Jabil Circuit Looks Like Strong Buyout Candidate, But I'm Not Buying

Today I received a voice message from a newspaper reporter in Florida, who wanted to know if Jabil Circuit (JBL) fit the profile for a typical buyout target. He seemed like a very nice guy, so here is my answer...

Yes. Jabil fits the profile for a typical buyout target, but I'm still not buying. As I described in a previous post, buyout targets are usually companies with 1) small or mid market capitalizations (large caps are often too big to be bought out), 2) low debt ratios (so the acquirer can add more debt to pay for the acquisition), 3) high cash flows (to pay down the new debt), and 4) a variety of management issues (room for improvement). 5) Further, the wave of buyout activity this year has been fueled largely by the low interest rate environment and low overall market valuations.

JBL is consistent with all of these characteristics:

1) JBL's market cap is around $5 billion. Based on the buyout activity we have seen in the last year, this is right in the buyout sweet-spot. As Goldie Locks might say, "not too small, not too big, but just right!"

2) JBL has a relatively low amount of debt. The current debt to equity ratio is just above 50%. Less debt would be better, but this is still within buyout target range.

3) JBL brings in cash. Last fiscal year JBL generated over $448 million in cash flow from operations (not bad considering operating income was only $241 million). They also have $558 million in cash sitting on their balance sheet as of May 31, 2007.

4) JBL has a variety of management issues which is a common characteristic among buyout targets. For example, they recently spent $4.1 million on legal and accounting expenses to deal with options backdating issues. Also, they haven't been able to get operating margins up to expectations following the acquisition of Taiwan Green Point. These are both examples of the "room for improvement" that acquirers like to see.

5) The current interest rate and valuation environment is conducive to buyout activity (i.e. interest rates are low, and JBL is trading at a discounted P/E relative to its historical levels).

So if JBL passes all of these buyout target tests, why aren't I buying?

Well, for one thing, I can't stomach a company with razor thin operating margins (JBL is around 1%) because it doesn't leave much room for error. Second, from a financial standpoint, there a far better companies out there in terms of buyout potential (i.e. companies with less debt, more cash, and simpler problems to solve). And third, the recent increase in stock price may actually have nothing to do with a potential buyout. Almost 90% of JBL's shares are owned by institutional investors. The price increase could simply be the result of some big institution picking up 10 or 12 million shares just because it adds diversification to their portfolio.

Regardless, I hope this information is helpful to the Florida newspaper reporter, and I look forward to keeping an eye on Jabil Circuit (JBL) over the coming weeks and months.