A duo of special situation analysts over at UBS AG (NYSE: UBS) recently compiled a list of potential leveraged buyout (LBO) targets.
Thanks, guys… but there’s just one problem: The list is 27 companies long! (You can access it here.)
Apparently, they don’t understand the concept of limited capital resources. It’s just not feasible, let alone practical, for everyday investors to spread their bets among 27 separate companies.
So let me finish the job for them and whittle down that list to a more manageable number for you. Like one!
Why should you care? Because nothing moves a stock price higher and faster than an unsolicited takeover offer. And after two years of fits and starts, a revival finally appears to be underway in the notoriously cyclical mergers and acquisition (M&A) market.
During the first quarter, $41.5 billion worth of LBO deals were announced – a 23% jump over the same period last year, according to Dealogic.
Not only that, the most aggressive and speculative buyers are returning in full force – private equity firms. And with private equity firms sitting on an estimated $1.5 trillion worth of buying power, all signs point to even more dealmaking.
As I noted, though, when it comes to identifying which takeover targets are best-positioned to profit, Wall Street is less than helpful. But that’s where we come in…
Eliminate the Merger Riffraff in Three Easy Steps
In order to avoid idle speculation – or worse, pure guesswork – there are certain key areas to focus on if you want to spot the best takeover prospects. Especially when there’s a list of 27 candidates! Here’s a quick, three-step guide…
1. Focus on the Sweet Spot
As Antonio Weiss, head of investment banking at Lazard Ltd. (NYSE: LAZ), said at a recent conference of dealmakers, “Most LBOs have topped out at $5 billion.”
That said, though, Weiss expects a $10 billion to $15 billion LBO by year’s end.
However, while financing is (finally) returning for larger deals, it’s always harder to get bigger deals done. So let’s avoid them.
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By eliminating companies with a market cap of $6 billion or more, our list of potential targets drops to 20. That’s a good start.
2. Insist on No Debt
The “L” in LBO is hardly a coincidence. It’s a well-known fact that private equity buyers love to acquire a company and lever up the balance sheet in order to squeeze out every last ounce of value.
As a result, the most attractive targets are often the ones with no debt. They provide the most potential for “wringing.”
By eliminating companies with debt, our list magically shrinks to eight companies. Now we’re getting somewhere!
3. Double the Buyer Pool
It only takes one buyer to get a deal done. But it’s always better to have multiple bidders. You understand this truth first-hand if you’ve ever sold residential real estate.
So it makes most sense to focus on companies that are both strong LBO candidates and attractive takeover targets for other publicly traded companies. Especially since public companies’ balance sheets are stuffed with cash, too – a record $1.9 trillion, to be exact. That’s equal to 11% of market value – almost double the historical average.
What’s more, shareholders are more insistent than ever that company executives put money to work. Now that the Great Recession has passed, there’s no good excuse to hoard cash.
So who has the most cash – and therefore the most amount of purchasing power?
The latest analysis from Goldman Sachs reveals that the Software & Services industry boasts the biggest pile of cash.
And by focusing on companies in this industry, UBS’ unwieldy list of 27 potential targets gets magically shrunk to one company: Amdocs Ltd. (NYSE: DOX).
In tomorrow’s column, I’ll dissect Amdocs’ fundaments to prove why it is indeed the safest bet on a resurgent M&A market. So stay tuned.
Ahead of the tape,