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Jubak's Journal Recent articles: • 3 stocks riding the big trends of 2006, 1/13/2006 • The big winners of Dow 11,000, 1/11/2006 • How a Fed halt could hurt you, 1/10/2006 More... | Jubak's Journal Cash in on the great buyout boom Buyout firms are now attracting billions to buy up underperforming companies -- and inspiring corporate bosses to do better. Here's how you can profit from the buyout binge now. By Jim Jubak Last year private buyout groups raised a staggering $106 billion, the most ever and a 90% increase over 2004. This year stands a good chance of beating that record. And in 2005, investments in value stocks outperformed investments in growth stocks. I think value will beat out growth again in 2006. The explanation for the better returns from value stocks is pretty simple: So much money has been raised for hedge funds and buyout funds that corporate management at any underperforming company is really under the gun. Improve your company's performance, the activist investors demand, or we'll improve it for you. Add in a huge spike in merger-and-acquisition activity and you have a value investor's dream: No more waiting for years until some catalyst finally forces the stock market to recognize the true worth of an undervalued company. Right now, that catalyst -- in the form of a buyout offer or a demand from a hedge fund -- is likely to arrive in a matter of months.
Getting management's attention Think that's overstated? Look at the drama unfolding at Borders Group Related news and commentary on MSN Money
The only thing they had been waiting for is for the company to announce its holiday sales: Weak sales would make the company more vulnerable to a bid -- and at a lower price -- while higher sales might convince management to fight back, or at least hold out for a higher price. Borders announced those numbers after the market close on Jan. 11 and forecast fourth-quarter earnings of $1.70 to $1.80 a share, up from the previous estimate of $1.60 to $1.80 a share. The next day saw the stock jump 10.2%. You don't think management was, how shall I put it, motivated to do everything it could during the holiday season to pull in every last dollar of sales? The Borders Group story isn't an isolated one. Last year, Toys "R" Us and Neiman Marcus were purchased by private buyout companies. Last week Burlington Coat Factory Warehouse Catalysts, flush with cash The amount of money raised for private buyout funds is staggering. In March, the Carlyle Group raised $7.85 billion for a U.S. buyout fund, the largest buyout fund ever -- at that time. This month, either Kohlberg Kravis Roberts & Co., now raising $10 to $12 billion for a new buyout fund, or the Blackstone Group looking for up to $13 billion for a new fund, will take the title. In 2005, U.S. private-equity groups raised $152 billion, an increase of 65% from 2004, according to "Dow Jones Private Equity Analyst." Of that, $106 billion went to buyout funds, the most ever, and 90% more than 2004's total. And that's not the end of the money available to incentivize CEOs to improve their company's performances. Last year was the most active worldwide since 2000 for mergers and acquisitions, with more than $2.7 trillion in deals, Thomson Financial says, up 38% from 2004. And it's different this time: Unlike 2000, when companies used their stock to acquire other companies, in 2005 they used cash. Only 11% of the year's deals were all-stock transactions. Some of that cash has come from accumulated earnings on company balance sheets, but more has come from the sale of new debt in the bond market. For example, Oracle The result of all that money jumping up and down on the managers of underperforming companies until they either performed or were bought out was that in 2005, value investing strategies outpaced growth. And the bigger a stock's market capitalization, the more value outperformed. At the small-cap end of the stock market, the Russell 2000 Value index ($RUJ.X) outperformed the Russell 2000 Growth ($RUO.X) index for the year, 4.71% to 4.15%. At the large-cap end, the Russell 1000 Value ($RLV.X) index beat out the Russell 1000 Growth index ($RLG.X), 7.05% to 5.26%. And at the very top of the market-cap pyramid, the Russell Top 200 Value index raced ahead of the Russell Top 200 Growth index, 4.6% to 2.88%. This year, the Russell 200 Value index was up 3.09% through Jan. 12, and the Russell 200 Growth index was up 2.76%. Value is outperforming growth even as the stock market stages a textbook January rally. Riding the backs of the buyout artists So how do individual investors put all this buyout cash to work for them? Find value stocks where an activist buyout fund has taken a stake. Take a look at Copart The stock is now trading at around $24 a share, with a trailing 12-month price-to-earnings ratio of 22. That strikes me as cheap for a company with projected earnings growth of nearly 10% in fiscal 2006 and 16% in fiscal 2007. The company, which owns about 30% to 35% of the salvage processing market, generated $315 