In May of this year, TALX got bought out by credit reporting giant Equifax (NYSE:EFX). That acquisition came to the delight of TALX shareholders -- me included. Equifax paid somewhere in the neighborhood of $1.4 billion for TALX, which was worth a mere $350 million a few years earlier.
Watching a company you partially own go through rapid expansion followed by an acquisition like that is a heck of a lot fun. Better yet, it's financially rewarding. After all, the entire point of investing is to wind up with more cash in your pocket when you're done than when you started.
Find the next target
But TALX isn't the only company that's been bought out lately. Far from it. For a number of reasons, we're in the midst of a buyout boom.
But in order to make your money, you need to identify potential targets before they make the big announcement. Here are a few characteristics that make companies an attractive target.
Unique niche
In TALX's case, the company was largely known for doing one simple thing well -- handling verification requests for employment records. That's a fairly straightforward business, and it was the undisputed leader in the field -- which is what made TALX so attractive to Equifax. Now Equifax can offer prospective employers the employment and credit histories of potential hires in one convenient place.
Undisputed leaders in niche businesses are often acquisition targets because they offer larger companies the opportunity to expand successfully without taking on much additional baggage. Take PayPal, for example. It was the perfect bolt-on for eBay (NASDAQ:EBAY). And YouTube was a natural fit for Google (NASDAQ:GOOG) in the online video space.
Money talks
Of course, filling a unique position in the market is only part of the story. The easiest way to justify an acquisition is on the basis of how it can help the acquiring company improve its own profits. TALX was a profitable company well before Equifax took it over. Showcasing how an independent company's unique (and already profitable) niche can be further leveraged by the firm doing the buying is a great way to make that case.
That's one reason why News Corp. (NYSE:NWS) is trying so hard to acquire Dow Jones (NYSE:DJ). Dow Jones is a profitable company that's home to The Wall Street Journal, America's undisputed leading business newspaper. News Corp. eyes the Journal's reputation and audience and believes it'd be easier to buy it than try to build a comparable following through its own business media offerings.
Smaller is easier
If you're looking to buy a company that's got a chance of being bought out, market leading, profitable businesses are a great place to look. It also helps if they're smaller-sized businesses, too. After all, the firm doing the acquiring has to pay for the company. The smaller the target firm, the easier and cheaper it is to get the financing needed to pay for the purchase. Paying cash is always an option, but if a target company is too large, that may not be a reasonable one.
Microsoft (NASDAQ:MSFT), for instance, is one of the largest and most conservatively capitalized companies around. Even so, it "only" had $7.6 billion in cash and equivalents on its most recently published balance sheet. If it wants to buy anything larger than that, it would need to sell off some investments, take out a loan, or swap its stock -- all of which carry higher costs than simply paying cash.
Put it all together profitably
All told, the kinds of companies that make for great potential acquisition targets:
- Hold dominant positions in a unique niche.
- Are profitable, and will therefore help the acquiring company's profitability.
- Are small.
That said, it wouldn't be wise to chase potential buyout targets hoping to strike before a suitor bids up your shares. Instead, focus on these core criteria -- they'll lead you to solid, well-run companies with room to grow. And buyout or not, those are the kinds of businesses you can hold for years.
If you need some help in that quest, those are also the type of companies sought out by Fool co-founder Tom Gardner and senior analyst Bill Mann for their Motley Fool Hidden Gems investing service. With help in part from the acquisition premiums paid for companies they had previously picked for the service, their performance has smoked the market's return and earned them the title of No. 1 performing newsletter over the past 12 months, according to independent Hulbert's Financial Digest.
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At the time of publication, Fool contributor Chuck Saletta owned shares of Microsoft and shares of Equifax that he picked up when it acquired TALX. Microsoft is a Motley Fool Inside Value recommendation. eBay is a Stock Advisor pick. The Fool has a disclosure policy.
