Event-driven investing: Hunting for yield

The country has seen historically low levels of M&A in the years since the 2008 financial crisis, as companies hoard cash on their balance sheets, focusing on consolidation. But recently, there have been signs business confidence is growing once more.

In February, Warren Buffett announced his Berkshire Hathaway fund would buy Heinz alongside funding from 3G Capital, in a deal worth $28bn. Since then, the market has seen a flurry of corporate activity which has seen investors benefit from higher payouts.

Microsoft raised its dividend by 22 per cent ahead of its agreement to buy Nokia’s mobile phone business in September, and committed to a $30m share buyback programme. Meanwhile, investors will be able to buy a share of the rapidly expanding social networking site Twitter, which has announced its intention to float on the stock market for an estimated $1.5bn

On the flipside, companies that have been bought could see their dividends coming under pressure.

Blackberry, which has been struggling to keep pace in the smartphone market, has recently made a buyout deal with a consortium of Canadian investment companies, causing its share price to fall and leaving some shareholders asking why the remaining cash in the ailing company was not distributed to them instead.

Cultural changes

Henry Sanders, lead manager of the Aviva Investors US Equity Income Fund II notes that the majority of this activity was coming from the technology sector, which while not traditionally an area investors look to for income was becoming a key source of yield.

“The technology sector has historically not been dividend rich but now just about every tech company yields,” he says.

He singles out Qualcomm, the semi-conductor manufacturer, as being in a good position to raise its yield as it holds lots of 3G patents.

Mr Sanders also thinks the attitude of American companies generally towards paying out to investors has changed.

“The convention was that the less dividends companies paid out the faster they grew, as they were using their cash for other activities. But actually research shows the companies that are more disciplined with their cash and have a culture of paying dividends can grow quicker, and are often less volatile.”

Paul Atkinson, head of US equities at Aberdeen, reports the same cultural change.

“Increasingly companies are willing to pay out higher proportions of their cash flow through increasing dividends or buybacks,” he says, noting that 90 per cent of the companies in his North American Income Trust had grown their dividend in the past 12 months.

“There’s lots of discipline going into what boards and CEO’s want to do with these high levels of corporate cash flow. They are being prudent and making sure there’s enough cash for maintenance and growth of cap ex, which we hope will increase,” he suggests.

Looking to listings

Felix Wintle, manager of the Neptune US Opportunities fund, said he will look to invest in Twitter when the IPO takes place, if it is a fair value.

“We don’t know anything about the pricing yet but but if it is reasonable, absolutely,” he said, adding that another social media company, Facebook, had struggled with its IPO and had not been priced competitively.

“Facebook underperformed because people worried it could not monetise its mobile business. Twitter already gets half its revenue from the mobile side, and if its a reasonable price than it could be an interesting proposition,” the manager explains.

Mr Wintle sees these stock market flotations as indication investors are prepared to be less conservative with their investments.

“Lots of IPOs is a good sign-those that have come to market are really oversubscribed. Risk appetite is there to take on these IPOS and we have not seen that for many years”.

But Ben Seager-Scott, senior analyst at BestInvest, argues investing in technology companies in the current climate is a double-edged sword, as while they are usually cash rich, a large proportion needs to be spent on innovating new products if the company is to continue to be profitable.

“These large tech firms have to be cutting edge or they get left behind. That’s exactly what happened to Nokia - it failed to keep up with the Smartphone market,” the analyst says.

Risks

He adds that even if a company is building up a lot of money on its balance sheet, that does not necessarily mean investors will receive a payout.

“A lot of investors worry they [the company] could do something stupid with the a windfall. There’s a risk they are not buying something because they really need it, but to be seen to be doing something with the cash.”

However, David Lebovitz, market analyst at JPMorgan Asset Management, agrees with Mr Wintle that these recent events are positive for investors.

“From a macroeconomic standpoint, the news flow over the last few weeks is a good sign. There was all this cash on the sidelines but now improving data in Europe and in emerging markets means people are more confident about what lies ahead,” he says.

“There are early signs M&A is starting to pick back up again, while companies with equity outstanding can make stock more attractive by offering more yield - they have just started paying out a little bit more”.

But he adds that choosing to invest based on an ‘event-driven’ strategy is “a risky approach to take”.

“We have managers looking for corporate restructuring and M&A that could send the share price one way or the other, and there have been some big headline events in the last few weeks. Its a complement but should not be a sole source of returns because its difficult to predict payouts,” he said.

“It’s important to keep in mind that these are big events and what they will produce down the road is difficult to predict. They could pay bigger dividends down the line, but the crystal ball is broken”