A merger arbitrage lesson to learn

The big news yesterday was the failed merger talks between Sun Microsystems and IBM. Sun Microsystems (JAVA) lost almost 23% of its value after the news hit the street. JAVA exploded on March 17 after rumors of a potential bid by IBM made Sun’s shares 79% more expensive.

The major sticking point was that Sun Micro believed IBM’s rumored offer of $9.40 to be too low. This news should be a lesson for all would be merger arbitrageurs to never initiate a position in an arb deal before the deal has been announced officially. Without a clear written intent from both companies, there is added uncertainty whether the deal would go through in order for the arbitrageur to close their position at a profit. That’s why arbitrageurs should expect higher risk adjusted returns if they waited for the official announcement of the deal before deciding whether the deal is worth participating in or not.

Another example of a badly timed merger arb play was the talks between Yahoo (YHOO) and Microsoft (MSFT) early in 2008. Back in February 2008, MSFT proposed to acquire YHOO for $31/share, which was a 62% premium to the closing price for the dot com company. After the announcement Yahoo jumped by 48% to 28.38. Check out my analysis of MSFT.

After three months of uncertainties however Microsoft decided that Yahoo (YHOO) valued itself too much and withdrew from negotiations, sending Yahoo shares down 15% for the day. Investors and institutions which bought Yahoo (YHOO) stock around $28.38 expecting to make an easy 9% gain were hugely disappointed.

As always, once the intent of BOTH companies is announced in favor of the deal and all the details have been accepted by both companies, should one consider initiating a merger arbitrage play. Otherwise, you would be speculating, which is not what Ben Graham and Warren Buffett preach as a winning investment philosophy.


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- Warren Buffett – The Ultimate Dividend Investor
- 40 Value Stocks that Graham Would Buy
- Arbitrage Opportunities – CEG and ROH
- Microsoft (MSFT) Dividend Stock Analysis

Dividend Stocks in the News

There were few dividend increases last week. The companies that raised their payments were WSO, EWST and MFA.

Energy West (EWST) raised its monthly dividend payment to $0.045 from $0.04. The distributor and seller of natural gas to end-use residential, commercial, and industrial customers in the United States has been consistently raising its dividends since 4Q 2005 and currently yields 6.80%.

MFA Financial (MFA) raised its quarterly dividends to $0.22/share from $0.21. The company primarily invests in mortgage-backed securities (MBS) that include hybrid and adjustable-rate MBS (ARM-MBS). The dividend is pretty volatile and despite the high current yield of 14.30%, it doesn’t seem worthy of income consideration at this moment.

Watsco (WSO), which distributes air conditioning, heating, and refrigeration equipment, raised its quarterly dividends for a 6th year in a row to $0.48/share. The 5 year average dividend growth is 36.1% annually. WSO would be an interesting addition to a dividend growth portfolio if it reaches a 10-year streak of consistent dividend increases 3 years from now. The stock currently yields 4.90%.

Despite the slow week for dividend increases, I am looking forward to a busy April, since historically some well-known dividend aristocrats tend to raise their dividends during the current month.

Johnson & Johnson (JNJ) has raised its dividend every April over the past five years. This dividend growth stock has been raising dividends for 46 consecutive years and has a 5 year dividend growth rate of 14.10%. (analysis)

Procter & Gamble (PG) has raised its dividends every March or April for the past four years. This dividend aristocrat has been rewarding shareholders with a rising dividend for 55 consecutive years. PG has a 5-year dividend growth rate of 10.94%. (analysis)

Exxon Mobil (XOM) has raised its dividends in April during four of the last five years. The oil giant has rewarded stockholders for 26 years with an increasing stream of dividend income. The five-year dividend growth rate for XOM is 9.49%. (analysis)

W.W. GRAINGER (GWW) is another dividend aristocrat which has increased its dividends in every in April over the past five years, while achieving an annualized dividend growth of 17.08%. GWW has a 37-year record of consecutive dividend increases. (analysis)

Full Disclosure: Long JNJ, PG, and GWW

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- Selected Dividend Increases in April

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3M (MMM) Dividend Stock Analysis

This article originally appeared on The DIV-Net one week ago.

3M Company, together with its subsidiaries, operates as a diversified technology company worldwide. It operates in six segments: Industrial and Transportation; Health Care; Safety, Security and Protection Services; Consumer and Office; Display and Graphics; and Electro and Communications.
3M Company is a major component of the S&P 500 and Dow Industrials indexes. The company is also a dividend aristocrat, which has been consistently increasing its dividends for 51 consecutive years. From the end of 1998 up until December 2008 this dividend growth stock has delivered an annual average total return of 7.30% to its shareholders.

At the same time company has managed to deliver an impressive 9.40% average annual increase in its EPS since 1999. In 2008 the EPS fell by 12%. The expectations for 2009 are for another drop in EPS to almost $4/share and an increase in 2010. Over the long run however, earnings for this conglomerate are relatively diversified which is a decent buffer during recessions.

The ROE has remained largely between 29% and 38% with the exception of a temporary dip in 2001 to 23%.

Annual dividends have increased by an average of 6.70% annually since 1999, which is lower than the growth in EPS. Most recently the company increased its dividends by 2% to $0.51/quarter. MMM typically enjoys a slow dividend growth during tough economic conditions, while compensating with stronger dividend growth during boom times. 3M’s dividend is safe, given the strong cashflows that the company generates from its diversified businesses.

A 7 % growth in dividends translates into the dividend payment doubling almost every ten years. Since 1973 3M has actually managed to double its dividend payment on average almost every nine years.

