Back in 2006, the U.S.economy was growing at a solid clip,
thestock market was on the rise, and big investors such as
pensionfunds were looking for ways to boost returns. The most
appealing destination for these investors was privateequity .
Private equity firms had done very well in previous years and
managed to pull in a stunning $700 billion in freshmoney between
2006 and 2008, according toinvestment research firm Triago.
But every silver lining has a cloud, and those same private
equity firms are scrambling to keep busy. They promised their
clients they would invest all the money within a five-year time
frame or give it back to investors. Well, five years have passed,
and roughly $100 billion of that money must be invested -- or
returned to shareholders -- by the end of thisyear . According to
Triago, that's the largest sum that private equity firms have
ever had to contemplate returning to investors in any
Thankfully, with the U.S. economy on the mend, these private
equity firms now face a more stable economic environment in which
to choose their prey. So even as deal-making has cooled in recent
weeks after a torrid start to 2013 (highlighted by deals
H.J. Heinz (
Dell (Nasdaq: DELL)
), you can expect an ample number of high-profile deals before
Why should you care? Well as we've stated before, it pays to
follow the moves of private equity. It may be an exclusive
playground, but there are ways for regular investors to
profit from their moves
One way is to monitor thewave of mergers and acquisitions
(M&A) activity we'll likely see due to this $100 billion
private equity surplus. If you can successfully identify firms
that are likely to be targeted, you could reap biggains from
thesestocks in short order.
Here are the key items to look for as you track these trends.
1. Robust balance sheets
Many private equity firms like to make a little capital go a long
way, so they are attracted to cash-rich, low-debt firms. Using
the robustcash balance sheets of theiracquisition targets allows
them to secure very strong financing terms with the biglenders
thatwill help them pay for any deal.
2. Big, but not too big
Private equity firms don't like to waste their time on small
deals. The relatively smaller payoffs just aren't worth their
time. Dell and Heinz fetched more than $20 billion each in
theirbuyout offers, which is at the upper end of the range of
what a major private equity firm can handle, even if they cobble
together a team of co-investors, as firms like Silver Lake
Partners like to do. Consider $2 billion to $10 billion to be the
sweetspot for any buyout firm.
3. Bloat or synergies
Private equity firms historically target bloated firms that have
ample room for cost-cutting. These firms tend to move much more
quickly than current management when it comes to reducing
headcount and exiting unwanted businesses. However, most
companies have been operating in a very lean fashion recently and
have little fat to cut.
Instead, look for buyout firms to target candidates that hold
a roster of valuable divisions, so the best assets can be sold
off piecemeal for the highest price. Or look for targets that
represent synergies with assets that are already owned by private
equity firms. In such cases, one plus one can equal three, which
can set the stage for a robustIPO in a few years' time.
There are three key sectors that are always in favor among
private equity firms: technology, consumer goods and energy.
Let's take a look at the leading candidates in each sector. Here
are a dozen technology companies that have at least $300 million
in net cash and have market values in the $2-$10 billion
In the consumer sector, private equity firms are likely to
focus on companies that are out of favor and can be acquired at a
fire-sale price, cleaned up and brought back into the public
sphere in a few years' time. That was the playbook for
Burger King (
Hertz Global Holdings (
and several other consumer-facing companies that were taken
private and then eventually brought public again at a higher
Yet on this list, most of these high-cash, easily digestible
companies are already faring well, which would make them more
appealing to strategic buyers (such as rivals) rather than
financial buyers (such as private equity firms).
Indeed,analysts have long suggested that companies like
Monster Beverage (Nasdaq: MNST)
might hold great appeal to soft drink makers like
, and recreational equipment maker
Polaris Industries (PII)
would make a good fit with firms like
or Canada's Bombardier.
In terms of private equity firms, you need to godownstream to
struggling retailers that have experienced decliningsales trends
and ever-weaker balance sheets. In recent years, private equity
firms have targeted struggling retailers such as Talbots
Coldwater Creek (Nasdaq: CWTR)
, and you can expect to see more activity in this segment this
The energy angle
In recent years, oil and gas drillers have largely been bought
and sold by strategic buyers. They have not been in the sights of
private equity buyers, but these two parties are ideally matched.
Many drillers have been forced to sharply reduce capital spending
this year due to weak cash flows, yet they are sitting on
valuable troves ofreal estate . Private equity firms have a
chance to buy some or all of a financially weak driller and
perhaps reap considerable profits when industryeconomics improve.
As an example, private equity firm
is looking to spend up to $1.5 billion in this
industry, according to Bloomberg.
Energy drillers such as
Comstock Resources (CRK)
Forest Oil (FST)
PDC Energy (Nasdaq: PDCE)
Plains Exploration (PXP)
Quicksilver Resources (KWK)
all have generated hugefree cash flow losses in recent years
thanks to heavy capital spending -- and they surely could use a
boost from private equity firms.
Risks to Consider:
You should never buy a stock in hopes of a buyout, as many
rumored deals never come to pass, and should instead use M&A
trends as onefactor among many in your investment research.
Action to Take -->
The key for investors is to track M&A activity. In the
past, when one or two players in an industry have received buyout
offers, other potential buyers have moved quickly to line up
their own targets for fear of missing out on an
Whenever you read about a buyout, move quickly to assess the
valuation metrics sported by various rivals. If those rivals
trade for much less than the acquired target (in terms of
price-to-sales, price-to-free cash flow , etc.), then
you've just hit on an investment opportunity worth further
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