The main point to note is that most bids are made at a premium to book value to tempt existing equity holders to part with their paper. However, if a company is being valued below book value in the first place, then we can get a double whammy of gains when it is taken over. That's because we benefit from both the share price discount to book value, implicit in the price we paid when we first acquired the shares, being realised as well as the premium to book value the acquirer is willing to pay.
We can also make money by playing the bid arbitrage game by buying shares in companies where there is a good chance of a formal bid being launched once the company has announced it is in bid talks after receiving an indicative offer from a suitor. To make life easy, Investors Chronicle publishes a list of all live bid situations on a weekly basis to cast your eye over.
Therefore, in any bid situation it's imperative to weigh up the risk:rewards to ascertain whether the risk you are taking on by buying shares in a target company after the initial bid approach has been made, but before a formal bid is launched, offers you adequate compensation. To do this you have to work out whether the difference between a bid target's share price and likely level of a recommended offer is wide enough to compensate for the risk that a formal bid may not materialise and how much the target’s share price would fall in that event.
We certainly do, which is why earlier this year we recommended buying shares in African oil explorer Cove Energy (COV) after three bidders made takeover approaches. True, sometimes the bid doesn't go through even after a formal bid has been launched, as was the case with my advice to buy shares in Goals Soccer Centres (GOAL), but more often than not there is a profit to be made playing the M&A game.
