In a true alphabet soup of an upgrade, analysts from Hong Kong-based CLSA have reached across the Pacific to tap EMC Corporation (EMC) for their latest recommendation.
"But wait!", you say. "Isn't EMC already getting bought out by Dell? Isn't it too late to buy the stock, and profit from the buyout?" Well, it is -- and it isn't.
CLSA points out the obvious
You've all probably heard that in October, now-privately owned Dell Corporation announced a plan to buy EMC for $67 billion -- roughly $33.15 per share. That buyout, however, contained a "go shop" clause that permitted EMC to look for another buyer to make a better offer than the one Dell had just handed it. The go-shop period expires on Dec. 12, by which date CLSA expects EMC to emerge empty-handed, and agree to Dell's buyout.
That's the background. Now here's where things get interesting. Currently, EMC stock sells for not the $33.15 that Dell is offering, but just $25.65 (give or take). That $7.50 difference between what a share of EMC costs today, and what Dell might pay for it eight days from now, is where CLSA sees an opportunity to make a quick 29% profit.
But is CLSA right about that?
Let's go to the tape
As a matter of fact, CLSA probably is right. After all, people have been saying that EMC stock is cheap for years (I've been one of those people). Yet to-date, EMC remains unbought. Chances seem slim that, all of a sudden, someone is going to step up to the plate and offer more for EMC just because Dell is already offering to pay a lot for it.
It's also worth noting that CLSA has a pretty good record of making smart calls in the stock market. At Motley Fool CAPS, we've been tracking CLSA's performance for years, and by and large, we've found them to be a more than adequate analyst of stock prospects, ranking in the top 20% of investors we track. Over these years, we've seen them correctly identify such winners as:
Company
|
CLSA Said: |
CAPS Says: |
CLSA's Picks Beating S&P By: |
---|---|---|---|
LSI Corp |
Outperform |
***** |
8 points |
Baidu.com |
Outperform |
**** |
39 points |
Apple |
Outperform |
**** |
70 points |
And chances look good that an analyst that was right about all those other tech picks in the past could be right about EMC as well, today ... but that's not even the point.
Valuing EMC
The real point here is that -- heads -- if CLSA is right about EMC going to Dell, a buyer today stands to earn a quick 29% profit on the pick. But -- tails -- even if CLSA is wrong about Dell's ability to buy EMC, you won't go too far wrong by buying EMC anyway.
Here's why: Valued today at almost precisely $50 billion in market capitalization, EMC shares sell for almost 22 times GAAP "earnings" -- but only 10.4 times free cash flow. Free cash flow, the actual cash profits that the business earns, are in my view a more accurate representation of how profitable the business is, and a better number to base a valuation on.
With EMC shares selling for just 10.4 times FCF, I'd ordinarily want the company to be growing its profits at 10.4% annually (or better) to consider the stock "cheap." And in fact, according to data from S&P Capital IQ, most analysts who follow EMC expect the company to grow its profits at 10.5%! Add in the fact that EMC pays its shareholders a 1.8% dividend, and you've got a very tidy margin of safety in EMC stock at today's price -- whether Dell buys it or not.
The upshot for investors
More than a decade in the stock market makes me wary of calling any thing a sure thing. But I have to say that when I look at EMC today -- the cheap valuation if Dell doesn't buy it, and the hefty 29% quick profit if Dell does buy it -- as the closest thing I've seen to a sure thing in quite a long time. And my fellow CAPS members appear to agree, rating EMC four stars (out of a possible five) even in the knowledge that a buyout may not happen.
Long story short: CLSA is right to recommend buying EMC today.