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Where to hunt for the new takeover plays
With stocks and the economy healthier, dealmakers' phones are ringing again. Heres where to find some potential targets.
By Michael Brush
If all the chatter about suitors going after the likes of PeopleSoft (PSFT, news, msgs), Overture Services (OVER, news, msgs) and Roadway (ROAD, news, msgs) have you thinking a new era of corporate buyouts is here, you may be on to something.
Even though the hard numbers would prove you wrong (takeovers are actually down so far this year), the pros at the cutting edge of the takeover business sense that the urge to merge is on the rise. That's good news for investors because buyouts can spell quick gains of 50% or more.
We feel like the wave is building, says Joe Krauss, a lawyer who vets deals for antitrust issues at the Washington, D.C., law firm Hogan & Hartson. Clients that have sat on their hands for a while are starting to look more closely at doing deals.
The phones ringing again, and people are picking up on transactions that had been stalled for a number of years, says Sam Rovit, who consults on mergers with Bain & Co. It is not back to where it was several years ago, but the activity level is picking up, agrees Michael J. Kollender, an investment banker with Ryan Beck in New York.
Some recent deals have rewarded investors handsomely. Shares of Roadway leaped more than 50% in one day earlier this month when a competitor announced plans to buy the trucking company.
Experts cite the following trends rekindling interest in takeovers.
- Stocks are higher. That means buyers have a stronger currency -- their own shares -- in takeover deals, says Mike Rosenberg with Barrington Associates, a Los Angeles investment bank. Besides, the economy looks like it may be heating up, so managers who were thinking of buying other companies want to do it now, before it is too late.
- Interest rates are low. So, corporate debt costs less. And many companies have cash because theyve been trimming costs and delaying capital spending. This makes it easier for them to buy, says Peter Kiernan, an attorney specializing in acquisitions at the New York law firm Ohrenstein & Brown.
- Fears about accounting scandals are easing, and potential buyers are less paranoid about hidden problems on the books.
- Antitrust enforcement by the Bush administration may be more lenient than in the past.
- Lower taxes on dividends make more equity as a currency in acquisitions more attractive.
- Small-cap companies are finding the extra costs of insurance and complying with Sarbanes-Oxley Act rules are driving overhead up to the point where going private makes more sense, says Ryan Becks Kollender.
I think all this points to a favorable time for acquisitions, says Tim Ghriskey of Ghriskey Capital Partners in Greenwich, Conn.
But what kind of mergers will play out and where? First, it's unlikely that we'll see a return of the ego-driven hostile takeovers or highly leveraged deals of the 1980s and 1990s. Instead, companies are more likely to be on the lookout for smart purchases to help them round out products and services ahead of what may be an economic rebound, says Doug Cogen, a mergers and acquisitions attorney with the law firm Fenwick & West in Mountain View, Calif.
Heres a look at how and where some possible deals may play out.
High-tech: Expanding the talent pool
Now that financing is easier and the economy may be picking up, many companies are likely to go on a buying spree because they recognize its easier to purchase the expertise or product lines they need, rather than start from scratch.
Takeovers done to build out an engineering bench make a lot more sense than simple plays for market share, like the proposed purchase of PeopleSoft by Oracle (ORCL, news, msgs), says Jim Goodnight, the chief executive of SAS, a Cary, N.C., software company. SAS, a private company that makes business analytical software used in managing risk or beating fraud, has recently made purchases of its own to build out its technology base. And Goodnight expects more to come in the software space. It has been a rough couple of years for most software companies, and cash is running out, he says.
That makes many companies potential targets of big players like Oracle, which has put together a team to look at acquisitions, or Computer Associates (CA, news, msgs), an active acquirer for many years. Any vendor of size will be looking for acquisitions, says Brent Williams at McDonald Investments in Cleveland.
Who are some other potential targets?
Vinson Walden, a portfolio manager at Thornburg Investment Management in Santa Fe, N.M., thinks Eclipsys (ECLP, news, msgs) could make a good fit inside the medical services division of General Electric (GE, news, msgs), McKesson (MCK, news, msgs) or Siemens (SI, news, msgs). Eclipsys produces software used to keep medical records of patients. You have to have teams of doctors and software workers working side by side to develop the software, says Walden. So it could be easier for a big company to simply buy Eclipsys to snap up expertise in the field. Thornburg Investment owns shares in Eclipsys.
Other potential targets in software, money managers say, include CyberSource (CYBS, news, msgs), which makes software used to prevent fraud in online transactions, or MicroStrategy (MSTR, news, msgs), Brio Software (BRIO, news, msgs) and E.piphany (EPNY, news, msgs), which sell business intelligence and analytical software.
Looking beyond software, DoubleClick (DCLK, news, msgs), which helps companies manage online advertising, and Switchboard (SWBD, news, msgs), which provides online yellow pages, could be targets for bigger players looking to build out their Internet capabilities and offerings.
In cable, equipment maker Concurrent Computer (CCUR, news, msgs) might be a target for Motorola (MOT, news, msgs) or Scientific-Atlanta (SFA, news, msgs). And TiVo (TIVO, news, msgs) could look attractive to a larger consumer electronics player such as Sony (SNE, news, msgs), or Comcast (CMCSA, news, msgs).
Defense: Buying expertise
Hogan & Hartsons Joe Krauss thinks a similar dynamic is playing out among defense contractors. Bigger companies are trying to fill out their product breadth, trying to better position themselves to get prime contracts, he says. That seems to be a biggie right now.
General Dynamics (GD, news, msgs), for example, recently announced plans to buy Veridian (VNX, news, msgs), which builds information systems for the government, driving Veridian shares up 20% in a day in June.
