By David Sterman
If you're an active investor who monitors investment screens with great frequency, then you have ample reason to look forward to Monday mornings again. This is when major deals are often announced, and if history is any guide, then we may be on the cusp of solid upturn in deal-making activity.
"Merger Mondays" could be a key theme in coming quarters, helping give the broader stock market -- as well as savvy investors -- a desperately-needed boost. Here's why…
It's no secret the economy has slowed to a crawl. This slowdown is hitting all kinds of companies. For instance, Cisco Systems (Nasdaq: CSCO) is expected to boost sales only 5% in fiscal (July) 2012. This is the same projected growth rate for Procter & Gamble (NYSE: PG) and Macy's (NYSE: M). And for mighty GE (NYSE: GE), the projected figure is even worse -- only 2%. In fact, analysts expect very few large companies will post major sales gains in 2012 -- at least on an organic basis.
Yet it's crucial to remember that many top executives have a large part of their compensation tied up in stock options. To get rich, they need to find ways to boost sales (and profits). And if internal growth at their companies is lacking, then deal-making can help bring a boost. With so many companies sitting on so much cash right now, and this cash earning very little interest, the itch to make deals is quite strong.
Make no mistake, hundreds of companies are probably analyzing potential deals right now. If the stars align, then a number of deals could come to fruition. Yet for this to happen, companies need a stable stock market first. Who wants to make an offer for a target acquisition when the target may fall even further in price in coming weeks? The economy also needs to stay at least at a level of zero growth. Negative growth (i.e. during a recession) has a way of turning promising acquisitions into botched deals, because hoped-for synergies and margin gains may never materialize.
The good news is the market may have begun to stabilize -- the S&P 500 rose or fell at least 2% on 10 occasions in August, but has done so only three times so far in September. And as I've mentioned before, the economy may not necessarily slip into recession, as some have feared.
With this in mind, here are five stocks in particular that may "get a bid" by the end of the year. They are all attractive in their own right and may still appreciate nicely even if a suitor never emerges.
A pair of chip stocks
Broadcom's (Nasdaq: BRCM) move to acquire networking chip-maker NetLogic (for a hefty nine times sales) has put a spotlight on rivals such as Cavium Networks (Nasdaq: CAVM) and EZChip Semiconductor (Nasdaq: EZCH). Both stocks spiked earlier in the week of Sept. 12 in hopes that they'd get acquired as well.
The logic is clear. Deal-making in high-tech follows a predictable pattern. A key niche player gets acquired and larger tech firms quickly scramble to acquire all of the other key players to ensure they have an equally competitive offering in said niche. I looked at this dynamic last year with the data storage sector, and two of the three companies I profiled were subsequently acquired. Smaller names in the communications/networking chip sector to watch include Vitesse Semiconductor (Nasdaq: VTSS.PK) and TransSwitch (Nasdaq: TXCC).
A Best Buy?
Consumer-electronics giant Best Buy (NYSE: BBY) recently announced and acknowledged what many already suspected: Sales are weak while consumers remain cautious. The same could be said for rivals RadioShack (NYSE: RSH), hhGregg (NYSE: HGG) and Conn's (Nasdaq: CONN), so an acquisition for any of these smaller players would help leverage fixed costs and buying power, while taking out some competition. The logic is especially clear in the case of RadioShack, which has a complementary approach to retailing by focusing on small stores in strip malls compared with Best Buy's big-box stores.
After losing roughly $8 billion in market value in the past 52 weeks (and the stock back at levels seen in the late 1990s), Best Buy's management is under the gun to make bolder moves. Best Buy's $2 billion cash balance could easily absorb RadioShack's $1.25 billion current market valuation, even allowing for a solid 30% to 40% premium to the current price.
Real estate gets healthier
Investors should brace for more deal-making in the real estate sector, which experienced major trauma in the financial crisis of 2008 but is far healthier now. Back then, a lot of real-estate firms were caught with too much debt and quickly-falling cash flow to support that debt, while major properties saw a spike in vacancy rates.
A great example is iStar Financial (NYSE: SFI), which saw its shares plunge from $50 in 2007 to below $2 by early 2009. I discussed the real-estate lending firm's woes in great detail last fall. Shares have risen about 20% since then, but remain vastly undervalued. As a result, there's a big chance a larger real-estate player may swoop in and pick up the company while it's selling on the cheap.
Importantly, iStar has cleaned up its balance sheet, retiring nearly $1 billion in debt in the most recent quarter. With concerns off the table that a weak economy would trigger fresh bankruptcy possibilities, investors can again focus on the value of iStar's financial assets. The company carries roughly $8.2 billion in assets, and after liabilities are deducted, still carries $1.7 billion in equity. These numbers already account for any distress iStar may be seeing among its properties and loans to other developers.
Meanwhile, the whole company is being valued for just $625 million by investors. The sharp disconnect has led iStar to buy back stock (a $65 million new buyback program replaced one that was recently completed). A larger player could potentially come in and offer a 30% premium to the current share price and still get iStar's assets at a sharp discount to their real worth.
Risk to consider: These specific companies may not get a buyout offer and instead may find their rivals in play. This is why it pays to look at all of the players in a sector and determine which might provide the most upside for any buyer.
You should never buy a stock simply in hopes it will get acquired, but instead view it as just another positive catalyst to your investment thesis. These stocks (with the exception of the chip stocks noted above) are very inexpensive right now, which makes them a bargain whether a suitor emerges or not.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.