"Strike while the iron is hot," is the new catchphrase in
Private Equity (PE) circles. Conditions are perfectly in place to
do deals, and you can expect to hear of many more this winter. Just
this week,
Yahoo! (Nasdaq: YHOO)
,
Wendy's/Arby's (
WEN
)
and
Seagate (
STX
)
are surging on word that PE investors are sniffing around. This
frenzy of potential deal-making comes as many public companies are
cash-rich but undervalued.
[See: "
This Sector's Mountain of Cash Could Soon Line Your
Pocket
"]
To pull off a deal the size of Yahoo! is no mean feat. The
company's
market value
already exceeds $20 billion. Seagate, which is now valued at around
$6 billion, is typically more in line with an ideal size for PE
investors, several of whom got burned in the last decade from deals
that were simply too large to digest. PE firms also made the
mistake back then of ignoring balance sheets, instead identifying
debt-laden targets upon which they heaped even more debt. These
days, PE buyers prefer to see lots of cash on the books so they can
easily talk a bank into lending them the money to finance a deal.
With interest rates quite low, theeconomics of deal-making are very
compelling.
These PE firms hope to take companies private while they're cheap
and then bring them public (or find another buyer) when valuations
improve. But buyers beware: by the time that a company goes public
again, debt levels can be alarmingly high. For example,
Hertz Global Holdings (
HTZ
)
was taken private in 2003 and then brought back public in 2006
through an
IPO
. Shares plunged below $5 in 2008 when a massive
debt load
suddenly became a scary prospect in an economic downturn.
To be sure, many potential PE candidates have already surged and
would be risky to buy at this point. Names such as
CommVault (Nasdaq: CVLT)
,
Isilion Systems (Nasdaq: ISLN)
and
NetScout Systems (Nasdaq: NTCT)
have already seen considerable
buyout
buzz.
With all that in mind, here is a quick list of five companies that
appear to be attractive targets for the PE crowd, yet still appear
undervalued.
1.
Symantec (Nasdaq: SYMC)
-- Shares of this data security and storage vendor started to
rebound after
Intel (Nasdaq: INTC)
bought rival
McAfee (
MFE
)
. My colleague Ryan Fuhrmann made a clear case for considerable
upside for shareholders, if a PE offer emerged. [
Read Ryan's take here
]
2.
Integrated Silicon Solutions (Nasdaq: ISSI)
-- This company checks all the boxes that PE firms look for. It
sports a reasonable $236 million market value, has roughly $90
million in net cash, is nicely profitable -- trading at less than
six timesearnings , and is utterly unloved. Semiconductor stocks
are far out of favor right now, and this maker of embedded chips
that go into a wide range of applications could be acquired and
combined with another PE holding to make a larger chip company.
3.
Novellus Systems (Nasdaq: NVLS)
-- This company, along with
Lam Research (Nasdaq: LRCX)
, trails behind industry leader
Applied Materials (Nasdaq: AMAT)
in the market for semiconductor manufacturing equipment. They all
toil in a highly
cyclical industry
, which means they are occasionally stuck with low
price-to-earnings (P/E) ratios-- right now they all trade for less
than 10 times next year's projected profits. Yet these types of
stocks are often attractive to PE firms that can buy them, extract
the cash, and take them public again when the sector is back in
vogue.
4. Huntsman Corp. (
HUN
)
-- This chemicals maker routinely traded in the high teens and the
low $20s prior to the financial crisis and now trades for around
$12. As
I noted in this article
, a buyer was prepared to pay $28 a share in 2007 before financing
dried up.
The chemicals business is highly cyclical, and Huntsman's profits
are just starting to rebound. The company is likely to earn $0.50 a
share this year and perhaps twice as much next year. But PE buyers
will note that
EPS
exceeded $2 in 2008, when economic conditions were better. Shares
trade for just six times that peak cycle profit. Of course,
Huntsman still carries a lot of debt, even as it has built up a
heftyload of cash, so PE buyers would likely use Huntsman's $1
billion in annual
free cash flow
to help secure financing for the deal.
5. Ciena (Nasdaq: CIEN)
-- When
Tyco International (
TYC
)
announced plans in July to acquire
ADC Telecom (Nasdaq: ADCT)
, investors quickly surveyed the landscape to see what rivals may
be up for sale.
ADTRAN (Nasdaq: ADTN)
seemed to some as the most obvious target, and its shares have
risen about +20% since then. But I think Ciena is more likely to
find interest. That's because Ciena was able to pick up Nortel's
telecom equipment business at a cheap price in bankruptcy court
earlier in 2010, and now has an even broader product platform and
deeper array of customers.
That newfound heft should help Ciena to secure rising
market share
in the telecom equipment market, whose demise has been greatly
exaggerated. Europe now represents 35% of sales for Ciena, which
currently represents a drag but will be a tailwind when the
Europeaneconomy rebounds and European telecom service providers
need to catch up on lagging infrastructure investments.
Action to Take -->
This list could go on and other names such as
JetBlue (Nasdaq: JBLU)
,
AMR (
AMR
)
,
Weatherford Industries (
WFT
)
,
Blue Coat Systems (Nasdaq: BCSI)
-- all are digestibly-sized and operate in consolidating
industries. Of course, many of these deals will never happen, so
you should buy these stocks for their fundamentals, and not because
you expect a buyout offer to emerge. But make no mistake, the PE
buyout frenzy is clearly underway and will remain in place as long
as borrowing costs and current equity valuations are low.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
More...
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.