Earlier this week, I looked at a range of
look quite attractive
in relation to the value of their assets.
I focused on
Freeport McMoran (NYSE:
as a clear example of a stock that looks quite appealing in the
context of its
, if not its
Yet other investors are focusing on Freeport McMoran for an
entirely different reason. A recent article on
that a major mining firm such as
Rio Tinto (NYSE:
could take advantage of share-price weakness and make a move to
acquire the copper and gold miner.
The article quickly reminded me of a lesson I learned from a mentor
nearly 20 years ago: "Never ever pursue a stock simply on the basis
rumor." He correctly noted that few rumored deals actually come to
Since then, I've added my own addendum to his dictum: If a stock is
reasonably-priced or downright inexpensive -- even after buyout
rumors have circulated -- then you could look at the potential deal
for the stock.
In that context, Freeport McMoran is already quite attractive on
its own merits, and a bid from Rio or
BHP Billiton (NYSE:
would just get you to your eventual target price that much more
quickly. The fact that Freeport McMoran's stock has risen only
modestly since the story ran only reinforces the notion that you
are not chasing someone else's "pump-and-dump" scheme.
Of course, there are many examples where investors foolishly chase
a stock ever higher on buyout rumors, only to get burned when those
rumors die down. This happened recently with drugstore chain
moved up from a $1 to $1.50 this past winter on improving results.
To most analysts, $1.50 looked like
. So when the stock shot past $2 on buyout rumors, the stock
suddenly became very risky. Indeed, that kind of move often means
it's a good time to sell.
Right now, the rumor mill is churning with talk of a
. Analysts at BMO took a deep look at the logic behind such rumors,
and came away impressed. Their key conclusion: the combined entity
would reap considerable synergies, so a deal could be priced that
provides 30% to 40% upside for shareholders of both grocers.
(Kroger would likely be the surviving entity, so Safeway's upside
would come sooner and Kroger's would come later.) The buying power
that a combined platform could muster with suppliers would finally
match up with the purchasing strength that has propelled
to overpower the grocery space.
More to the point, if the merger doesn't happen, then both of these
stocks still look reasonably valued on a standalone basis. Each
stock trades for less than 10 times projected 2013 profits. This
isn't an endorsement of these stocks, but a framework through which
you can look at them.
Yet investors should note that Safeway reports
on Thursday, April 26, and the results are likely to be mediocre at
best due to some near-term headwinds. It may pay to wait until
after the news is digested to play the merger and
(M&A) angle on this stock.
All that cash -- looking for a home
Frankly, it's fairly surprising how little buyout activity we've
seen in recent quarters. The ever-rising cash balances at many
companies, the low cost of borrowing and the need to find growth
opportunities in this tepid
should be fueling a furious bout of deal-making. Private-equity
firms, with more than $400 billion in cash could also be looking at
breaking out their checkbooks, according to Goldman Sachs. Though
it hasn't been much in evidence yet, I remain convinced that robust
M&A activity will turn out to be one of the key investing
themes when 2012 comes to a close.
So what other companies could be in play? Well, the key is to focus
on companies that are already so cheap based on their current
, that they would both appeal to potential acquirers and have solid
downside support in terms of valuation -- in case a deal never
In play yet again -- but this time, with downside
Unfortunately, this means companies that are deeply out of favor
should be the focus. Take Radio Shack (NYSE:
) as an example. Its stock has slumped from $20 in late 2010 to a
recent $6 on a string of weak quarterly results. Indeed, you can
probably assume that the electronics retailer will disappoint
investors yet again when quarterly results are released this
Tuesday, April 24.
But here's the rub: this stock has fallen so sharp, that a
financial or strategic buyer could
a 50% premium and still pay a low price for this company.
RadioShack has generated an average of $150 million in annual
free cash flow
-- on average -- during the past eight years. The company is now
valued at just $600 million, and its fairly strong balance sheet
(with $592 million in gross cash) is precisely the kind of weapon
that private-equity firms like to target.
RadioShack was the subject of buyout rumors when its stock was at
$20 -- and investors got burned. Now, with shares off 70%, those
rumors are back, though this time the
in the stock seems much lower. Again, it's foolish to own a stock
like this in hopes of a buyout, but the dowdy valuation means it's
already a bargain on the fundamentals.
Could this be the next big energy deal?
Investors may also seek continued M&A in the energy sector,
especially as natural gas-focused firms are short of funds to
exploit their assets. As an example,
Chesapeake Energy (NYSE:
is scrambling to raise cash to meet its 2012 capital spending
plans, and fears of balance sheet troubles have pushed this stock
below $20 for the first time since 2009. (Behind-the-scenes
Aubrey McClendon that have raised conflict-of-interest concerns
have also pressured shares.)
Chesapeake is now worth less than $12 billion. Note that
Exxon Mobil (NYSE:
paid more than $40 billion to acquire XTO Energy in 2010, and
Chesapeake's current energy assets are even more extensive than
XTO's were. To be sure, natural gas prices are now much lower, but
strategic investors such as ExxonMobil know this won't last and may
well conclude that Chesapeake is too much of a bargain to pass up.
Risks to Consider:
Companies such as RadioShack, Chesapeake Energy,
Best Buy (NYSE:
and many others have made a series of missteps to find themselves
in the bargain bin, and further missteps can't be ruled out. That's
why you must stress-test a company in terms of its downside
Action to Take -->
It's wisest to focus on quality companies that are simply out of
favor such as Freeport McMoran, Kroger or RadioShack. If you hear
of buyout rumors, go straight to the
to be sure that these companies have the assets or the cash flow to
support the stock, even if buyout rumors evaporate.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of RIO, CHK in one or more if its "real money"