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It’s MADness! (Mergers, Acquisitions, And Divestitures)

Approximately half of all mergers & acquisitions eventually fail. There seems to be little benefit to long-term investors from M&A. If a stock is truly undervalued, it is worth owning. How do companies create value for shareholders? In the long run, nothing matters more than earnings and earnings growth. The more a company earns, the higher the stock price should go. That might seem obvious, but it might also surprise you if you have been listening to what CEOs say. For example, Hewlett-Packard (NYSE: HPQ ) announced a few months ago that it was planning to split itself into two companies. In July, CEO Meg Whitman said, “Today, I’m more convinced than ever that this separation will create two compelling companies well positioned to win in the marketplace and to drive value for our stockholders.” In other words, the CEO argued that the sum of the parts is greater than the whole. If Whitman believes that earnings drive value, then she must also believe that the combined earnings of the two separate companies will be greater than if they remain together as one. Sounds logical. But on Tuesday, Walgreens Boot Alliance (NASDAQ: WBA ) announced plans to acquire Rite Aid (NYSE: RAD ). Rite Aid CEO John Standley said, “Joining together with Walgreens Boots Alliance will enhance our ability to meet the health and wellness needs of Rite Aid’s customers while also delivering significant value to our shareholders.” In other words, Standley believes that the whole is greater than the sum of the parts. If he believes that earnings matter, then he must be arguing that the combined entity will create more earnings and more value than if they remain separate. Can both Whitman and Standley be right? When two companies merge, they often argue that the merger will create “synergies.” In other words, they might be able to reduce total costs by getting rid of duplicate functions. (For example, you don’t need two CEOs.) The merger might increase market share and, therefore, create more pricing power. There may also be some tax advantages or perhaps a greater degree of diversification. If the benefits of the merger outweigh the transaction costs, then shareholders should come out ahead. If that’s the case, then why are there divestitures? Companies often argue that a divestiture (in the form of a spin-off, carve-out, etc.) will create value by allowing distinct business segments to separate into new companies in order to focus more intently on their separate businesses. They may claim that the market does not understand or appreciate the value of the combined businesses, and that a divestiture will “unlock” value for shareholders. So, if you believe all this, it must follow that separating a large company into two creates more value. Two companies merging into one creates more value. One company buying another creates more value. And a company splitting off a small part of itself creates more value. Well, do you believe it? There are lots of examples of mergers that have succeeded; yet, there are also plenty of examples of mergers that have failed. One of the best-known failures is Hewlett-Packard’s own acquisition of Compaq. It’s still haunting former CEO Carly Fiorina on the presidential campaign trail. When it comes to mergers, acquisitions, and divestitures, here’s what we know for sure. When Company A announces plans to buy Company B, it typically pays a premium. In order to convince the target company’s shareholders to approve the deal, it has to offer to pay more than the market price. So, Company B’s shareholders often see a quick and significant increase in the value of their shares. What happens to the shares of Company A, however, is less consistent. Sometimes they rise a little when the deal is announced. Sometimes they fall. Over the long run, how the shares perform depends on a number of factors, including whether the merger was really a case of exploiting potential synergies, or a desperate bid to grow the top line without regard to profits. As far as divestitures go, we know that they often follow mergers & acquisitions. In fact, academic studies show that 35-50% (or more) of acquisitions are later divested by the acquiring firm. In other words, it appears that approximately half of mergers & acquisitions eventually fail. They may create a lot of value in the short term for shareholders who want to sell, but there seems to be little benefit to long-term investors. Over the years, I have recommended the stocks of many companies that acquired other businesses, were acquired themselves, or that engaged in some sort of divestiture. When that happens, there is often a quick increase in value. I’m happy to take the gains. However, my recommendations are never based solely on the hope that these kinds of transactions will occur. In my view, if a stock is truly undervalued, it is worth owning. It may take a while before the true value is appreciated by the rest of the market, but that’s something I’m willing to wait for.