Paul Nisbet, a defense sector analyst with JSA Research, sees defense technology companies Anteon International (ANT, news, msgs) and SRA International (SRX, news, msgs) as possible buyout candidates.
Another potential target is Cubic (CUB, news, msgs). This candidate was mentioned by Sven Monberg, who serves as editor of Superstock Investor, a publication specializing in identifying takeover candidates. (Monberg also is an analyst for the Tampa, Fla., brokerage GunnAllen Financial.) Cubic makes electronics used in military training simulators and surveillance systems. Monberg points out that Cubic founder and chief Walter Zable, who owns 40% of the company, is 87. So he or his estate planners may be more likely to consider offers put on the table.
Health care: Seeking convenience
Health care and biotech are always prime hunting grounds for buyout candidates whenever the takeover market heats up. Smaller players find it convenient hook up with larger companies for their sales and marketing clout. And many bigger pharmaceutical companies have mature product pipelines, says Luis Cortez, a biotech analyst with John Hancock Health Sciences fund (JHGRX).
Cortez thinks possible candidates include two companies that develop cancer treatments -- Celgene (CELG, news, msgs) and ILEX Oncology (ILXO, news, msgs). John LaForge, of Phoenix-Hollister Value Equity Fund (PVEAX), thinks the AIDS drugs produced by Gilead Sciences (GILD, news, msgs) might be of interest to a bigger pharmaceutical company such as Merck (MRK, news, msgs) or Bristol-Myers Squibb (BMY, news, msgs).
Superstock Investors Monberg says the tiny Span-America Medical Systems (SPAN, news, msgs), which makes foam products such as special mattresses used in hospitals, could get taken out soon -- as a large shareholder is challenging the board to put the company in play. The company looks cheap, trading at .65 times sales. And understated real-estate assets could add $3 or $4 to the share price of around $9, in any deal, says Monberg.
Banking: Merging markets, cutting costs
The United States has too many banks. So you can expect consolidation in the sector as bigger players continue to reach out into new territory. Smaller banks also face new pressures to merge, says Paul Fusco, a banking sector analyst with the John Hancock Regional Bank Fund (FRBAX). They are seeing costs rise as it gets trickier to keep records to satisfy the requirements of homeland defense initiatives and the Sarbanes-Oxley act.
Its not how we select stocks, but we see smaller and mid-cap banks as likely targets, says Fusco. He looks for the most aggressive acquisition activity to play out in California, Texas, Florida and around Chicago -- areas where bigger banks are most interested in expanding.
Robert Clark, an analyst with SNL Financial in Charlottesville, Va., sees Florida banking company Fidelity Bankshares (FFFL, news, msgs) and Detroits Comerica (CMA, news, msgs) as potential targets. Others include Seacoast Banking (SBCF, news, msgs) of Stuart, Fla., and Cullen/Frost Bankers (CFR, news, msgs) in San Antonio.
3 more plays, including a fund
Companies owning a majority stake in other businesses are sometimes inclined to take the plunge and buy the balance of the business, juicing shares of the target in the process. One candidate in this camp, says Monberg, is A.S.V. (ASVI, news, msgs), which makes track-driven vehicles like bulldozers. A.S.V., a Michigan company, is majority owned by Caterpillar (CAT, news, msgs). Monberg says a play for the whole company could push A.S.V. shares into the mid-$20 range from a recent price of $17.
The Environmental Protection Agency's tightening up of water purity rules could spark consolidation among water utilities. Water companies may hook up to spread the cost of compliance across larger business bases, says Superstock Investors Monberg. Possible takeover candidates include: American States Water (AWR, news, msgs), California Water Service (CWT, news, msgs) and Philadelphia Suburban (PSC, news, msgs), all of which offer dividends between 2.3% and 4%.
Investors seeking to profit from an increase in takeovers should consider the Merger Fund (MERFX). It doesnt speculate on buyout candidates. Instead, says Morningstar analyst Dan Culloton, it takes positions in merger partners after deals are announced, attempting to exploit valuation discrepancies in stocks before deals are finalized. The fund lost money last year when acquisitions slumped, but it has a 10-year annual return of just under 10%. If mergers and acquisitions pick up, this fund is sure to do better, says Culloton.
Be careful out there
If youre drawn to the idea of betting on companies that might see their shares bounce when they become takeover bait, a few words of caution are in order.
Dont expect huge gains on an actual takeover announcement. Buyout candidates often make half their advance or more on rumors before a deal is even made public. For example, OfficeMax (OMX, news, msgs) advanced to $7 from $5 in May and June in part on takeover rumors. Then the stock leapt 25% to $8.75 when Boise Cascade (BCC, news, msgs) confirmed it was buying the company on July 14. Most of the takeover premium for Neuberger Berman (NEU, news, msgs) the move to $40 from $30 in May and June, occurred before it was formally confirmed that Lehman Brothers (LEH, news, msgs) was buying the asset manager.
Never make a possible takeover your sole reason for owning a stock. It can be part of the thesis on a security, says Ghriskey. But we never buy a stock just because it may be a buyout candidate.
One big problem is that expected deals often fail to pan out. Its all guesswork, says David Dreman, chairman of Dreman Value Management in Red Bank, N.J. For every real story, there may be 10 rumors.
Chasing those rumors can be costly. Earlier this week, for example, speculators betting that Irish pharmaceutical company Galen Holdings (GALN, news, msgs) would be bought saw 18% of their money go up in smoke when the drug maker announced that talks with a suitor broke down.
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