Markets

How To Profit From The Latest Mega Merger

Steeped in rich history, DuPont (NYSE: DD ) and Dow Chemical Co. (NYSE: DOW ) the massive chemical companies responsible for the development of everything from gunpowder to plastics to pesticides and other agricultural products recently announced plans to merge. Subject to regulatory approval the deal will give shareholders from each company roughly 50% ownership of the new company's shares.

The deal alone is not a shocking development. The two companies have been in talks for years about a possible merger.

It's what this new company will do after the completion of this merger that may have many scratching their heads.

The combined company, to be named DowDuPont, will immediately begin disbanding the moment it begins running as one business.

You see, right now, each of the two separate companies operates a number of separate businesses.

Like I mentioned, Dow and DuPont make a multitude of agriculture products, specialty chemicals for manufacturing and paints, sealants and insulation products for consumers, and that's only the tip of the iceberg. There are hundreds - likely thousands - of different products sold be each company if you were to list them all.

Obviously, when dealing with such a large array of manufactured goods, there's bound to be certain productivity gains and losses when considering an alliance. That's where this merger and its eventual dissection come into play.

Manufacturing these types of products can be extremely costly. It requires massive facilities and expensive machinery to be able to make these products on a large scale. That doesn't even account for the tens of thousands of employees it takes to churn out and package these products.

By combining forces - facilities, equipment and workforces - DowDuPont will save an estimated $3 billion in the first 24 months of its creation.

However, there's a downside to all those products. You don't exactly shop at Home Depot for both deck sealant and the rare and costly chemicals used in modern electronics. Those are two far different industries and customer bases.

That's why in order for the two companies to take advantage of the synergy and cost savings that such a merger can bring DowDuPont will look to spin off its various operations. It'll likely separate into three independent companies: one for its agricultural products, another for its material sciences (like plastics and packaging solutions) and a final company for its specialty products like its high-end electronic parts manufacturing.

As you can see, this idea of merging just to disband does make sense. More so, it will likely result in a great amount of profit and growth for those involved.

The question investors should be asking themselves is what's the best way for me to profit?

Both companies have a market cap of approximately $59 billion.So as of right now, there's no real arbitrage to be gained by buying one over the other ahead of the merger. And there won't likely be any until the deal is closed.

That doesn't mean there won't be money to be made.

The Unique Way To Play This Deal

Multiple studies have a compelling argument for large-scale mergers like this one. For example, both the 1992 Journal of Finance report The Post-Merger Performance of Acquiring Firms: A Re-examination of an Anomaly and the 2001 University of Alabama and University of Pennsylvania study The Post-Merger Performance Puzzle , show that the stock of a company after a big merger significantly underperforms the rest of the market .

Now, without going into all of the minute details, suffice it to say that investor optimism prior to the completion of the deal has more to do with the post-merger performance than the actual business profits and losses. In other words, investors gamble big prior to a deal's completion, sending shares up too high.

That too creates an opportunity, however.

When shares that are overbought suffer their inevitable selloff, it often creates buying windows. Just as investors overbuy a stock on its upswing, they oversell on their downswing.

Management at both Dow Chemical and DuPont have stated that they believe it will take about 24 months AFTER the completion of this deal to realize all of the cost savings. Therefore, your buying window will be between the initial selling wave following the merger and the beginning of the spinoff process of the three eventual independent companies.

The spinoffs themselves will create healthier businesses that focus only on their niches, rather than a paint company messing around with a fertilizer company as it now stands.

So you can see how this all might play out.

Right now, there's a wave of positivity surrounding this deal. That optimism will spike right around the time DowDuPont begins trading next year -- likely in the second half of 2016.

Once those new shares of the combined company begin trading, studies point to a general selloff, or at least substantial profit taking.

When that happens, you'll have an opportunity to buy shares of DowDuPont on the cheap, ahead of the short-term stock boost that will likely come with the inevitable spinoffs.

So the best advice I have on how to play this merger is to wait six-to-18 months after its completion. Buy shares at that point and then wait for the separation of its businesses, which could send your shares up higher from there.

Investing in companies that are involved in mergers and acquisitions like this might sound like fun, get-in get-out profit opportunities. But as you can see, sometimes the best way to play them is by employing patience.

Risks to Consider: Just because scholarly studies point to one outcome happening more often than another, doesn't mean it's an exact science. Shares of DowDuPont could skyrocket in price and never look back once it hits the NYSE trading floor. If that happens, this opportunity I'm predicting might never come about. However, if that's the case, you'll have lost nothing by being patient.

Action to Take: Be on the lookout for a selloff following the completion of DowDuPont. If that happens, and there's no piece of corporate news that would change the likelihood of the planned spinoffs, buy shares of the new company. You'll likely see them head back up in price with each successive spinoff announcement.

P.S. Thanks to a loophole in our tax system the newly formed DowDuPont will be able to pursue the separation of its three independent companies through tax-free spin-offs. But large multi-national companies aren't the only ones who can benefit from this "Legal Tax-Evasion." In fact, there are a handful of companies that allow investors to legally skip out on costly tax penalties. We've put together a special "legal tax-evasion" guide with all the details including the names and ticker symbols of several companies. Go here to access the guide .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.