In yesterday’s column I noted the recent uptick in leveraged buyout (LBO) activity. And while UBS AG (NYSE: UBS) got the ball rolling with its list of 27 potential takeover targets, I did some heavy lifting by narrowing the list down to one company – Amdocs Ltd. (NYSE: DOX).
Today, let me detail exactly why the company represents the surest way to bet on a resurgent M&A market…
An A-List Client Directory
Founded in 1982, Amdocs is a leading provider of software and services to telecommunications companies.
Its products enable customers to complete critical tasks more efficiently. Tasks like tracking and billing, determining ideal rate plans, managing network resources, plus the sales and ordering process.
The company’s blue-chip client list underscores the value of its offerings. Top tier companies like Verizon (NYSE: VZ), Sprint (NYSE: S), AT&T (NYSE: T), Vodafone (NYSE: VOD), Comcast (NYSE: CMCSA) and DirecTV (Nasdaq: DTV) wouldn’t bother with Amdocs if its products didn’t add significant value.
And the reason the company makes for such an attractive LBO target is simple: It possesses all the qualities that private equity buyers crave.
Five Hallmarks of Predictability
As I noted yesterday, private equity buyers love to lever up the balance sheet of acquisitions in order to extract as much value as possible. And Amdocs boasts no debt, which makes it easy to add debt.
But buyers need more than just room on the balance sheet.
More than anything, they need a predictable business. They need to know without a shadow of a doubt that there’s going to be enough cash coming in the door to service that hefty debt load.
A quick review of Amdocs’ fundamentals reveals that Amdocs more than qualifies as “predictable.”
1. Recurring Revenue Model
Roughly 70% of sales come from customers on long-term contracts (three to seven years) for core business services. The other 30% comes from discretionary projects… and in the aftermath of the Great Recession, this area is rebounding, as telecommunications companies resume capital spending.
2. Sticky Customer Base
Because Amdocs’ products are so intertwined with its customers’ operations, the costs to switch to another company are high. So customers rarely leave. In fact, most have been with Amdocs for over five years.
When times get tough, people don’t cancel their wireless, wireline, or cable services en masse. They’re too vital to everyday life. And since Amdocs’ customers provide those “must have” consumer services, it benefits from steady demand, too.
4. Stable Growth
Over the last five years, sales have increased by an average of about 10% per year. Looking ahead, management expects to come close to matching that rate, thanks in large part to expansion into emerging markets.
5. Cash, Cash and More Cash
Amdocs’ free cash flow checks in at about 13% of revenue. In dollar terms, free cash flow has risen every year and currently stands at $654 million. It also has $1.25 billion in the bank, which acts as an instant “rebate” for potential suitors.
Add it all up and Amdocs is like the beauty queen at the LBO prom. And every private equity firm should want to dance with her.
In fact, the fundamentals are so compelling, I wouldn’t be surprised if other publicly traded companies like Oracle (Nasdaq: ORCL) and