Mergers and acquisitions are big news lately, what with the blockbuster multibillion-dollar deals that have taken out Placer Dome Inc., Dofasco Inc. and Falconbridge Ltd. While many fund managers look for stocks that may become juicy takeover candidates, only one specializes in tracking down potential targets.

John Campbell, manager of the $500-million Investors Mergers & Acquisitions Fund and president and CEO of Vancouver-based Camlin Asset Management Ltd. , scours the equity universe for eligible candidates.

“It’s a pre- and in-play mergers and acquisitions fund,” says Campbell of the offering from Winnipeg-based Investors Group Inc. “We have a North American mandate, although we are moving into Europe, too.”

He concentrates on industries that are going through long-term consolidation dynamics and identifies the acquirers in the given industry. “We put ourselves in a buyer’s shoes and simulate its acquisition criteria. This allows us to identify good targets within each industry,” says Campbell.

He looks for growth-oriented franchises that are trading at significant discounts to their strategic value. “This lets us win on the fundamentals, since we’re picking good companies, and win again if the company gets bought out,” he says. “This gives us a second payday.”

Categorized as “sectoral equity” by Morningstar Canada and launched in June 2000, the “C” version of the fund returned 4.8% in the year ended Sept. 30, vs 6.7% for its peers. For the most recent three-year period, it had an average annual compound return of 15.1%, vs 10.6% for the median fund. Over five years, it returned 11.0%, vs 9.3% for the median. It has returned an average of 12.6% a year since inception, vs a flat performance by its benchmark, the MSCI North America Canadian-dollar index. (The fund has about 40% of its assets in the U.S.)

Campbell is focusing on five segments that show the most promise: U.S. financial services; Canadian oil and gas; base metals and gold firms; health-care companies; and technology firms.

The financial services group is the largest — at 30% — and reflects the opportunities in a vast U.S. banking sector that is undergoing consolidation. Campbell likes smaller community banks that are attractive to consolidators that want to buy their way to greater market share.

Campbell owns about 40 such potential takeover targets — one-quarter of the 160 names in the fund — mainly because there is uncertainty about which ones will be bought. “When one stock is put into play, the whole group moves up on speculation. We’re trying to capture that wave by having all these positions,” he says.

One holding that proved successful was Community Bancorp Inc., a San Diego-area bank. “It had excellent management and a growth orientation,” recalls Campbell.

The firm had expanded its assets to US$1 billion from US$300 million four years ago. It was recently taken out at about 4.5 times book value and 20 times earnings, vs 1.5 times book value and eight times earnings four years earlier. Campbell paid about US$6.50 a share, but got out last summer at US$40 a share in a share swap made by the acquirer, First Community Bancorp Inc.

The oil and gas sector, which accounts for 20% of the portfolio, is dominated by junior Canadian producers.

“If you pick a company with good management that is growing rapidly, it will be attractive to a larger player.” Campbell says. “Or, if it gets to a point at which it is taxable, it will convert to a trust or be taken out by one. In Canada, there are very attractive exit scenarios.”

Although not a junior, Husky Energy Inc. is a favourite holding that goes back five years. The company was very much out of favour at the time, yet Campbell saw the potential for a turnaround and expected that its main shareholder, Li Ka-shing, would sell the firm at some point.

The sale hasn’t happened yet, says Campbell: “But the company has been built out beautifully, in terms of bringing on new production.”

Husky Energy stock recently traded at $68.80 a share; Campbell paid less than $20 a share.

About 13% of the M&A fund is in the base metals and gold sector, which has done extremely well because of global demand and strong commodity prices.

“There is a very tight commodity market. At the same time, the major players have amassed huge cash reserves while their production is falling,” says Campbell. “They’re looking at buying smaller players, especially junior miners. As soon as the juniors get to the feasibility stage, they’re taken by one of the majors.”

@page_break@Campbell has more than 12 holdings split equally between base metals and gold players. One favourite is Miramar Mining Corp., a Canadian gold exploration firm that is active in the Northwest Territories and has about eight million ounces of gold in reserves.

