Magazine

Who's Ripe For A Takeover


Takeovers are back with a vengeance, and investors smart enough -- or lucky enough -- to own stock in a company that is being pursued can make handsome gains.

While no one can say with certainty what companies will be acquired, a variety of financial measures offer ways to narrow the field. With the help of Richard Sloan, a professor of accounting and finance at the University of Michigan's Stephen M. Ross School of Business, we screened for candidates using the FactSet Research Systems (FDS) database of 5,875 companies. We included only American companies listed on the three main stock exchanges in the U.S.

Sloan zoomed in on a handful of characteristics common to companies that get bought out. Among them are familiar measures such as price-to-earnings and price-to-book-value ratios, and some lesser known, such as price-to-net tangible assets. Armed with such financial facts and figures, an investor can begin to ferret out companies that have good assets that could be bought at a reasonable price.

That narrowed the list to 1,656. From that universe, we took companies with the lowest valuations for each measurement. The result: a list of 15 businesses that could be attractive acquisition opportunities for another public company or a private equity firm.

Of course, number-crunching goes only so far. A well-constructed stock screen simply gives you a starting point to begin your qualitative research. "These screens are not foolproof and are [in] no way guaranteed," says Sloan. "But they can turn the probabilities in your favor."

Nearly half the companies on the list are specialty retailers, from Payless ShoeSource (PSS) and Jo-Ann Stores (JAS) to Charming Shoppes (CHRS) and Stage Stores (STGS). Each caters to a niche and is up against unique challenges. Payless, for example, the mass-market shoe retailer, reaps 25% of its revenues from athletic footwear. Competition has heated up as Nike (NKE) teamed with Wal-Mart Stores (WMT) and started to manufacture and distribute a new line under the Starter brand of athletic footwear and apparel. Still, with 4,700 stores across the country, Payless is the largest shoe seller in the U.S.

PRICE RESISTANCE

Several of the 15 companies on our list lead their industries. American Greetings (AM) is the largest publicly traded maker of greeting cards, yet with Wal-Mart and Target selling cards for as low as two for $1, customers are becoming resistant to the higher-priced cards that American Greetings sells. Freescale Semiconductor (FSL), a recent spin-off from Motorola (MOT), is one of the largest semiconductor makers for networking equipment, automobiles, and cell phones. Investors worry that, with 28% of its revenues coming from its former parent, Freescale could be vulnerable if Motorola shifts business elsewhere.

PRIVATE EQUITY PREY

Antitrust regulations may keep a market leader from falling prey to a major competitor. But private-equity funds, flush with an estimated $200 billion bankroll, could buy such companies without riling the watchdogs. One leader on the list, bookstore chain Borders Group (BGP), gets 16% of its revenues from selling recorded music. With the music business in the dumps, Borders is in more pain than its main rival, Barnes & Noble (BKS), which earns less than 5% of sales from music. Borders didn't follow some of Barnes & Noble's winning strategies, such as a self-publishing unit and a readers' advantage discount program, which offers rewards for frequent purchases. If Borders management doesn't fix these problems, perhaps a buyout artist will.

Some outfits may come cheap, but they're not easily fixed. Archer Daniels Midland (ADM) (ADM), a processor of agricultural products, has problems in its ethanol business, which accounts for 25% of the company's operating profit. Typically the price of ethanol correlates with crude oil and gasoline prices. But ethanol must be blended with gasoline at an oil refinery to make it usable as a fuel. With the shortage of refining capacity in the U.S., ADM has an oversupply of unrefined ethanol.

Although our list here highlights only 15 companies, BusinessWeek Online showcases 100 undervalued companies identified through the same screen. These outfits missed the parameters we set, but they still have many of the attributes that acquirers are known to value. Two recognizable names on the BusinessWeek Online list are King Pharmaceuticals (KG) and Circuit City Stores (CC), which were pursued by acquirers this past year until the deals fell apart. The numbers suggest they could be in play again soon.

Corrections and Clarifications

In ``Who's ripe for a takeover'' (Personal Business, May 23), BusinessWeek screened for stocks that limited insider ownership to 20% or less. American Greetings Corp. erroneously made the list. The stock screen did not pick up the separate set of class B shares that are not traded and have 10 votes per share, which are designed to keep family control.

By Toddi Gutner


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