As Joel Greenblatt points out in The Little Book that Beats the Market, there are plenty of factors that can drive the stock of a cheaply valued company up. For one, it reaches the radar screen of value based investors once it gets low enough. Second, the company itself may find its stock an attractive investment and put capital to work buying back shares and lowering the share count, which leads to price appreciation because each share earns a larger portion of profits. Third, and the point here, is that a competitor or private equity group could find the entire company attractive at the market price and decide to purchase it outright.
The best part about buyouts is that they are nearly always at a premium to the current market price of the company. This makes sense of course... investors would be unwilling to sell their shares unless they could realize an acceptable return on their investment. Often, the market value premium is significant. In some years it has reached as high as 50%, although recently most takeouts have occurred in the 30-40% premium range.
Cheap stocks are prime candidates for acquisition, and good companies at cheap prices are even better buyout bait. These are just the companies that the Magic Formula screen was designed to find. 2010 was a very active year for Magic Formula stock buyouts (dates are when deal was announced). The average premium was over 40%.
* Bare Escentuals (was BARE) acquired January by Shiseido for $1.7 billion ($18.20/share). 43% premium.
* K-Tron (KTII) acquired in January by Hillenbrand (HI) for $390 million ($150/share). 32% premium.
* COMSYS IT Partners (CITP) acquired in February by Manpower (MAN) for $431 million ($17.65/share). 33% premium.
* DynCorp (DCP) acquired in April by Cerberus Capital for $1 billion ($17.55/share). 49% premium.
* Interactive Data (IDC), a former Top Buy pick, acquired in May by Silver Lake/Warburg Pincus for $3.4 billion ($33.86/share). 33% premium.
* Odyseey Healthcare (ODSY) acquired in May by Gentiva (GTIV) for $1 billion ($27/share). 40% premium.
* Sybase (SY) acquired in May by SAP (SAP) for $5.8 billion ($65/share). 44% premium.
* DivX (DIVX) acquired in June by Sonic Solutions (SNIC) for $323 million ($9.25/share). 33% premium.
* Hewitt Associates (HEW) acquired in July by Aon (AON) for $4.9 billion ($50/share). 41% premium.
* Gymboree (GYMB) acquired in October by Bain Capital for $1.8 billion ($65.40/share - notice the target price from my June review!). 57% premium to pre-deal chatter.
For the end of 2010 and into 2011, there is no shortage of current Magic Formula stocks with plenty of buyout rumors swirling around them. Here are a few of the more prominent ones:
* Seagate (STX) has a new rumor every week. Here's the latest one. Competitor Western Digital (WDC) is often mentioned as well.
* Aeropostale (ARO) is just one of several retail targets mentioned here.
* Citi believes that both Veeco Instruments (VECO) and Teradyne (TER) are attractive leveraged buyouts in chip equipment.
Buyouts are a quick strike way to make a big profit, and they are most common amongst quality value stocks. Just another reason to consider making the Magic Formula Investing strategy your investing strategy.
Disclosure: Steve owns WDC, VECO, JCG