The fourth segment consists of a 10% weighting in health-care stocks. Campbell likes medical-device firms that have sales of less than $50 million but have a product line that could be attractive to a much larger industry player. He also invests in biotechnology firms with promising drugs that are in Phase 2 or later development: “Once a small biotech firm can demonstrate it has a blockbuster drug, a major drug firm inevitably takes it out.”

Finally, in the technology sector, Campbell has about 10% invested in software firms.

“We like those that have licensing revenue, which gives the business a nice annuity,” he says. He favours niche players such as those in security or design of the so-called “Internet backbone.”

On average, Campbell holds a stock for two years. He has to wait for the growth story to play out and for the company to become a potential takeover target.

“As long as a company is increasing its franchise value and becoming more attractive, we’ll hold it,” he says, adding that annual name turnover is about 40%.

M&A activity in Canada is at record levels. In the U.S., the record was set in 2000, with US$2 trillion in deals. When the technology bubble burst, merger activity dropped by half, to US$1 trillion. But it has gradually come back, and this year could hit US$1.6 trillion, based on statistics from Bloomberg LP.

“Growth is slowing, so companies are looking to buy growth through acquisitions,” says Campbell, who tends to avoid industries such as automotive that are suffering from excess capacity.

“A cycle like this could run another three years before hitting an all-time high,” says Campbell. “Even in the mid-1990s, M&A activity was around US$600 billion. It will always be reasonably significant because of factors such as globalization and regulatory changes. As to whether synergies are created, well, that’s another matter.”

The son of an engineer who worked across the country and in Australia, Campbell has had a varied career that spans management consulting, M&A and stock analysis. In 1976, he graduated from the University of British Columbia with a bachelor of commerce in finance. Two years later, he received his chartered accountant designation and then moved into the management-consulting arm of Price Waterhouse. In 1981, he went in a different direction, having been hired as a U.S. securities analyst at Pemberton Securities, which was subsequently acquired by RBC Dominion Securities Inc.

“It was a great time to buy stocks — like shooting fish in a barrel,” Campbell says. He got involved in money management in the mid-1980s, when he helped run Pacific U.S. Growth, a DS in-house U.S. equity fund.

In 1987, Campbell made another major shift, when he was recruited as an M&A specialist by industrialist Jim Pattison, who had business interests across the continent. Among other assignments, Campbell helped look after risk arbitrage and worked in Pattison’s New York office. “Jim is a master of M&A,” says Campbell, “so it was terrific experience learning from him.”

In 1989, Campbell returned to Pember-ton to head up the research department, only to leave six months later when DS bought the firm and closed his department.

With business associate Bruce Hodge, Campbell set up CWC Capital, an investment banker that raised capital for small businesses and conducted M&As of privately held firms. In 2000, as a sideline, he approached Investors Group with the idea of an M&A fund; the firm grabbed it. After Campbell parted ways with his partners and set up Camlin, CWC was wound up, with some partners forming Pender West Capital Partners Inc.

With a team of four, Campbell also runs the $45-million Camlin Turnaround Mandate, which is in the Pioneer wrap program offered by Richardson Partners Financial Ltd. in Winnipeg. That fund focuses on so-called “fallen angels” in the corporate world.

Opportunities still abound, Campbell maintains: “There are always areas of the market that attract consolidation.” Even in the worst-case scenario, his fund is not so big that it will lack for opportunities. “We only buy companies that are growing. Even if they don’t get bought out, there is a case for appreciation.”

Indeed, only half of the fund’s 40% turnover comes from transactions by completed mergers. The other half comes from price appreciation.

Fund analyst Gordon Pape, Toronto-based publisher of the Internet Wealth Builder, rates the fund a three out of four on his online mutual fund buyer’s guide. Pape has two caveats: the fund carries a 3.3% management expense ratio on the C version; and there may also be a question of suitability.

“It’s a niche product. I can’t see how it can fit comfortably into anyone’s conventional portfolio. It’s neither fish nor fowl,” says Pape. “It’s not a core fund because of its unusual mandate.”

Dan Hallett, head of Windsor, Ont.-based Dan Hallett & Associates Inc. , expresses concern about the MER: “It charges north of 3%. That poses a challenge to make it worthwhile for people to invest in.” IE