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MagicDiligence (< 20)

Magic Formula Buyouts and Bankruptcies 2009

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November 12, 2009 – Comments (0) | RELATED TICKERS: RX.DL2 , TRA.DL , AMSWA

It should come as little surprise that many stocks that make it into the Magic Formula Investing (MFI) screen are attractive acquisition targets. Many, if not most, are good businesses selling at cheap prices, exactly what the screen is designed to find. When you have quality selling cheap, not only individual investors but business managers, both public and private, take notice as well. Particularly if the screened business is one that is a current or potential competitor, or a business that nicely compliments current operations, it makes sense to acquire it at a favorable price. When this happens, investors reap big rewards in short periods of time.

Of course, there is the other side of the coin too - declining businesses or heavy cyclicals can find their way onto the screen as well, usually well into the downside. With these firms we need to be very careful - too much debt can land them in bankruptcy court. Unfortunately, MFI has turned up a few of these as well. Let's take a look at some individual "buyouts and bankruptcies" on the MFI screen in 2009.

Buyout: IMS Health (RX) by private capital firms TPG Capital and CPP Investment Board.

IMS Health, a former MagicDiligence Top Buy, is an attractive business with great cash flows, stable revenue streams, high margins, and a dominant competitive position in prescription data. Although the deal has not closed yet, the $22/share cash offer is well above IMS's trading range of $10-15 for most of the past year, and a 31% gain over the price when the deal was announced. Those who got into this stock during its 2009 MFI run could have recognized as much as a 100% gain in less than 9 months.

Buyout: Marvel Entertainment (MVL) bought by Disney (DIS).

This deal, announced at the end of August, featured on-again off-again MFI stock Marvel Entertainment, the well-known comic-book and movie producer, being acquired for $4 billion dollars in cash and Disney stock. The buyout values Marvel at about $52 a share (it varies based on Disney's stock price), a significant premium to its 2009 trading range. Marvel had 2 stints on the MFI screen this year: 2/6 - 3/13 and 7/23 - 8/3. If you would have bought in the latter range, you could have pocketed a nifty 27% gain. But those that jumped on Marvel in the earlier time frame would have more than doubled their money in 8 months.

Buyout: Sepracor purchased by Japanese drug maker Dainippon Sumitomo.

This may have been the most surprising MFI deal of the year. Sepracor, maker of the sleep drug Lunesta, was acquired by Dainippon Sumitomo for $23 a share, a $2.6 billion valuation, in early September. Sepracor rode the MFI lists from the beginning of July on through the final purchase, trading pre-news in the $18 range, netting investors about a 28% gain in just a few short months. I was surprised because Sepracor was a company facing some big challenges, as 85% of sales come from Lunesta and Xopenex, two drugs that face strong branded and generic competition.

Buyout: Gevity HR acquired by TriNet Group.

In a human resources deal in the thick of the bear market (the deal was announced in March), TriNet purchased Gevity for $98 million - an amazing 97% premium to the stock's trading price at the time. Gevity was in MFI for some of January and most of February, just prior to the deal. The stock was trading in the low $2 range and was purchased for $4 a share, making some small cap MFI players huge profits in a very short period of time.

Of course, there is always the dark side too. MFI turns up a couple of bankruptcy candidates every year, and 2009 was no different. Maybe the most impressive thing is how few there actually were, considering the economic climate for much of the year. Both of these stocks never appeared in MFI during 2009, but were MFI stocks in 2008 less than a year before going under, meaning investors could have lost their shirt on them.

Bankruptcy: Lear Corp.

Lear (formerly LEA), a maker of automotive seats and electronics, filed for bankruptcy protection in early July. Lear last appeared in the screen in October 2008.

Bankruptcy: Soapstone Networks

Formerly SOAP, Soapstone Networks made specialized networking equipment. The company announced a liquidation plan in June, leaving equity investors just pennies per share. Eventually the firm's assets were purchased by Extreme Networks for a paltry $5 million dollars in August.

There were some other deals as well. Cox Radio was taken private by Cox Enterprises, Aladdin was bought by Vector Capital after a drawn out battle (that eventually hurt the shareholders), and American Software (AMSWA) finally purchased the remaining 12% of Logility, a supply chain management software firm. There is an ongoing takeover battle between Terra Industries (TRA) and competitor CF Industries (CF), who in turn is trying to be acquired by Agrium (AGU)! All 3 have been in the Magic Formula universe this year. There may be deals that I've overlooked. And there are plenty of instances of MFI companies doing acquisitions instead of being bought, but we won't go into that here.

The point of all this? Magic Formula Investing can net you some huge gains in short amounts of time as it tends to turn up attractive buyout targets, but can also lead you into an implosion if you are not careful. Always apply Magic Diligence before choosing your positions. Choose wisely!

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