Don't Buy Stocks For Their Buyout Potential

by: Valulicious

With private equity commanding so much attention today, it seems that every company is hailed a buyout candidate. That said, I think buying a stock based solely on the hope that someone else will buy the company for a fat premium is a poor investment strategy.

Consider the conclusions of the following strategic alternatives processes:

Celebrate Express (BDAY): "It is in the best interests of the Company and its shareholders at this time to continue operating as a stand-alone entity." link

UTStarcom (NASDAQ:UTSI): "We have determined that our best course of action is to move forward with the company as it exists today." link

Champps Entertainment (CMPP): "Did not receive any definitive proposals that the committee deemed acceptable." link

Consider further the following companies that are selling themselves, but for below market prices:

James River Group (NASDAQ:JRVR): Selling itself to D.E. Shaw for a 1.9% discount. link

Yardville National Bank (YANB): Selling itself to PNC Financial Services (NYSE:PNC) for a 2.2% discount. link

Certainly there are many counter examples of companies sold for hefty prices. But I still think it's a mistake if you need a buyout for your investment to work. They don't always happen the way we hope for.

A better idea is to formulate an investment thesis that can stand alone, and think of a premium buyout as a nice surprise. If a company is priced very cheaply or has a particularly attractive business as an independent entity, then you have reason to hope your investment will rise even without a private equity takeout.

Paying a big price hoping someone else will pay an even bigger price is putting all your eggs in one very precarious buyout basket. If you buy high and wait for a greater fool to come along, he may have already arrived.