Buyouts can produce sizable returns on capital in fairly short time periods. However, the next red-hot buyout target isn't always easy to identify ahead of time. Of course, it's never wise to buy a stock simply because you think it might be acquired. But, a company with a strong enough business that it is sought by other companies may very well be a stock that you should seek for your own portfolio.
With this concept in mind, we asked three of our contributors which companies they think are ripe for a buyout. They suggested Geron Corp. (NASDAQ:GERN), Laredo Petroleum (NYSE:LPI), and Lululemon Athletica (NASDAQ:LULU). Here's why.
This small-cap biotech is packaged and ready to go
George Budwell (Geron Corp): Buyouts in biopharma are the norm rather than the exception. Even so, it's been oddly difficult to predict which company will be gobbled up next, with many takeovers seemingly coming out of left field.
Having said that, Geron, a small-cap biotech with a novel cancer-fighting drug called imetelstat to its credit, appears to be packaged and ready to go. Geron decided to license imetelstat to Johnson & Johnson's (NYSE:JNJ) Janssen at the end of 2015. After doing so, the company slashed its workforce down to just 15 employees and did away with the remnants of its R&D engine.
In other words, the company no longer has the capacity to rebuild its pipeline without a major success with imetelstat, and even then, the quickest path toward maximizing shareholder value would most likely be a sale to its R&D partner J&J. Building a pipeline from scratch, after all, would cost hundreds of millions in potential licensing fees, and Geron would also need to spend a sizable sum on reconstituting its internal framework for handling clinical-stage assets.
What might spark a buyout? Geron recently reported that J&J and Janssen are more or less satisfied with imetelstat's clinical progress to date. As such, the companies are planning on submitting a data package to the FDA to refine the drug's proposed pivotal-stage trial in lower-risk myelodysplastic syndromes. If approved, this trial is set to start in the fourth quarter of this year.
To keep other potential suitors at bay, J&J may decide to pull the trigger on a buyout late this year, or perhaps early next year. Either way, it's hard to imagine J&J waiting too much longer given the enormous demand for novel cancer-fighting agents like imetelstat and the drug being close to entering a late-stage trial.
Time to cash in?
Matt DiLallo (Laredo Petroleum): The Permian Basin in western Texas has been a hotbed of merger and acquisition activity over the past year. Fueling the land grab is a desire by the industry to lock up as much acreage as possible because greater scale reduces costs and enhances a company's growth profile. That boom has been great for sellers, especially private equity funds, which have been racing to cash in before land values cool off.
While several Permian producers could be next in line for a buyout, one that stands out is Laredo Petroleum. The company controls a contiguous acreage position in one of the best spots of the Basin, which it expects will fuel 15% production growth this year. Propelling that growth is the fact that newly drilled wells on its land can earn 60% returns, on average, at $45 oil thanks to a combination of technology advances and cost-savings initiatives. In addition to that, Laredo owns extensive midstream infrastructure in the region, including a key oil pipeline, which an eventual buyer could sell to a midstream company to recoup some of the purchase cost.
Meanwhile, two things make Laredo more likely to sell than other Permian drillers. First of all, a large private equity company owns a third of its shares, and at some point, it will need to cash out. Further, the company's CEO has founded and sold several other oil companies over his 30 years in the industry, making it all the more likely that he'll exit Laredo via a buyout.
While none of this means Laredo will auction itself off anytime soon, it certainly makes sense that the company's owners would want to take advantage of a scorching-hot M&A market and cash in on the company's prime Permian position.
A match made in sportswear heaven
Rich Smith (Lululemon Athletica): Lululemon's fourth-quarter financial report fell well short of analyst estimates, but the company still grew its revenues a healthy 12% (helped by 4% increases in both store count and square footage), and profits grew 16%. So, even if growth wasn't as strong as investors had hoped to see, the company is still growing -- and at a respectable pace. This could make the company -- now nearly 20% cheaper than it was a month ago -- an intriguing target for an acquirer in an adjacent sector such as, say, Nike or Under Armour (NYSE:UA) (NYSE:UAA).
13 times larger than Lululemon by market cap, some might argue that Nike is the more likely acquirer. But consider how this might work as a so-called "merger of equals," with Under Armour playing the role of "accounting acquirer" and issuing new Under Armour shares to pay Lululemon shareholders for their shares. The big worry for investors in Under Armour right now is that the company didn't grow fast enough last year, and it isn't guiding for much faster growth this year. But by acquiring Lululemon in an all-stock transaction, Under Armour would pour $2.3 billion in annual revenues into its own $4.8 billion revenue stream. That's nearly 50% more potential revenues for Under Armour -- and mostly to women. (In fact, combined with the $1 billion in "women's" sales that Under Armour did last year, a purchase of Lululemon would almost immediately balance Under Armour's sales between the genders -- $3.8 billion to men, $3.3 billion to women.)
What's more, these are high-quality revenues. Last quarter, Under Armour posted revenue growth nearly as strong (11%) as Lululemon's own. But Under Armour's profits declined year over year, while Lululemon's profits rose faster than revenues. That's a function of the higher profit margins Lululemon's yoga-wear commands -- 18.3% operating profit margins versus Under Armour's own 8.6% margin.
So by acquiring Lululemon, Under Armour could simultaneously (1) bolster its revenue growth, (2) balance its sales between the men's and women's markets, and (3) help to grow its profit margins at a pace closer to that of its revenue growth. Simultaneously, by bringing Lululemon in-house, it would add cross-selling possibilities to help jumpstart Lulu's efforts to sell more yoga-, training-, and running-wear to men. By offering to buy out Lululemon, Under Armour could enhance the value of both businesses.
George Budwell has no position in any stocks mentioned. Matt DiLallo owns shares of Johnson & Johnson, Lululemon Athletica, Under Armour (A Shares), and Under Armour (C Shares). Matt DiLallo has the following options: long January 2018 $45 calls on Nike and short April 2017 $55 calls on Nike. Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Johnson & Johnson, Lululemon Athletica, Nike, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool has a disclosure policy.