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 year.
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 for
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
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
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
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 range.
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 price.
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 and
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 industry'sconsolidation
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 research.
-- David Sterman
P.S. -- Private equity companies aren't the only way that retail
investors can access the previously untouchable private market. In
fact, another investment can give you yields of 8%, 10% -- even 12%
or higher. For years, this arena has been off-limits to investors
like you and me. But thanks to our latest research, we've found a
way you can access this underground market. You can learn more by
clicking here now.
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.