The surest way to profit from takeover speculation in the stock market is to bet it's wrong.
Electronic news services, brokerages and newspapers reported at least 1,875 rumors about potential buyouts of 717 companies between 2005 and 2010, according to data compiled by Bloomberg. A total of 104, or 14.5 percent, was acquired, the data show. While stocks that were the subject of takeover speculation initially jumped 2.9 percent, betting on declines yielded average profits of 1.2 percent in the next month, an annualized gain of 14 percent.
Opportunities to employ the strategy are increasing as mergers recover from the worst recession in more than 70 years, data compiled by Bloomberg show. After bottoming in 2008, the number of unconfirmed stories about possible mergers surged 71 percent to 611 last year from 2009, data compiled by Bloomberg from more than 50 news providers and brokerages show.
"Sell into the strength," said John Orrico, who focuses on mergers and acquisitions at New York-based Water Island Capital, which oversees about $2.2 billion. "We see it as an opportunity to sell if we think the rumor is false or ridiculous, which in most cases they are."
Short selling is the sale of borrowed stock in the hope of profiting by buying the securities later at a lower price and returning them to the shareholder.
Short selling to speculate on declines on supposed takeover targets produced more than twice the average return generated by U.S. stocks, data compiled by Bloomberg show. At the same time, companies in the Russell 3000 Index had the same chance of being acquired in any 12-month period since 2005 as those that were the subject of merger stories, the data show.
Stocks tracked by Bloomberg fell 0.2 percent, 0.6 percent and 1.2 percent on average in the day, week and month following a rumor report, Bloomberg data show. The S&P 500 rose 0.03 percent, 0.2 percent and 0.5 percent on average during the same periods.
The 14 percent annualized profit from short selling compares with a 6.2 percent yearly return since 1900 before dividends for U.S. stocks, inflation-adjusted data from the London Business School and Credit Suisse Group in Zurich show.
Akamai Technologies has been the subject of more buyout rumors than any other U.S. company since the start of 2005, data compiled by Bloomberg show. The provider of computing services that speed delivery of Internet content remains independent after being named 21 times.
The most recent instance was Dec. 16. After rallying 1.7 percent when the speculation was reported, shares of the Cambridge, Mass.-based company lost 3.8 percent in the next week as the S&P 500 gained 1.1 percent.
A telephone call and e-mail to Jeff Young and Jennifer Donovan, spokesmen for Akamai, weren't returned.
"Don't chase rumor stocks," said Michael Vogelzang, Boston-based chief investment officer at Boston Advisors. "You never know where you are in the chain, whether you're the first to hear it or the last. You're just playing with fire because you know if it doesn't work out, it's going to come down."
Netlist Inc., a maker of computer-memory systems, rose 1.9 percent when rumors were reported on Dec. 28, 2009, that Microsoft might buy the Irvine, Calif.-based company. The shares declined 2.2 percent a day later, 9.4 percent a week later and 31 percent in 30 days.
Jill Bertotti, a spokeswoman for Netlist at Allen & Caron Inc., declined to comment.
By the time market chatter is publicly reported, it's been passed around trading desks via instant messages and e-mail and is usually old news, according to Todd Salamone, an equity analyst at Schaeffer's Investment Research in Cincinnati. Profiting from the reports is impossible because shares already have rallied, he said.
"I don't know where that stuff comes from," he said. "The rumors tend to create a pop, and eventually the fundamentals and technicals take over, especially in those situations that prove to be only rumors. It's a very short-term event."
"The question that remains unanswered is where does the takeover story originate," said Michael McCarty, managing partner at Differential Research LLC in Austin, Texas. "It's most likely from someone who's interested in selling."
Deliberately spreading false rumors may violate securities laws, especially if the intent is to sway prices, said James Cox, a professor at Duke University School. But proving a market-manipulation case is difficult, according to Peter Henning, a law professor at Wayne State University in Detroit and a former federal prosecutor.
"You might be able to see a unicorn before you see a market manipulation case established based on rumors," Henning said. "It's so difficult to pin down, and even if you can, to try to link them. You get lots of investigations announced and very few cases brought."
Short selling rumors "is not a bad strategy," said Mark Yusko, the Chapel Hill, North Carolina-based president of Morgan Creek Capital Management, which allocates about $10 billion to hedge funds. "The data confirms a lot of things that we've seen as we've gone through the last 20 years of information access and availability. As information has become ubiquitous, it is very difficult to separate the real information from the fake."
