Leveraged buyouts are back.
The perfect storm of low interest rates, consolidation fervor, and cash-rich companies that just happen to be out of favor is fueling the chatter about more deals in the coming months.
Barron's just singled out a dozen "attractive" LBO candidates. A few make sense, but I found myself shaking my head at most of the suggestions.
Private-equity firms have to walk the fine line that separates temporarily unloved stocks from companies in permanent states of decline. Even if there is some juicy cash cows to milk on the way down, the math doesn't usually work if a company becomes less valuable with every passing year.
Let's go over five of Barron's speculative recommendations that I can't see sailing away on the S.S. LBO.
Dell (Nasdaq: DELL )
Remember when Dell slept through the netbook revolution two years ago? Now it's missing out on the tablets. There were more iPads sold than Macs this past quarter -- and Dell is getting it all wrong by aiming for screens that are too small be functional as full-blown tablets.
These are knocks on the consumer side. Dell, naturally, is more of a corporate beast. Surely, Dell must be faring better there. Right?
Well, let's see where things are headed there. Cloud computing is a trend with legs, as data storage and applications move to web-served solutions. The portability is great, but what does this mean for companies having to update their fleet of PCs every few years? Cloud computing, for the most part, is spec-sheet agnostic when it comes to individual computers. Connectivity is the key. Yes, this will mean good news for Dell and its rivals when it comes to servers, but it's going to be brutal for PCs and laptops.
Gap (NYSE: GPS )
Unlike the many leveraged apparel retailers, Gap is blessed with a positive net cash position. Private equity may drool over the prospects of picking up the parent of Old Navy, Banana Republic, and its namesake stores, but this is a company that continues to fade in relevance.
A decade ago, Gap owned consumers seeking out fashionable basics, denim, and khakis. These days, every "cheap chic" discounter can do the trick.
Let's go to the measuring tape. How can it be that Gap has narrowly bested Wall Street's bottom-line targets in each of the past three quarters yet fiscal year estimates are going the other way? Three months ago, analysts figured that Gap would earn $1.82 a share this fiscal year and $1.93 a share next year. Now those estimates targets stand at $1.78 a share and $1.87 a share, respectively.
Comps rose a measly 1% in Gap's fiscal second quarter, and that's after declines of 8%, 10%, and 5% during the three previous years.
It's time to call in the Navy -- and not the Old Navy.
Yahoo! (Nasdaq: YHOO )
Everyone seems to be talking up LBO wedding bells here, with the smaller AOL (NYSE: AOL ) managing Yahoo! in a private-equity bankrolled deal.
It's not going to happen -- and I highlighted three reasons why this dot-com partnership isn't going to happen.
The company's appeal to private equity is that when you combine the value of Yahoo!'s cash and marketable securities with its meaty Asian investments, you've already accounted for roughly $12 a share. If Yahoo! could somehow be acquired in the teens, private equity would have one of the Internet's most popular traffic generators at a ridiculous price.
The problem, though, is that Yahoo! knows that it too could do the exact same thing. Why yield control when it can crack open its own pinata? CEO Carol Bartz is holding back because she realizes that these Asian investments will continue to appreciate, certainly at a headier clip than Yahoo! organically.
In other words, Yahoo! would require a hefty premium to cash out -- and that's a price that any potential buyer will scoff at given Yahoo!'s lackluster growth in recent years.
GameStop (NYSE: GME )
I ran into quite a bit of bullish resistance when I initially bashed the leading video game retailer two years ago.
- The chain is expanding!
- Earnings and sales are growing!
- The small box economics generate a ridiculous return on investment!
- The lull in video game sales will pass!
Where are we now? Some of those arguments are still being made, but GameStop has shed roughly half of its value.
Investors and gamers have seen the future. Tomorrow belongs to digital distribution. Everyone carries hardware. Even GameStop's resale business -- where its chunkiest margins can be found -- is being invaded by the consumer electronics behemoths. It also doesn't help that industry sales in general have been slipping since early last year.
GameStop continues to have healthy store-level metrics, but private equity firms know that they didn't make money buying mall record stores on the way down. This one's next.
eBay (Nasdaq: EBAY )
I'm torn on this one, because PayPal's an undisputed winner. The only reason that eBay is even singled out in LBO chatter is that its namesake marketplace has been in a funk for a couple of years.
The company has been making some interesting moves recently to get its marketplace mojo back, but the game has changed.
No one denies that newspapers are being dinged up by the proliferation of free online classifieds and the more convenient dissemination of news in real time. Why should eBay.com get a free pass?
In other parts of the world, marketplaces like MercadoLibre (Nasdaq: MELI ) and Taobao have done well. But eBay is doomed. There's Craigslist. There are niche marketplaces and auction sites with kinder terms than eBay. There's Facebook to swap stuff between friends.
The bigger roadblock here will be PayPal. Why should eBay cash out when it has the fast-growing champ of online financial transactions? It could break the company in two -- and cash out of its Skype stake after the IPO -- just as private equity firms would do to unlock value in eBay. In other words, this is yet another leveraged buyout that isn't going to materialize.
Do you think Rick's wrong about one or more of these companies? Which of these stocks do you see going out in an LBO? Share your thoughts in the comment box below.
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