This is the year of mergers and acquisitions. From General Electric's (NYSE:GE) recent $13.5 billion acquisition of Alstom's power grid business to Valeant Pharmaceutical's (NYSE:VRX) ongoing quest to acquire Botox-maker Allergan (NYSE:AGN), companies have spent lots of money on global deals. Data from Thomson Reuters reveals that mergers and acquisitions worldwide totaled $1.75 trillion as of June 26, an increase of 75% from a year ago despite a 0.7% decline in the number of deals made.
Low interest rates, high cash levels and strong balance sheets have driven companies to make major strategic acquisitions this year. While some firms have made these deals to gain stronger footholds in their industries, others, like Medtronic Inc. (NYSE:MDT), have acquired competitors in order to move their operations overseas and escape the US's 35% corporate tax rate. In fact, cross-border merger and acquisition activity has accounted for 39% of all global deal volume so far this year, up 132% from 2013.
And shareholders have benefited from the flurry of deal-making activity. According to Reuters, almost 70% of announcements for US deals valued at $1 billion or greater led to a rise in stock prices for the acquirers. The seven-year average is 55%.
Given cash flow's role in the uptick in merger and acquisition volume, we decided to start with a screen using that metric. We began with a group of stocks undervalued as indicated by high ratios of levered free cash flow/enterprise value (LFCF/EV).
Levered free cash flow is the free cash flow left over after a company subtracts interest payments on outstanding debt, and it's the money a company can use to expand. Enterprise value is a valuation measurement calculated by adding market cap, debt, minority interest and preferred shares (minus total cash and cash equivalents). When a company has a levered free cash flow/enterprise value ratio greater than 10%, it may signal that the company is being undervalued.
Next, we screened for companies that are popular among institutional investors, specifically screening for stocks with significant net institutional purchases comprising 5% or more of share float over the current quarter. When investors make such purchases, it indicates that they are confident in the stock's ability to outperform into the future.
Finally, we limited our group to companies involved with media and entertainment since that sector has had the second largest amount of mergers and acquisitions this year. Reuters reports that Comcast's (NASDAQ:CMCSA) (CMCSK) proposed $45.2 billion merger with Time Warner Cable (TWC) and AT&T's (NYSE:T) $48.5 million offer to buy DirecTV (DTV) have boosted deals to $220.7 billion, nearly three times the amount from the previous year.
Net institutional purchases in the current quarter at 981.3K shares, which represents about 5.2% of the company's float of 18.88M shares. The two top holders of the stock are Hodges Capital Management with 1.6 million shares and Dimensional Fund Advisors with 1.3 million shares.
Levered free cash flow at $23.77M vs. enterprise value at $181.65M (implies a LFCF/EV ratio at 13.09%).
In October 2013, A.H. Belo sold the Riverside, California,-based The Press-Enterprise to Freedom Communications Holdings for $27.25 million. The company announced in December that it was exploring the sale of The Providence Journal.
2. DreamWorks Animation SKG Inc. (DWA): Engages in the development, production and exploitation of animated feature films and characters worldwide. Market cap at $1.93B, most recent closing price at $22.79.
Net institutional purchases in the current quarter at 5.1M shares, which represents about 7.66% of the company's float of 66.54M shares. The two top holders of the stock are Horizon Kinetics with 11.1 million shares and Wellington Management Company with 10.6 million shares.
Levered free cash flow at $488.53M vs. enterprise value at $2.16B (implies a LFCF/EV ratio at 22.62%).
In April 2013, DreamWorks acquired AwesomenessTV, a teen network on YouTube, for $33 million with an extra $117 million to be paid if the channel reaches specific milestones.
3. Martha Stewart Living Omnimedia Inc. (MSO): An integrated media and merchandising company that creates media and merchandise in the areas of cooking and entertaining, holidays, crafts, home, whole living, weddings, organizing, gardening, and pets. Market cap at $268.19M, most recent closing price at $4.71.
Net institutional purchases in the current quarter at 2.2M shares, which represents about 7.22% of the company's float of 30.49M shares. The two top holders of the stock are Royce & Associates with 1.9 million shares and BlackRock Institutional Trust Company with 1.1 million shares.
Levered free cash flow at $22.22M vs. enterprise value at $208.06M (implies a LFCF/EV ratio at 10.68%).
In 2008, Martha Stewart Living Omnimedia acquired celebrity chef Emeril Legasse's merchandising franchise for $50 million.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Kapitall is a team of analysts. This article was written by Mary-Lynn Cesar, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.