With hedge funds, VCs, and private equity firms rushing to lobby Hillary and other presidential hopefuls, it really makes you wonder if we will see a GOP change in fall 2008. While European tax policy is easing and foreign cash is flowing smoothly as funding for massive U.S. deals, and with Grandfather Clause blinding Steve Schwarzman and friends from seeing any real threat to profit with a potential change in capital-gains taxing, the M&A frenzy so far has just been a warmup act. I’ve done my research, and found five attractive companies that look ripe to be acquired, or make important acquisitions of their own.
The most popular bookstore in my town, Borders (BGP), is one I visit every morning to pick up a copy of IBD, browse the money section, and grab a cup of coffee. I notice the most consistently popular feature of Borders is its Java Café, where I often find large numbers of readers and from myself to the elderly. The company’s balance sheet, however, is absolutely horrendous in its earnings and revenue growth. Missing estimates quarter after quarter, Borders needs to make an acquisition to grow market share and build more of these in-house cafes to draw more customers; rival Barnes & Noble (BKS) runs small Starbucks cafes in each of its chain stores, which no doubt helped the company crush earnings estimates 10-fold last quarter.
A great acquisition target for struggling Borders is Books-A-Million (BAMM). BAMM operates most of its 206 stores in the demographically-advantageos southeast, and also runs online confectionary company JoeMuggs.com. The number to know for BAMM? 5.5 - that is the EBITDA multiple, and in this M&A-driven market, it wouldn’t be crazy to see a company with BAMM’s good balance sheet to go for 7-8x EBITDA. If Borders or another large bookstore chain purchases Books-A-Million, the results of the additional market share would prove beneficial, as would the chance to scale and consolidate on distribution, purchasing, and the like. BAMM, a $280M company, also has shown mediocre returns on equity and its stock price has lagged of late. I give BAMM a buy rating as a speculative play; take care, however, as the seemingly ever-present threat of higher crude prices being blamed should the company slip up and miss same-store sales, or any other metric.
Retailers have experienced a great deal of pain lately, despite beating frighteningly low estimates, but men’s specialty retailers are starting to look up slightly. Men’s Wearhouse (MW) has long been the market-share leader in business apparel among specialty retail chains, and small rival Joseph A. Bank Clothiers (JOSB) has been left in the dark. I recently shopped at the local Jos. A Bank, and was amazed at the variety of upscale apparel at low prices when compared with companies like Nordstrom and Men’s Wearhouse. As a larger small-cap at about $700M, JOSB surprises me with $76M in operating cash flow, almost no debt, and an outstanding quarterly earnings growth rate of nearly 43%. The problem with JOSB is its market share and management, which could be corrected if the company came under new ownership. When large specialty retailers like Men’s Wearhouse, Brooks Brothers, and Macy’s (which has been the source of much buyout speculation itself) realize the valuation and great financials JOSB has, I see at least one of them contemplating a bid. I have a buy rating on JOSB, although the stock might suffer if the oil threat does materialize and begins to hurt retail.
In my recent analysis of insurance giant American International Group (AIG), I came across a small-cap property/casualty insurance play called United Fire & Casualty Co. (UFCS). With some quick financial checks, I saw this small insurer trading at just 12 times forward earnings and less than 1.5x book value. Insider ownership near 20% means that investors have management on their side, and with a forecasted PEG of 1.3 along with no debt and an excellent reputation, this Iowa-based commercial and personal insurer is completely overlooked among competitors. An analyst recently downgraded UFCS, saying the company had deteriorating pricing and a near-correct valuation; I beg to differ. The financials and free cash flow on hand contradict each statistic the analyst gave, and with UFCS indicating the possibility of a stock buyback program soon, I give UFCS a buy rating even without it being acquired. Large insurers have had a summer free of catastrophes, leaving more cash on hand to make acquisitions and diversify away from the volatile Gulf Coast and East Coast market, which I think makes UFCS a prime acquisition target and therefore a buy.
My fourth potential buyout play is a small-cap gold/copper company called Northgate Minerals (NXG). First of all, this name is obviously a speculative stock in any portfolio; at about $3.26 a share, Northgate Minerals’ shareholders indeed run the risk of NXG sinking to under $2 a share and down toward net cash at $1.10. I chose this small-cap stock because it stood out in hot sector, displayed positive financials, and owned a large share of acreage and mines from Ontario, Canada, to lower South America. Trading at under 8 times forward earnings and just 3.5x EBITDA, Northgate seems undervalued from a purely financial standpoint. But, as with the homebuilding and financial sectors, current financial valuations do not signify a complete success story waiting to emerge; investors must analyze the stock’s sector and look for a bargain entry point - like Wednesday’s pullback.
The minerals sector is sizzling hot, with most large and mid-cap minerals companies operating most of their business outside of the U.S. (where foreign currencies rise as tax policies ease and inflation is under control); markets are extremely liquid, and with numerous new investors discovering the benefits of old-fashioned equities (industrials, minerals, machinery, oil) versus U.S. bonds, even more capital is driving companies’ cash flows and spurring acquisitions left and right. The obvious deal of note here is Freeport McMoRan’s (FCX) $26 billion acquisition of Phelps Dodge, where the acquirer had no problem floating over $10 billion in debt. Northgate Minerals, with over $85 million in free cash flow, operating margins of 30%, and an enterprise value of under $600M, could easily be snapped up without a second thought by any of the new acquisition-oriented mining majors. I see Goldcorp (GG) or Yamana Gold (AUY) as potential buyers of Northgate, using the acquisition to expand mining and gold expedition into the domestic United States and southern Canada. I give NXG a buy rating at the $3.15 level, and see it as a speculative growth/value blend.
My final play, in the midst of the hottest sector rotation today, is Hurco (HURC). The Indiana-based industrial technology company recently announced a filing to sell an additional $200 million in debt and stock, which will be used to fund capital commitments and acquisitions. In light of this news, I researched this small-cap ($344M market cap) and found quite interesting financials. Trading at 14x forward earnings and with a PEG of 0.65, Hurco is an excellent play on small-cap tech making a noticeable turnaround after a long period of consistent sector woes. Hurco has no debt, low capital expenditure requirements that help produce solid cash flow, and has a consistent “Goldilocks growth rate” on the top line of above 10%. HURC grows revenues 15.3% quarterly, while earnings grew 19.1%.
The real attention-grabbers of this small tech stock are the industries it services and where it operates its business. Hurco Companies produces computer systems and machine operating tools for the aerospace, defense, medical equipment, energy, transportation, electronics, and computer industries, which are all some of the biggest bull markets so far this year. Additionally, the company sells products throughout North America, Europe, and Asia, while its major distributors reside in England, France, Germany, Italy, Singapore, and China. Tech giants Agilent (A) or Thermo Fisher (TMO), which both maintain enormous cash flows but with mostly domestic distribution, would benefit from acquiring Hurco, as it would quickly give them better global reach, market share, and additional machine tool technology.
After huge growth in the last six months, Hurco Companies still has my buy rating around the $52.50 level, especially in this tech turnaround market.
Disclosure: Author has no position in stocks mentioned