time of the merger announcement, Gulf's stock had been selling at about $71 a share. A month earlier it was selling for around $55. Savvy investors stand to make millions.

Likewise, investors in Getty. In January, Texaco bought Getty Oil for $10.1 billion. At the time of the merger announcement, Getty's stock had been selling at about $36 a share. By late February, Getty was valued at around $43 a share.

Investors who bought Gulf and Getty stock may have been fortunate - or smart - if they knew how to find potential takeover candidates. Can you, in fact, screen the market for likely target companies?

Sometimes you can. But whether you're a novice investor or a seasoned veteran , an important factor in your success will be the time you spend doing your homework.

Are mergers and acquisitions here to stay? Yes. That's the good news. There has been a surge of activity in this area on Wall Street, prompted by the growing presumption among businesses that it is cheaper and quicker to buy assets than to create them. Essentially, this thought underlies most acquisitions.

Last year the number of mergers and acquisitions completed or pending set a nine-year record of 2,533, according to merger consultants W.T. Grimm & Co., while the dollar value paid for completed transactions surged to $73.1 billion from $53.8 billion in 1972.

The bad news is that there is no easy path to quick profits in picking stocks of companies likely to be taken over. In situations as complicated and fast moving as mergers, specialists say it's difficult at best for an average investor to make the right moves, since most people lack legal and accounting training and research capabilities. Even for professional risk takers, the process is difficult. As a result, they rarely try to speculate on unannounced deals.

Increasingly, takeover attempts are hostile. Sometimes corporate raiders are not even interested in the entire target company. The efforts of Mesa Petroleum's T. Boone Pickens Jr. to split up Gulf Oil illustrate such a trend. Corporations are looking at how their targets are structured before making their moves.

According to Douglass M. Barnes, vice-president of D. F. King & Co., a New York-based proxy-solicitation firm, a substantial number of contests involve ''situations in which the parts (of the target firm) are worth more than the whole.''

In shopping for the best investments, Wall Street experts urge that you think like a potential acquirer and use the tools of a security analyst. Read annual reports, proxy materials, outside research data, and the business news in newspapers and magazines. What should you look for? Some signs deserve attention. None by itself would signal a good stock buy, but together they can point to a company's soundness.

* Good fundamentals. Companies whose fundamental prospects are better than those of competitors are often a lure for acquisitors.

* The balance sheet. One rule of thumb is that companies must have strong balance sheets, with little or no debt and lots of liquid or undervalued assets. ''These may be hidden assets that don't show up in a report or are grossly undervalued by the marketplace,'' says Lawrence Garshofsky, a risk arbitrage specialist at Argus Research Corporation, a financial services firm. An example, he says, might be real estate properties that have been carried on the company's books at historical costs for years and have since appreciated in value.

* Proprietary goods or services. A company that is a leader in its field, marketing goods or services at higher profit margins than competitors, would be attractive to another company. Also, see whether the company has a lot of patents to protect its products.

Consider Maryland Cup Corporation, the largest maker of paper cups and straws. For 10 years, the company had produced impressive earnings growth and developed an excellent distribution system. Last June, before Fort Howard Paper Company announced plans to acquire the company for a combination of stock and cash, Maryland Cup stock had been trading in the high 30s. By the end of August, when the merger was completed, investors saw the stock rise to $49.

* Stock activity. If you notice an unusual amount of trading activity in a company's stock, this may mean a predator is seeking a ''toehold'' in the target company or intends to expand holding when conditions improve.

Investment experts have other signs that they look for in takeover candidates. They counsel people, for instance, to look for companies whose directors have staggered terms, or have adopted other ''shark repellent'' measures, such as rules requiring mergers to be approved by 80 percent of shareholders. This may indicate that management sees the company as a likely takeover candidate and is adopting a defense posture.

If an outsider has already acquired a chunk of the company, that individual or organization may want to buy more, or may provoke someone else to make a bid. ''Generally speaking, when someone acquires 5 percent or more of a company's shares, it's only a matter of time before a merger or acquisition develops,'' says Richard Spring, senior vice-president of David J. Greene & Co., a New York-based investment advisory firm.

But not always. ''You have to make your own judgment,'' says Leonard Chazen, a partner of Fried, Frank, Harris, Shriver & Jacobson, a New York law firm that has been in many takeover battles. ''Frequently, the (outsider) will change his mind.'' Australian publisher Rupert Murdoch says he is after up to 49.9 percent of Warner Communications. Whether or not he really is, Murdoch had to tip his hand about his initial stock buy. Securities and Exchange Commission rules require reporting of an acquisition of 5 percent or more of a company's shares.

One hot area is the leveraged buy-out, in which management and private investors, financed largely with money borrowed against the assets acquired, purchase the publicly held shares of the company and take it private. Two well-publicized LBOs - as they are commonly called - have involved Royal Crown and Dr Pepper, two soft-drink firms. But compared with most standard hostile takeovers, premiums yielded by leveraged buy-outs are modest, experts say.

In the future, the juiciest targets of takeover attempts are apt to be banks, savings institutions, and other financial service concerns, investment experts predict. Natural resource and metals companies will also be attractive targets. And don't rule out electronics, computer, and telecommunication concerns, partly because of the breakup of AT&T and the settlement of a federal antitrust suit against IBM.

So the best places to scout will be in these areas, particularly banks. Predicts D.F. King's Mr. Barnes: ''The banking arena is going to be explosive in terms of mergers and acquisitions over the next five to 10 years.''

Anyone so inclined can expect to do reasonably well in anticipating reorganization plays - at least some of the time. But choosing a stock, you should develop a good understanding of the company's fundamentals and feel comfortable owning it for a while. That will limit your risk and enable you to judge how much to invest.

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