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Published: October 19, 2010
"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 (NYSE: WEN) and
Seagate (NYSE: 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.
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,
the economics 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 (NYSE: 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
(NYSE: MFE).
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 times
earnings, 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. (NYSE: 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. 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 hefty load 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
(NYSE: 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 European economy 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 (NYSE: AMR), Weatherford Industries (NYSE: 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
Staff Writer
StreetAuthority
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