Screening for Potential Buyout Targets

I built a simple stock screen to identify companies with multiple characteristics common to the persistent wave of buyouts we have been seeing, and the results are included below.

I was happy when I logged on to the Internet Monday morning and learned that a company I purchased on Friday was a buyout target, and its price was up 7% (not a bad return for one business day).

Buyout targets are usually companies with small or mid market capitalizations (large caps are often too big to be bought out), low debt ratios (so the acquirer can add more debt to pay for the aquisition), high cash flows (to pay down the new debt), and a variety of management issues (room for improvement). They get bought out by hedge funds and private equity firms looking to do a little house keeping. The wave of buyout activity this year has been fueled largely by the low interest rate environment and low overall market valuations. I don't buy stocks based solely on buyout potential, but it is occasionally a contributing factor in my overall investment thesis.

The results of my buyout screen (below) are just a starting point, and there is certainly no guarantee that any of them will actually get bought out. Over the coming weeks, I plan to review as many of the interesting ones as I can to determine if there are any good investment opportunities for me. Also, for anyone who is curious, I do already own a couple names on the list.

Accuray Inc (ARAY)
Alaska Communicat... (ALSK)
Alpharma Incorpor... (ALO)
Altana Ag (AAA)
Amr Corporation (AMR)
Aruba Networks In... (ARUN)
Asia Satellite Te... (SAT)
Bearingpoint, Inc... (BE)
Blount Internatio... (BLT)
Brick Group Incom... (BRK)
Calpine Corporati... (CPNL)
Cell Therapeutics... (CTIC)
Centennial Commun... (CYCL)
Charter Communications (CHTR)
Cincinnati Bell,... (CBB)
Compass Minerals... (CMP)
Continental Fuels... (CFUL)
Crescent Point En... CPG.UN
Crown Holdings, I... (CCK)
Crown Media Holdings (CRWN)
CV Therapeutics,... (CVTX)
Delphi Corporatio... (DPH)
Deluxe Corporatio... (DLX)
Domino' S Pizza,... (DPZ)
E-L Financial Cor... (ELF)
Finish Line, Inc.... (FINL)
Gencorp Inc. (GY)
Goodyear Tire & R... (GT)
Healthsouth Corpo... (HLS)
Hualing Holdings... (HLGHY)
Ico Global Commun... (ICOG)
Illumina, Inc. (ILMN)
Incyte Corp. (INCY)
Indevus Pharmaceu... (IDEV)
Inergy Holdings,... (NRGP)
Intermune, Inc. (ITMN)
Invensys PLC (IVNY)
Investools Inc. (SWIM)
Ipc Holdings, LTD... (IPCR)
Kelly Services In... (KELYA)
Kimball Internati... (KBALB)
Koppers Holdings... (KOP)
Ladbrokes PLC- Ad... (LDBKF)
Lodgenet Entertainment (LNET)
Mediacom Communic... (MCCC)
Meruelo Maddux PR... (MMPI)
MPS Group, Inc. (MPS)
National Western... (NWLIA)
Navigators Group,... (NAVG)
Nevstar Corporati... (NVSC)
Northbridge Finan... (NB)
On Semiconductor... (ONNN)
Pinetree Capital... (PNP)
Rentokil Initial... (RTOKY)
Resverlogix Corp (RVX)
Revlon, Inc. (REV)
Rhodia (RHA)
Rural Cellular Co... (RCCC)
Safety Insurance... (SAFT)
Samsonite Corpora... (SAMC)
Shore Gold Incorp... (SGF)
Sirius Satellite... (SIRI)
Skyterra Communic... (SKYT)
Stelco Inc. (STE)
Switch & Data Fac... (SDXC)
Town Sports Inter... (CLUB)
Transalta Power L... TPW.UN
Unisys Corporation (UIS)
Usa Mobility, Inc... (USMO)
XM Satellite Radi... (XMSR)

Full disclosure: Long KOP and DLX at the time of writing.

Comments

[Ralph F]

It would be helpful to know exactly what factors you used to generate this screen. Can you be more specific than "companies with small or mid market capitalizations (large caps are often too big to be bought out), low debt ratios (so the acquirer can add more debt to pay for the aquisition), high cash flows (to pay down the new debt), and a variety of management issues (room for improvement)"?

[mark.d.hines]

Ralph- This is an art more than a science (I build a screen like this every couple months and I use slightly different factors every time). The goal is to figure out which companies will be the next takeover targets before there is actually any public information. If you want concrete numbers, try market capitalization between $500 million and $8 billion (this seems to be the sweet spot for a lot of buyouts), debt to equity less than 0.5 (in reality the lower the better), and positive cash flow consisting mostly of cash flow from operations (again, the more the better). Once you’ve got your list, try to think like a private equity firm. If you wanted to make a ton of money, which firm would you acquire? If you want more concrete numbers, check out CNBC’s 13 factor takeover target profile: (www.portfoliochallenge...).

Mark Hines

[jimidean]

Curious as to how a copany like HLS would pass the debt to equity screen. It has no equity.

[mark.d.hines]

I'm with you James, this one shouldn't have passed the debt to equity screen. As an anecdotal story, I used to work for a bank that paid over $100,000 per month for one of the most respected quant models in the industry. After several months, it was discovered that one of the factors in the model (9 month earnings momentum) was completely wrong! That's why I never rely totally on quant models and stocks screens. They're just a starting point, and should be re-tested regularly and followed up with detailed fundamental analysis. Thanks for bringing this to our attention!