million in operating cash flow in the last four quarters. The stock is cheap because the company missed October-quarter earnings forecasts due to Hurricane Katrina's effect on the salvaged vehicle market. But what makes this a value stock rather than a cheap growth stock is the balance sheet and the value of the company's Internet auction system. At the end of the October 2005 quarter, Copart had $255 million in cash and other short-term investments on its balance sheet (and no long or short-term debt). Not too shabby for a company with a market capitalization of just $2.2 billion. The company is working to secure patents on its new Internet auction platform, VB2, which employs a technology that could be applied to other markets, according to Wall Street analysts. The market has been reluctant to put a value on Copart's VB2 platform, however, because the company has been sued for patent infringement by a competitor. Looking for a catalyst? It's reassuring to see Jana Partners in the list of Copart's institutional owners on our site. Jana Partners owned 3.1 million shares as of Sept. 30 and had bought 370,000 shares since the end of the previous reporting period, our ownership tool shows. Jana Partners is one of the private equity groups that has piggybacked on Carl Icahn's attempt to force Time Warner Tilting the playing field Sorting through ownership lists on CNBC.Com on MSN Money one value stock at a time looking for a private equity fund to show up on the page is extremely time consuming. But you can at least narrow the search if you remember what the buyout groups themselves look for in an investment, including:
But by aligning yourself with the buyout boom, you've put one more financial-market trend to work for you. That always helps. There's no point to investing on a level playing field, after all, unless you absolutely have to. In my next column, I'll take a look at the dark side of the current buyout boom and why some savvy investors are already starting to think of ways -- maybe as early as 2007 -- to profit from picking up the pieces after the boom goes bust. Updates Buy Copart I first came across Copart in June 2004 while doing the research for my weekly stock picks for CNBC's "Morning Call." Since then, the stock has been as high as $27 and as low as $18. More recently, the shares bottomed at $22.70 in December on news that the damage from Hurricane Katrina had disrupted operations in the automobile-salvage business enough that the company missed Wall Street earnings projections for the quarter that ended in October 2004. I like the way the stock has come back together since then, as investors have looked past the short-term hurricane-related problems to focus on Copart's 30%-35% share of the auto-salvage auction market and the likely rebound in growth in 2006 and 2007. On the strength of its balance sheet and its strong cash flow, I'd even go so far as to say that Copart is not just a cheap growth stock, but actually a value stock. That's important, because I think value will outperform growth again in 2006, and because value investors have a catalyst in the ownership stake taken by hedge fund Jana Partners. Nothing like a hedge fund breathing down your neck to focus management on improving returns to shareholders. I'm adding Copart to Jubak's Picks with a target price of $31 a share by December 2006. Sell Coach I added Coach to Jubak's Picks on April 5, 2005, in order to increase the portfolio's exposure to the retail sector. With the Christmas holiday shopping season behind us and with retail sales for December showing a possible slowdown, however, I'm reducing my exposure to this sector by selling Coach. (My other reason for owning Coach -- its growth in the recovering Japanese economy -- still makes the stock attractive. But I've recently added other exposure to Japan to the portfolio.) December sales were up 6.4% from December 2004, but that's less than the 8.7% growth in December 2004 and represents a tiny seasonally adjusted 0.7% increase from November 2005. Jubak's Picks shows a 15% return from its position in Coach, which was purchased at $28.77 a share. (Full disclosure: I will be selling my personal position in Coach three days after this column is posted.) Sell Cell Genesys Sometimes you have a good idea -- buying the biotech sector because the sector looked set up to outperform -- but you simply pick the wrong horse. The biotech sector as a whole indeed is ahead -- Merrill Lynch Biotech HLDR New developments on past columns 5 growth stocks for a weak-kneed rally: I'm not surprised to get nervous e-mail from readers as Feb. 2 approaches. That's the date Pentair Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For suggestions to help navigate the treacherous interest-rate environment see Jim's new portfolio Dividend stocks for income investors. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: Cell Genesys, Coach, and Pentair. He does not own short positions in any stock mentioned in this column. | |||||||||||||||||||||||||||||
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