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Do IT this week: Layering
Investors with stock benefit in such deals that are emerging trend
Published on Saturday, Nov 21, 2009
Warren Buffett's takeover of Burlington Northern Santa Fe Corp. illustrates an emerging trend: Takeovers are back.
That's good news for investors. When companies are eager to make acquisitions, it's an encouraging sign to the market.
And, of course, it's lovely if you happen to hold a stock that becomes a target. Buffett's Berkshire Hathaway Inc. offered $100 a share for Burlington Northern when it was trading around $76. That's typical: Takeovers are often done at 30 percent or more than the market price.
In October, U.S. companies announced 770 deals, the highest monthly total since September 2008, according to data compiled by Bloomberg. Wall Street executives are optimistic about the outlook for more deals next year.
Google, owner of the world's top search engine, recently agreed to pay $750 million to acquire closely held Admob Inc., a mobile-phone advertising company.
Meanwhile Kraft Foods reiterated its offer of about $16 billion to acquire Cadbury PLC, a British candy maker. So far Cadbury has rejected the offer. Some Cadbury holders are hoping that Switzerland-based Nestle SA will jump in with a higher bid.
Hewlett-Packard Co., the world's largest personal-computer maker, said it will spend $2.7 billion to buy 3Com Corp., which makes computer networking equipment and gets almost half its revenue from China.
One way to speculate who's next is to seek out companies with characteristics likely to make them attractive to potential acquirers. Often, these same qualities make for a good investment, even if no suitor shows up.
Last week, I screened about 2,600 U.S. companies looking for ones with alluring valuations, low debt and at least $100 million cash in the till.
All of these qualities, I believe, make a target company attractive to a potential acquirer. Cash is important because sometimes a buyer can use the target's own money to defray part of the acquisition cost.
Several managed-care organizations met the criteria. They are cheap now because investors are uncertain how the rules for health-care companies will change, assuming Congress enacts a legislative overhaul this year or next.
Aetna's appeal
Aetna Inc., I think, is a tempting target. With a market value of about $13 billion, it is small enough for a potential acquirer to swallow. Rivals such as UnitedHealth Group Inc., at $34 billion, and Travelers Cos., at $29 billion, would be more difficult to digest.
Aetna is cheap enough to be attractive, selling for about nine times earnings. And it had $1.8 billion of cash and near-cash as of Sept. 30.
Investors figure the federal government will pay a bigger share of the nation's health-care bill in the future. Under pressure from huge federal deficits, the government might be stingy with payments under Medicare, Medicaid and whatever programs are created under new legislation.
What the pessimists overlook, however, is that any new health-care laws will mandate some form of compulsory insurance coverage, which will expand insurers' pool of customers.
Ensco modernizes
Another potential takeover target is Ensco International Inc., an offshore oil drilling company based in Dallas. When I first became a securities analyst 12 years ago, Ensco had a reputation as a driller with a hodgepodge of relatively old equipment, exploring primarily in the Gulf of Mexico.
The company has changed since then. It has more modern equipment today than many competitors, and it drills all over the world, especially in Asia and the United Kingdom.
Ensco stock sells for only seven times earnings. And the company has about $1 billion of cash and equivalents. All this might be enough to make a potential acquirer salivate.
Some of Ensco's rivals, Diamond Offshore Drilling Inc. and Noble Corp., also look like takeover bait to me. However, at $14 billion and $11 billion market value, respectively, they might be harder to acquire than Ensco at $6.5 billion.
Allstate's value
A third possible takeover candidate is a company I never expected to consider in that vein — Allstate Corp., the largest publicly traded U.S. home and auto insurer which has operations in Summit County.
The stock market has banged up Allstate up so badly that it now has a market value of less than $16 billion. Burlington Northern, by contrast, is valued at more than $33 billion, or twice as much.
Is Burlington Northern really worth twice as much as Allstate? I can make a good case that it's not.
Last year Burlington Northern had revenue of about $18 billion while Allstate's revenue was $29 billion. To be sure, Allstate had a loss last year while Burlington Northern had a profit. Yet Allstate had its best year in 2006, earning about $5 billion and the following year it earned $4.6 billion.
Burlington Northern, by contrast, has never earned more than last year's total of $2.1 billion.
I say this not to argue that Warren Buffett overpaid for Burlington Northern, but to point out that Allstate is very probably undervalued.
Disclosure note: For clients and personally, I own shares of Nestle SA. One client of my firm holds Allstate. I have no long or short positions in any of the other stocks mentioned in this week's column.
John Dorfman, chairman of Thunderstorm Capital in Boston, is a columnist for Bloomberg News. His firm or clients may own or trade securities discussed in this column.
Warren Buffett's takeover of Burlington Northern Santa Fe Corp. illustrates an emerging trend: Takeovers are back.
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