Lucky investors gain big as M&A surges in new year

Published on NewsOK Modified: February 17, 2013 at 11:22 am •  Published: February 17, 2013
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Those looking to profit on deals by picking companies before they're taken over should know it's not easy. But there are guidelines for choosing possible M&A targets. One is a reasonably valued stock, not so high that it's likely to scare off buyers.

Other signs are low debt and a history of generating lots of cash. Those are key for buyers who borrow heavily to finance deals, says Hottovy, the Morningstar analyst. Their debt can be repaid with the money coming out of target companies.

Among the picks in a Morningstar report co-authored by Hottovy last month:

— Kohl's: The department store chain has strong cash flow and its stock trades at 10.7 times per share earnings in the previous 12 months, which Morningstar considers attractive. The average for S&P 500 companies is 17 times.

— Chesapeake Energy Corp.: The second-biggest U.S. gas producer is a target of investors looking to get the share price up. Embattled CEO Aubrey McClendon was pushed out last month. The stock is down 12 percent in the past 12 months.

— City National Corp.: Morningstar likes that the Los Angeles-based bank courts wealthy business owners as customers and has increased earnings per share by 63 percent in two years. The stock is up 17 percent in the past 12 months.

Conditions seem ripe for plenty more deals.

Borrowing money to buy has rarely been cheaper since interest rates are near record lows. And many companies can pay for M&A out of their own pocket. Companies in the Standard and Poor's 500 index have more than $1 trillion in cash on their books, up 66 percent in five years.

If the means are plenty, so are the motives.

Before the Great Recession, buyout firms raised hundreds of billions of dollars from investors. They promised to use the money to buy companies within a set time or return it. Some of those deadlines are fast approaching. As of September, buyout firms had $193 billion left to spend by the end of 2013, according to Triago, which helps raise money for the industry.

About a quarter of the money spent to buy U.S. companies this year has come from leveraged buyout firms. That is about the same as before the recession, according to Dealogic.

The Dell deal recalls the era of the super-sized buyouts, a heady time before the recession of bidding wars and overpriced purchases. The motive was to cash out after a few years by flipping the acquired company to another buyout firm or by selling stock in a public offering.

Most buyout deals today, though, are smaller and involve much less debt.

Experts say many companies are buying rivals in the hope that the combined businesses will quickly add to profits. For years, companies have been cutting staff and squeezing workers. Now they are finding that path to higher earnings is tough. Earnings in the first quarter are expected to increase less than 1 percent from last year for companies in the S&P 500, according to FactSet, a financial data provider.

Morningstar's Hottovy cautions investors not to get too excited about a big year for deals. Despite the good signs, CEOs can sour on M&A if their confidence evaporates. He says a flood of deals about a year ago turned into a trickle on fears that the European debt crisis would hurt U.S. companies.

"We thought we were back," Hottovy says. "But then Europe put a halt to all that."

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AP Business Writer Steve Rothwell contributed to this story.

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