Saturday, February 19, 2005

That 80's Show

Most reruns are boring, but this one is going to be anything but!
This is a followup to the post on Circuit City and is also a response to a few articles this last week.

Some are predicting that we will see a revival of 80's style buyouts where the buyers are not other corporate entities. The major departure would be that the current bout will see hedge funds as buyers. They have accumulated huge piles of cash in the last 3 years. With very few opportunities for high returns, most of the cash is still sitting idle. Some of these hedge funds' individual stash amount to billions! The most profitable way to put this money to work right now seems to be to takeover underperforming businesses with great cashflows.

With executive underperformance finally getting the attention it deserves, it would be easy for these funds to keep existing shareholders happy by paying a small premium in a buyout. Once private, aggressive cost cuts should allow these businesses to be extremely profitable, and the funds can get their returns either selling these revived businesses to others or taking them public again 2/3 years down the road.

Retail is going to be an obvious choice for such takeovers, since they offer a huge cushion in terms of valuation for the underlyinig real-estate. Small (< 200 million market cap) software firms and smaller still biotechs will be other prime targets. With the former, hedge funds can just use an initial offer to set off a bidding war with other potential corporate buyers, profiting one way or the other. With small biotechs, the funds have an upper hand in negotations given these business' appetite for research funding - the secondary market is not friendly anymore and remaining public won't be an option for many of them!

So, start looking for boring, close-to-book-value, constant cash-flow businesses.

Another angle to this is the window that earnings restatements (followed by a sizable pullback in the stock) provides for opening positions. Restatements are now a regular affair with the increasing spotlight on accounting. At times, perfectly good businesses get lumped with bad ones, and their stock gets punished. Hedge funds have started using these to make their moves.

It will be an interesting rerun!


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