Online Extra: Fishing for Takeover Bait

If mergers and acquisitions keep up the current pace, this year could post $1 trillion worth of deals completed -- a number not seen since 2000, when M&A volume peaked at $3 trillion. Whether these deals are being done by corporations attempting to gain market share or the new, cash-rich, private equity corporate raiders hunting for undervalued companies, the end result is mergermania. And that can mean opportunities for investors.

Searching for takeover candidates can be profitable -- even if the buyout never materializes. Investors can make money when they own stock in companies that are likely to be acquired. That's because takeover offers are often made at prices above current market levels, and this spurs share prices to rise toward the offer. Even without a buyout offer on the table, a management team that's concerned about a possible takeover will likely try to boost its company share price to make it too expensive to buy. In either case, shareholders win.

Of course, no one has a crystal ball to predict which companies are most likely to be takeover targets. There are, however, disciplined ways to narrow the field by using valuation and other financial measures. With the help of Richard Sloan, professor of accounting and finance at the University of Michigan's Ross School of Business, we screened for candidates from the FactSet Research Systems database of 5,875 companies. We included only American companies listed on the three main U.S. stock exchanges.

LOOKING FURTHER. We then identified eight characteristics of companies that get taken over: A market capitalization of at least $500 million; insider ownership less than 20%; debt as a percentage of assets of 25% or less; and low valuations for price-earnings ratio, price to free cash flow, price to working capital, price to book value, and price to net tangible assets. We looked for companies that had the lowest valuations for each parameter and came up with 15 names.

This list incorporates those 15 companies and shows an additional 85 that meet some of the parameters we set. Highlighted below are several companies from the expanded list that may still make good takeover candidates.

Furniture Brands International (FBN) is the largest domestic producer of residential furniture in the U.S. The furniture manufacturing industry is undergoing a seismic shift, with retailers selling Asian goods under private label and more products being manufactured overseas. Consequently, Furniture Brands is seeing shrinking margins and disappointing demand. It's unlikely any public company would want to buy Furniture Brands, but perhaps a private equity firm would be able to make the tough decisions necessary to help the company better compete with the Asian invasion.

Highwoods Properties (HIW). This commercial real estate investment trust in the Southeast expanded without discipline in the 1990s. It was also the largest landlord to WorldCom prior to the company's bankruptcy and has exposure to US Air, another troubled company. Highwoods has recently been selling properties outside of its core markets in the mid-Atlantic region.

H.B. Fuller (FUL). H.B. Fuller Co. and its subsidiaries manufacture and market adhesives and specialty chemical products globally. The adhesive industry needs to consolidate to benefit from economies of scale, and while some of the smaller players have been gobbled up, there's still too much capacity. Many of Fuller's competitors, which are divisions of larger companies, are content to operate with capacity utilization rates of 45%. But Fuller, which is unique in standing alone, can't operate at that level.

Tech Data (TECD) is a provider of info tech products and logistics management. The company sells PC hardware and software products, purchased directly from manufacturers and publishers in large quantities for sale to more than 90,000 resellers. Given the slowdown in corporate computer upgrade activity, analysts aren't expecting a lot of growth out of Tech Data for the foreseeable future. Most corporations did a big computer upgrade for Y2K and then again from mid-2003 through 2004. While sales in the industry are cyclical, Tech Data takes an extra hit because most other companies that provide these products are divisions of larger companies.

Allmerica Financial Corp. (AFC). Allmerica provides property and casualty insurance, as well as asset management and financial services. With new management in the last 18 months, the company aims to become a superb regional prop-cas company. But Allmerica has a life and annuity business, worth at least $500 million, that has had capital problems and looks to be pulling the rest of the company down. There has been intense shareholder pressure to sell this division and take the money to buy back stock. By Toddi Gutner in New York

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