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Spot
Takeover (Buyout) Targets
Stock research & analysis
Even in this
market, you usually make money if you are lucky enough to hold a stock
when the underlying firm is bought out.
For instance,
golf course owner National Golf Properties, a real estate investment
trust, was losing money and a potential bankruptcy candidate when it
agreed to be acquired by an investment group for $12 per share last
Monday. National Golf had been trading at $8 or so before rumors of the
impending buyout pushed it up to the $10-$11 range a couple of months
ago.
There are two
different types of firms that typically acquire companies.
A buyout
firm, organized specifically to seek out undervalued and usually
distressed companies that they can rejuvenate and then bring public
again, purchased National Golf. The process is similar to a real estate
investor who buys a rundown house, fixes it up, and then resells it.
The other
type of acquirer is a growth company that employs acquisitions as a part
of its expansion strategy.
Your
procedure for identifying acquisition candidates depends on the type of
acquiring firm that you have in mind. We’ll focus on identifying
companies of interest to buyout firms.
Rules for
Takeover (Buyout) Candidates
Jon Markman, managing editor of the CNBC/MSN Money financial site,
described an approach for uncovering buyout firm acquisition candidates
in a July 31 article. In the article, provocatively titled “Feast
along with the buyout vultures,” Markman defined characteristics that
make takeover candidates attractive to buyout investors.
For example,
when making an acquisition, buyout firms typically invest only 35
percent of their own funds and borrow the rest according to Markman. So
a takeover target must have a solid balance sheet and strong cash flows
to support the added debt the investors will need to complete the
buyout.
Markman says
experts advise individual investors seeking takeover targets to
concentrate on “small to medium-sized industrial manufacturers or
service companies whose depressed shares are largely controlled by a
single family or organization.”
Screen for Takeover Candidates
Markman devised a search using MSN Money’s screening program that you
can use to identify takeover candidates. The screen specifies a $100
million to $1 billion market capitalization to pinpoint small to
mid-sized candidates. He covers the high cash flow requisite by
requiring a maximum (stock) price to cash flow ratio of three. Markman
calls for a maximum debt to equity of 1 to satisfy the strong balance
sheet condition.
You can run
Markman’s screen at any time. Starting from MSN Money’s main
investing page at moneycentral.msn.com/investor,
find his buyout article by selecting SuperModels (left menu), clicking
on “More”
under Recent Articles, and then selecting the 7/31/02
article. Once there, look for the Buyout
Candidates link in the left-margin.
Markman’s
search listed 8 stocks when he wrote the article, but it turned up 36
takeover prospects when I ran it last week. That was too many to
research, so I made a couple of modifications to his screen.
Many experts
consider that debt/equity ratios above 0.5 signals high-debt, so
Markman’s 1.0 maximum debt/equity ratio requirement may be too
lenient.
Further,
since Markman said that investors should look for companies with
depressed stock prices, I added a condition requiring that passing firms
have current stock prices no higher than 60 percent of their 52-week
high.
I don’t
have room to explain the workings of MSN Money’s screening program,
but these changes are easy to do if you start with Markman’s existing
screen, and follow the directions in the Help file.
Changing the
maximum debt/equity ratio to 0.5 and adding the maximum stock price
requirement cut the list down to only 11 candidates. Here's
a link
to the modified screen.
Of those,
only three, building material producer USG Corporation, financial
services provider Metris Companies, and parcel company Airborne, Inc.,
fit in the manufacturing or services provider categories that Markman
said were preferable.
Of the three,
Metris had the most insider ownership (43 percent). That much insider
ownership is a good sign that just a few shareholders control large
blocs of shares. You can see the insider ownership totals by clicking on
a ticker symbol in the screen results, and then selecting
“Ownership” from the left-menu. USG Corporation is problematic,
since the firm, although solvent, filed bankruptcy in June 2001 to avoid
asbestos litigation.
Spotting
potential acquisition candidates takes time and patience. There is no
way of knowing when a company will be acquired, and many promising
prospects will not be acquired.
published 9/22/02 |