The dividend payout has steadily decreased over the past decade; due to the fact the dividend growth was much slower than earnings growth. Currently the payout is a little over 50%, which good. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

3M is currently attractively valued. The stock trades at a P/E of 10.5, yields 4.20% and has an adequately covered dividend payment. I would be a buyer of 3M at current prices, as long as it does not increase above $68.

Full Disclosure: Long MMM

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S&P Dividend Aristocrats under performing S&P 500 in 1Q 2009

S&P 500, which is the benchmark against which most money managers track their performance, lost 11.67% in the first quarter of 2009. The S&P Dividend Aristocrats however underperformed the benchmark by almost 2% after losing 13.84% in the first quarter. Now if we add dividends to the picture the S&P 500 loss drops to 11.01% while the loss for Dividend Aristocrats decreases to 12.90%.

The average performance of S&P 500 dividend payers was much lower than non-dividend payers in the S&P 500 for the first quarter -12.99% versus – 0.23%. The S&P is expecting dividends on the S&P 500 to drop to $21.92 in 2009 versus $28.39 in 2008. With expectations for dividend cuts across the board, investors who are looking to scoop bargains at depressed prices are seeing lots of opportunities. In their fear of dividend cuts some investors are putting all dividend payers in one basket. Just because one sector cut its dividends however, does not mean that all sectors will cut dividends. There are certainly dividend stocks, which won’t cut their dividends anytime soon. Some are even increasing them, despite the “worst crisis since the Great Depression”. Long term investors who focus on the big picture instead of focusing on intraday ticks would most likely be rewarded with double digit yields on cost two decades from now. Companies with wide moats, which have strong competitive advantages that enable them to reward shareholders with consistent dividend growth, have outperformed the S&P 500 over the past 20 years.

You could find the year to date performance of all dividend aristocrats in the table below:

The best performers so far this year include discount retailer Family Dollar (FDO), chemicals companies Rohm and Haas (ROH) and Air Products and Chemicals (APD) as well as the drug store chain Walgreen (WAG).

Some of the worst performers include this years dividend aristocrats, which have cut their payments to shareholders. Names like Ganett (GCI), General Electric (GE), US Bancorp (USB), Pfizer (PFE) and State Street (STT) are some of this years worst performers. The companies will certainly be booted out of the index by the end of the year.

One of the flaws in the S&P Dividend Aristocrats index is that it keeps any dividend cutters in the list until the annual rebalancing in December or until the stock is dropped from the S&P 500.
Full Disclosure: Long FDO, ROH, APD, ED, MHP, KO, ADM, PEP, WMT, CLX, ABT, ADP, GWW, JNJ, MCD, KMB, SHW, MMM, CB, DOV, MTB, CINF

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- Why do I like Dividend Aristocrats?

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Best High Yield Dividend Stocks for 2009-1Q Update

Back in December 2008 several US and Canadian Bloggers provided four of their best stock picks for 2009. The rules of the stock-picking contest do not allow actively trading stocks. The performance of the individual bloggers’ picks is reviewed every quarter.
You might recall that I selected four high yielding dividend stocks from different sectors which I believed have sustainable dividend payments for 2009. Check out my original post for the rationale behind my picks.

Realty Income (O) closed 2008 at $23.15. At the current price of $18.82 plus the $0.42525 in distributions collected during the first quarter the investment in the owner of commercial retail real estate properties in the US is underwater by 16.90%. This dividend achiever, which has consistently increased its distributions multiple times/year since 1994, currently spots a very attractive 9.50% yield. Check out my analysis of Realty Income.

Kinder Morgan Energy Partners (KMP) finished 2008 at $45.75. At the current price of $46.72 plus the $1.05 in distributions collected during the first quarter the investment in the owner of energy transportation and storage assets in the US is up by 4.40%. This dividend achiever, which has consistently increased its distributions several times/year since 1997, currently spots a very appealing 9.00% yield. Check out my analysis of Kinder Morgan.

Consolidated Edison (ED) ended 2008 at $38.93. At the current price of $39.61 plus the $0.59 in dividends collected during the first quarter the investment in this provider electric, gas, and steam utility services has gained 3.30%. This dividend aristocrat, which has consistently increased its distributions several times/year since 1975, currently spots an attractive 6.10% yield. Check out my analysis of Consolidated Edison.

Phillip Morris International (PM) finished the year at $43.51. At the current price of $35.58 plus the $0.54 in dividends collected during the first quarter the investment in manufacturer of cigarettes and other tobacco products in markets outside of the United States of America is underwater by 17%. This dividend stock currently spots an attractive 5.60% yield.

Overall the four dividend stocks that I picked lost 8.30% so far in the first quarter of 2009; if you add in the dividends received over the first quarter of the year the total return improves to a negative 6.50%. In comparison S&P 500 lost 11.25% in the first quarter of 2009.

Check out the performance of the other bloggers year to date returns in the table below:

Rank

1 Intelligent Speculator 4.33%

2 The Financial Blogger -0.94%

3 FourPillars -2.67%

4 Million Dollar Journey -2.96%

5 Dividend Growth Investor -8.27%

6 WildInvestor -8.90%

7 Wheredoesallmymoneygo -21.77%

8 ZachStocks -24.19%

9 My Traders Journal -27.54%

I would like to reiterate the fact that in order to generate dividend income for the long run, a more diversified portfolio consisting of at least 30 stocks should be constructed. Check out the Best Dividend Stock for the Long Run list, which is a good addition to today's post.

Full Disclosure: Long ED, KMP, O, and PM

Relevant Articles:

- Best High Yield Dividend Stocks for 2009
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- Kinder Morgan Energy Partners (KMP) Dividend Analysis
- Realty Income (O) Dividend Analisys
- Consolidated Edison (ED) Dividend Analysis