6 Stocks Priced for a Takeover

In September this column recommended against a purchase of Ann Taylor (ANN) stock, "barring a much deeper discount." The discount has since been applied, and it's astounding. Shares have lost 84%.

Put different, two months ago you could've owned Ann Taylor outright for about $1.4 billion. For that sum today, you'd get Ann Taylor, Talbots (TLB), Chico's FAS (CHS), Jones Apparel (JNY) and about $250 million change.

Shop carefully. For two of those chains, Talbots and Jones, the debt you'd inherit far exceeds the cost of the outstanding stock. Talbots is yours for a mere $98 million, but you'd better be able to make payments on the $400 million it owes. Ann Taylor and Chico's have negligible debt and ample cash. In a buyout, those cash balances could be applied to the deal, further reducing already slashed purchase prices. Ann Taylor, whose stock is now valued at $228 million, could be had for just $184 million, net of cash. Chico's cash reduces its price to $192 million from $412 million.

Of course, takeover financing is scarce at the moment, so deals are few. But there are some. In August, this column recommended shares of Mentor (MNT), a breast implant maker. Shares have since gained 11%, outperforming the broad market by 45 percentage points, thanks to a Monday buyout announcement by Johnson & Johnson (JNJ). In women's clothing stores, Charlotte Russe (CHIC) received a mid-November offer of nearly $200 million from a pair of investment firms. Its board rejected the deal as "opportunistic." The company is now valued at $89 million, or $59 million after deducting for its cash.

I recently ran a search for companies whose takeover prices -- the cost to buy their shares and pay off any debt while using available cash -- look low relative to underlying earnings power. I purposely sought subpar operating margins; those are sometimes a sign of corporate fat waiting to be trimmed after a merger. And I favored companies that produce free cash.

Ann Taylor made the list. Its freefalling shares recently breached $4. Financial trends are worrisome. In the company's third quarter, sales at longstanding stores plunged more than 19%. Sliding sales against a big fixed cost base can make profits disappear fast. This fiscal year, which ends Feb. 2, earnings per share are expected to fall more than 70%. In the following fiscal year analysts guess they'll plunge again, by 78%.

In addition to long-term concerns, there are three short-term reasons to fear shares. First, loss-saddled share owners might sell before year's end for tax purposes. Second, institutions own a large portion of Ann Taylor's stock, and minimum price requirements might force them to sell. Third, as of mid-November, short-selling in the stock was rising.

But consider what you get for $4 ($2.60 if you subtract the cash). There's more than $35 a share in yearly sales. There's more than $13 in book value, or what accountants figure the company's assets are worth. There's no dividend, so if you buy the stock, don't expect to make money right away. This is no mere lull in retail clothing sales; it's a long-term shrinking from an unsustainable size to an affordable one. Ann Taylor is likely in for years of sliding sales and messy earnings charges for store closings. That said, the stock is cheap enough to regard as a long-term option, and maybe a bet on a buyout. Tuck a bit of it away and forget it for five years. By then, if Ann Taylor is still standing, or if it's been swallowed by a suitor, I'm guessing you'll have made decent money.