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John Dorfman: Seven Stocks Look Like Prime Takeover Targets

Monday, 09 May 2011 12:28 PM

(John Dorfman, chairman of Thunderstorm Capital in Boston, is a columnist for Bloomberg News. The opinions expressed are his own. His firm or clients may own or trade securities discussed in this column.)

Picking takeover candidates for fun and profit is a perennial investment sport.

How can it not be? When one company takes over another, it typically pays a 20 percent to 70 percent premium over the target’s prevailing stock price. Takeovers can enrich investors instantly.

According to Bloomberg’s database, there were 2,061 deals announced in the first quarter. The dollar volume of $269 billion was more than in any of the previous nine quarters.

In the second quarter so far, the average takeover premium has been unusually rich — 61 percent, the highest in 12 years.

I don’t expect that lofty figure to last. Premiums will probably revert to a more normal range of 30 percent to 45 percent. The good news is that I expect a continuing flow of deals in 2011 and 2012.

On Oct. 4, 2010, when merger and acquisitions started to resume after a recession-induced freeze, I wrote a column mentioning nine stocks that I thought could become takeover candidates. As a group, through May 4, their performance has trailed one percentage point behind the 19 percent total return in the Standard & Poor’s 500 Index.

I prefer to judge stock picks based on a time frame of one year or more. Yet I’m doing a new takeover-candidates list now because M&A activity is heating up.

Finding Candidates

To find a new crop of candidates, I am using the following set of criteria, which are modified slightly from those of six months ago:

• U.S.-based companies with a market value of $500 million to $5 billion.

• Enterprise value (the combined value of a company’s stock and debt) divided by Ebitda (earnings before interest, taxes, depreciation and amortizing) of five or less. This EV/Ebitda ratio is often used by companies scouting for acquisitions.

• Total debt no more than 75 percent of shareholders’ equity (corporate net worth, or assets minus liabilities).

• Cash or safe short-term investments of $75 million or more.

• Stock price no more than 1.5 times the company’s sales.

When I ran this screen on May 4, only 39 companies met all the criteria. Here are seven that look to me like they have takeover allure, and should be decent investments even if no suitor calls.

Coventry, GameStop

The largest, with a market value of $4.9 billion, is Coventry Health Care Inc. of Bethesda, Maryland. Selling for only 1.15 times book value, I think it is alluring bait.

Coventry, which provides managed health care services, has been the subject of takeover speculation. In the summer of 2008, for example, the stock jumped on speculation Aetna Inc. would take it over.

GameStop Corp. of Grapevine, Texas, is the world’s largest video game and entertainment software retailer, according to its website. Its stock peaked at more than $63 in late 2007, and sells for a little more than $25 now.

With GameStop shares fetching less than 10 times earnings and 1.3 times book value, it appears to me to be a potential magnet to buyers. In March 2010 the stock ran up 27 percent amid acquisition rumors, which later subsided.

Chicago-based Telephone & Data Systems Inc., the parent of U.S. Cellular, has a market value of $3.3 billion. At a time when AT&T Inc. is trying to acquire T-Mobile USA Inc. for about $39 billion, it’s not hard to imagine this company giving up its independence.

Telephone, Oshkosh

Telephone & Data is profitable, yet has struggled with growth. It has $592 million in cash and near-cash along with $300 million in short-term investments. To me, it looks ripe for the plucking.

With the U.S. defense budget under pressure, mergers may pick up among defense contractors. Oshkosh Corp., which makes military transport vehicles and specialty trucks such as fire engines and cement mixers, could be picked off by a larger competitor. The Oshkosh, Wisconsin, company’s stock languishes at five times earnings.

Seacor Holdings Inc., located in Fort Lauderdale, Florida, transports men and material to and from offshore oil platforms. Selling for about 1.2 times book value, it could probably be acquired for less than $3 billion.

In the semiconductor-equipment industry, I favor Kulicke & Soffa Industries Inc. of Fort Washington, Pennsylvania. At five times earnings, it strikes me as a very cheap stock.

One more candidate is RadioShack Corp., based in Fort Worth, Texas. It earned $1.84 a share in 2000 and $1.68 a share in 2010. A larger retailer could probably milk more growth and profitability out of this well-known brand.

Disclosure note: I own Kulicke & Soffa personally and for clients. I have no long or short positions in the other stocks discussed in this week’s column.

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(John Dorfman, chairman of Thunderstorm Capital in Boston, is acolumnist for Bloomberg News. The opinions expressed are his own. Hisfirm or clients may own or trade securities discussed in this column.) Picking takeover candidates for fun and profit is a perennial...
Monday, 09 May 2011 12:28 PM
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