Return of the 'Hostile' Takeover?

|
 |  Includes: AFG, BBY, BEN, BIO, BKE, BRO, CA, CHKP, CTCM, CUB, DHR, ERIE, FDP, GES, GRMN, GWW, L, LANC, LII, MCY, NEU, NWSA, ORCL, QSFT, SEIC, SPY, SSD, WERN, WPC, WRB, Y
by: Kenneth Hackel, CFA

Sounds crazy, no?

Given that corporate Boards remaining relentless in cash maximization policies, alongside reluctance to spend without a confident payback period, the obvious outlet is stepped-up acquisitions. Given a strategic free cash flow-based acquisition, firms could put themselves in a position of stepping up their return on invested capital, given the very low cost of debt that might need to be raised to fund the purchase. A well-priced and timed acquisition can significantly add to shareholder value, while of course, an ill-priced, ill-executed and poor candidate would severely destroy value.

Better managed firms take advantage of weak asset prices despite a understandable reluctance to shy away.

Upcoming merger activity should be led by an increase in the cash payment and debt, rather than all (tax-free) stock deals.

If in fact, we see, as I fully expect, an increase in business combinations, could we then see a return of the “hostile” takeover? As impossible as this may sound during these moments of falling equity values, experience has shown, that when M&A activity does perk up, executives wonder if they are next.

If the house across the street sold for 40% more than you estimated, it might rouse your interest into putting your place up for sale- especially if you hadn't had a decent raise in 3 years.

Most executives are afraid of their jobs. They are afraid of losing control. Of a new boss. Of a declining stock price. They wish to avoid proxy contests. They are afraid of being squeezed by a stronger, more combatant competitor...and investment bankers are now especially hungry for deals given their firms declining profits. So many deals will also be sold as a means to buy revenues, which is never a good thing, as the expected boost is invariably disappointing. But nevertheless its going to take place, if nothing else, as a means to buy time for the economy to improve.

As my merger scenario takes hold, companies of strong credits, yet with insiders holding a minority portion of shares outstanding, will lead the way. These firms' Board of Directors, especially in today’s environment, are in no position to stick to their independent "guns", as was true during the bull market of years ago, given the fall in stock values over the past decade. And you can be sure the private equity firms are looking at the same numbers I am.

The table below consists of firms which could be, for the most part, good buyout candidates. The essential ingredients: free cash flows, low leverage, positive cash (not reported) tax rate (two exceptions), and strong but not overpowering ownership are all there. I'd bet many such firms indeed put their house up for sale.

click to enlarge


Disclosure: No positions