Let's Make A Deal

3/3/2014


Depending on how you slice the data, the mergers-and-acquisitions environment worsened or improved in 2013. According to Thomson Reuters, the number of announced deals in the U.S. declined to 8,734 from 8,764 in 2012. Dollar volume of M&A activity, however, rose 11% for the year, lifted by Verizon Communications' ($46; VZ) $130 billion purchase of the 45% of Verizon Wireless it doesn't own from Vodafone ($41; VOD). The U.S. was the bright spot for global M&A, as the number of deals worldwide fell 7% on a nearly 6% decline in dollar volume. 

Some analysts predicted extremely low interest rates would propel more deals last year, and the lack of aggressive gains in M&A came as a surprise to many investors. However, the drama in Washington and uncertainties concerning global economies probably dampened CEO confidence.

Early indications point to more companies playing "Let's make a deal" in 2014. Dollar volume of deals in the U.S. hit $153 billion for January, more than three times the level in 2012, according to Thomson Reuters. And a number of factors point to accelerating takeover activity:

Money is still cheap. Interest rates, which have backed down a bit so far this year, remain extremely low. Financing should not be a problem, and low interest rates make it easier to reach deals that add to per-share earnings immediately.

Rising stock prices increase buying power. Strong market gains in 2013 boosted the value of a prominent takeover currency — stock. Of course, the same force has also boosted the prices of takeover targets.

Deals can generate growth. The market advance puts pressure on companies to validate those higher stock prices. Wall Street wants to see growth, and some companies would rather buy than build.

Improved overseas economies, especially in Europe, could expand the number of acquirers. Cross-border M&A activity fell 18% in 2013. With Europe looking like it has bottomed economically, we may see more deals in coming quarters.

Acquirers are reaping rewards. According to Dealogic, in 2013 acquirers' stock rose an average of 4% on the days they announced takeovers worth $1 billion or more. Historically, Wall Street has punished acquirers with share-price declines on such announcements, and the switch could spur more executives to pursue deals.

An increase in dealmaking this year begs the question — what companies will have the urge to merge? One metric used to ferret out stocks ripe for takeover is the enterprise ratio, or a company's enterprise value (stock-market value plus debt minus cash) divided by EBITDA (earnings before interest, taxes, depreciation, and amortization).

Analysts often use enterprise value as a proxy for a company's takeover value, since enterprise value takes into account both debt and equity. The lower the enterprise ratio, the more attractive a company appears to a potential acquirer.

TAKEOVER TARGETS
Enterprise Ratio
Quadrix
Overall
Score
Company (Price; Ticker)
Div.
($)
Yield
(%)
52-Week
Range
($)
Trailing
P/E Ratio
Absolute
Quadrix
Score
Alaska Air ($85; ALK)
1.00
1.2
87
-
49
16
5.5
88
99
Foot Locker ($41; FL)
0.88
2.1
42
-
31
15
6.7
81
97
Helmerich & Payne
($97; HP)
2.50
2.6
98
-
56
17
6.9
80
97
Lear ($80; LEA)
0.80
1.0
84
-
51
14
5.8
86
89
Note: Quadrix scores are percentile ranks, with 100 the best.

Our Quadrix stock-rating system calculates the enterprise ratio for more than 4,600 stocks. The table above features four Buy-rated stocks with enterprise ratios that put them in the cheapest quintile (one-fifth) of all stocks in our research universe. As with most valuation ratios, stocks with low ratios earn higher scores. The Forecasts does not advocate buying a stock simply because of takeover potential; all four of the stocks also earn Overall scores in the top quintile, boasting attractive fundamentals in addition to their takeover potential.

The airline sector has had its share of consolidation, which makes Alaska Air ($85; ALK) an interesting takeover play. The stock's Overall Quadrix score of 99 gives it plenty of appeal beyond its takeover possibilities. The stock has gained more than 16% so far in 2014, far outpacing the broad market. Per-share profits should rise at least 21% in 2014. Alaska Air trades at 13 times the consensus 2014 earnings of $6.55 per share, 11% below the industry median. The stock is rated Buy.


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