By JACK HOUGH
Takeover math suggests Best Buy (BBY)
Shares of the electronics chain jumped 13% Monday after founder Richard Schulze, who left the company three months ago, offered to buy it for $24 to $26 a share -- a premium of up to 47% over Friday's close.
That the stock didn't climb higher on Monday suggests investors doubt either Mr. Schulze's ability to complete the deal or Best Buy's willingness to accept it. Indeed, by one measure, Mr. Schulze's offer looks frugal, even though it is well above the stock's recent price.
Merger analysts often use a measure called "EV/Ebitda" to discuss deal pricing. EV is enterprise value, equal to the cost of buying all of a company's shares and paying off its bondholders and other investors, while applying its cash to the deal. At a purchase price of $26 a share, Best Buy would have an enterprise value of about $10 billion, based on FactSet data.
Ebitda stands for earnings before interest, taxes, depreciation and amortization. It's mostly useful for making comparisons among companies. Best Buy produced Ebitda of $3.3 billion during its fiscal year ended March 3, and similar amounts the two years before.
That gives the company an EV/Ebitda ratio of 3, based on the top end of Mr. Schulze's offer. During the first quarter of this year, the average takeover of a retailer was priced at an EV/Ebitda ratio of 8.2, and the average over the prior six years was 9, according to Demeter Group, an investment bank.
For investors, one way to identify other companies that seem priced for takeover appeal is to run a screen for low EV/Ebitda ratios. A recent one produced Dell (DELL)
Of course, there's more that goes into a takeover decision than price. Mr. Schulze's interest in Best Buy surely stems in part from his deep experience with the company and 20% ownership stake. Also, just because a company is priced right for a takeover doesn't mean ordinary investors should buy shares. Some companies are cheap because they're struggling, making it difficult to decide whether shares are a worthwhile risk.
Take Best Buy. Among 14 analysts with forecasts for its "same-store" sales this year, the average expects them to shrink 3.2%. Same-store sales, a closely watched measure on Wall Street, ignore the effect of store openings and closings to show whether performance for a chain is improving or deteriorating.
Morningstar last year began publishing predictions on takeover targets based on things like size, leverage, cash flow and other, industry-specific factors. It also refined its list of targets to highlight ones that look undervalued for purposes of ordinary investors buying shares.
Predicting takeovers isn't easy, but Morningstar is off to a good start. Last year, two of its 20 top picks, Constellation Energy and Petrohawk, were taken over at premiums of 22% and 96%, respectively, to their stock prices at the time Morningstar published its recommendations in January. So far this year, two out of a list of 13, Collective Brands and Amerigroup, were bought at premiums of 49% and 31%, respectively.
Conditions look ripe for takeovers: Loans are cheap, revenue growth is hard to come by and companies are stuffed with cash. Then again, those conditions have failed to produce a buyout boom of late. There were 5,900 U.S. deals during the first half of this year, versus 5,100 a year earlier, but the average size shrank to $68 million from $102 million, according to research firm Dealogic.
For investors looking for attractively priced stocks that also have takeover appeal, Morningstar revisited its top picks late last month and came up with 16 companies. They're listed below.
- Charles River (CRL)
- Chico's (CHS)
- Guess (GES)
- Icon PLC (ICLR)
- iRobot (IRBT)
- Leap Wireless (LEAP)
- Mosaic (MOS)
- Myria Genetics (MYGN)
- Nasdaq OMX (NDAQ)
- NII Holdings (NIHD)
- Range Resources (RRC)
- Riverbed Technology (RVBD)
- Rockwell Automation (ROK)
- SandRidge Energy (SD)
- Stoneridge (SRI)
- Ultra Petroleum (UPL)