Inside The Continued Surge In Sugar ETFs

The rally in sugar prices seems to be unstoppable when most of the other commodities are finding the going tough. Its days of a supply glut ended in late August when future prices touched the lowest point since 2008. Since then, raw sugar prices at New York Mercantile Exchange recovered nearly 40% to around 14 cents per pound as of October 27, 2015, despite a surprising 1.5% fall in Tuesday’s trading session. The recent strengthening of the U.S. dollar on the back of Eurozone and Chinese stimulus measures could not derail the greenback priced commodity off the track. In fact, Morgan Stanley (NYSE: MS ) predicted raw sugar prices on the New York exchange will average 15.2 cents per pound in the final quarter of 2015 and 17.3 cents per pound in 2016. The advantage lies primarily in adverse weather conditions across the globe causing supply bottlenecks. Brazil, the world’s largest sugar producer accounting for 40% of global exports, is expected to witness above-average rainfall linked to a strong El Nino in growing regions that could disrupt the harvest, leaving a chunk of cane left to cut. Moreover, biofuel mandates and modification in energy taxation in Brazil are prompting sugarcane processors to convert cane for ethanol production instead of raw sugar, limiting its supply in the world market. According to the Brazilian Sugarcane Industry Association, or Unica, ethanol production in south-central Brazil went up 2.6% year over year to 20.2 million kiloliters while sugar production dipped 7.2% to 23.2 million tons during the April-September period. India, the world’s second largest sugar producer, is also expected to trim sugar production due to El Nino-induced drought in the region. Per Indian Sugar Mills Association, India is likely to cut its sugar output by 5% to 28.3 million tons in 2015. Other major sugar producing countries such as Thailand and China are also hit by droughts and are expected to cut sugar output. According to the International Sugar Organization and U.K. sugar trading house Czarnikow, there will be a sugar shortage of roughly 3-5 million tons in the global market for the current crop marketing year, which began this month. These apart, there are other factors that are driving the sugar price rally. China, the world’s largest importer of raw sugar, recently released data that showed a robust 80% year-over-year hike in sugar imports in September to 656,000 tons. It was the highest recorded volume since 2013, as per data from Commerzbank . Further, a recent report from Commitment of Traders revealed that hedge funds have been betting on sugar at a lower-than-expected pace, indicating the availability of surplus money to aid further rallies. Riding on the continued surge in sugar prices, ETFs that are exposed to this soft commodity have been experiencing double-digit gains over the past one month (as of October 27, 2015). Below, we highlight three of those ETFs that investors should definitely consider to play the bullish sugar market. iPath Dow Jones-UBS Sugar Subindex Total Return ETN (NYSEARCA: SGG ) SGG tracks the Dow Jones-UBS Sugar Subindex Total Return Index, which provides the returns that are in an investment in the futures contracts on the commodity of sugar. The note has garnered nearly $60 million in assets and trades in a daily volume of roughly 54,000 shares on average. It charges 75 bps in annual fees. The note was up 18.1% in the past one month and has a Zacks ETF Rank #3 (Hold) with a High risk outlook. Teucrium Sugar Fund (NYSEARCA: CANE ) This ETF tracks the Sugar Futures index, which reflects the daily changes of a weighted average of the closing prices for three futures contracts for sugar that are traded on ICE Futures US. The fund is nearly overlooked as it has gathered nearly $4 million in assets and trades in a paltry volume of around 6,000 shares. However, the ETF is expensive, charging a hefty 176 bps in fees from investors per year. It was up 12.3% over the last one month and carries a Zacks ETF Rank #3 with a High risk outlook. iPath Pure Beta Sugar ETN (NYSEARCA: SGAR ) This is another sugar ETN by iPath and follows the Barclays Capital Sugar Pure Beta TR Index. The index consists of a single futures contract but it has a unique roll structure which selects contracts using the Pure Beta Series 2 Methodology. SGAR is also neglected with only $1.5 million in AUM and is thinly traded with average volume of nearly 2,000 shares. The note charges 75 bps in annual fees and was up 17.5% in the past one month. It also carries a Zacks ETF Rank #3 with a High risk outlook. Original Post

Market Neutral Funds: The Best And Worst Of September

Market-neutral funds are a subset of long/short equity strategies. Both market-neutral and more standard long/short equity strategies combine both long and short positions in stocks to mitigate portfolio volatility and to capitalize on the downside of correctly identified underperformers. But while traditional long/short strategies typically remain net long , market-neutral funds aim to balance their long and short holdings to generate returns that are entirely uncorrelated with the broad market. Alternative mutual funds pursuing market-neutral strategies provide investors with professional security selection and portfolio management. These funds, which aim to achieve positive returns regardless of overall market conditions, eked out a tiny aggregate gain of 0.12% in September, according to Morningstar, but there were several that greatly outperformed – and others that posted significant monthly losses. Top Performing Funds in September The Invesco All Cap Market Neutral Fund (MUTF: CPNAX ) was the top-performing mutual fund in Morningstar’s Market Neutral category for September, returning +7.03% for the month. This brought the fund’s year-to-date gains through September 30 to +7.63%. In the third quarter, the fund posted huge gains of 15.01%, boosting its one-year returns to +8.64%. The fund, which debuted in December 2013, had assets under management (AUM) of $32.1 million, accounting for just a tiny fraction of the category’s $25 billion total AUM. The AQR Equity Market Neutral Fund (MUTF: QMNIX ) was the second-best performer in the category in September, gaining 5.79% for the month. The fund, which debuted October 7 of last year and had $127.6 million in AUM as of October 19 of this year, gained an impressive 14.99% in the first nine months of 2019. Finally, the Vanguard Market Neutral Fund (MUTF: VMNIX ) rounded out the category’s top-three performers with September gains of 5.11%. Unlike the other funds mentioned thus far, which have debuted in the past two years, VMNIX has a much longer track record – through September 30, the fund had generated respective three- and five-year returns of +6.19% and +4.67%, easily besting the category averages of +1.04% and +1.49%, respectively. The fund debuted on October 19, 2008 and had $446.2 million in AUM precisely seven years later. Worst-Performing Funds in September The worst-performing market-neutral mutual funds for September were: Castlerigg Event Driven and Arbitrage Fund (MUTF: EVNTX ) Visium Event Driven Fund (MUTF: VIDIX ) The Arbitrage Event-Driven Fund (MUTF: AEDNX ) The Castlerigg fund debuted in February 2015. It lost 4.72% in September and a painful 10.37% in the first nine months of 2015 – ouch! The fund had just $10.3 million in AUM, as of October 19. The Visium fund is another small and underperforming market-neutral fund. It lost 4.70% in September, barely outpacing Castlerigg, and it was down 9.14% for the year ending September 30. The Visium fund’s AUM, as of October 19, were $23.4 million. Finally, the Arbitrage Event-Driven Fund rounded out September’s list of market-neutral underperformers, with monthly losses of 3.73%. But this much bigger fund, which debuted in 2010 and had $357.5 million in AUM as of October 19, has a much longer track record than last month’s other laggards: For the five years ending September 30, 2015, the fund returned an annualized +0.63%. Unfortunately for investors who didn’t buy in before 2012, the fund’s returns for one- and three-year periods, as well as three- and nine-month terms, were all negative. Conclusion A recent white paper by Northwestern Mutual further explains the benefits and drawbacks of market-neutral strategies and market-neutral mutual funds in particular. According to Northwestern, these funds “tend to generate consistent returns that are above the historic U.S. Treasury Bill rate (3-6%) whether the market is up or down” – and this makes them particularly attractive amid the current market environment.