Ablin's "Buyout Forecast"

01/06/2006 12:00 am EST

Focus:

Jack Ablin

CIO & Executive Vice President, BMO Private Bank

Quantitative expert Jack Ablin, chief investment officer for the prestigious Harris Private Bank , looks to market history as part of his future assessment. One trend he sees re-emerging in the coming year harkens back to the 1980scorporate buybacks. Here, he explains.

"In the early 1980s, Drexel Burnham, captained by Michael Milken, refined the high-yield ('junk') bond market and with it fueled leveraged buy-outs. Thanks to an increased appetite for public equities, LBOs were largely responsible for a soaring stock market, pushing the market up 210% from 1982 to the middle of 1987. Today, cash-rich private equity buyout firms have increased their appetite for public equities. Recently, privately held Koch Industries Inc. agreed to pay a 39% premium for Atlanta-based papermaker Georgia-Pacific Corp, creating the nation’s largest family-run business. While Koch is not a buyout firm, the move toward privatizing public companies is the same.

"Buyout firms have raised $68 billion at an annualized rate through September of this year as compared to $46 billion in 2004, according to a BusinessWeek report. Megafund Blackstone Group is raising $12.5 billion earmarked for buyouts while Thomas H. Lee Partners is putting together a $7.5 billion fund. Both offerings are being met with eager demand. Through the first half of 2005, the combination of buyouts, stock buybacks, and other deals have sucked close to $260 billion of non-financial corporate equity out of the market at an annualized rate.

"Another ingredient exacerbating the trend: Sarbanes-Oxley, an onerous set of regulations that hold corporate higher-ups personally responsible for their public filings, is making the push to go private more attractive. Pete Correll, Georgia-Pacific’s CEO, cited Sarbanes-Oxley as one of his reasons to pursue the Koch transaction. At the same time, corporate balance sheets are brimming with cash, making them enticing buyout targets. Debt financing is easy also. The yield premiums lenders require to hold lower-quality bonds is rather scant by historical standards.

"Willing investors, ready lenders and motivated sellers are creating an ideal buyout scenario. Through the third quarter, buyout firms have raised over $50 billion, although they’ve invested less than $30 billion. While the increased appetite for buyouts will support equities, not all companies are ideally suited for such a transaction. Private equity firms favor stable businesses with strong, free cash flow. Following is a screen of non-finance companies in the S&P 500 that possess attractive cash-flow attributes.

Name

Ticker

Recent Price

Price (adjusted for Cash and Debt)

Cash Flow/Adjusted Price

US STEEL CORP

X

48.11

51.72

14.2%

LOUISIANA-PAC

LPX

27.63

24.43

17.2%

COMPUTER SCIENCE

CSC

49.52

51.50

11.1%

CARDINAL HEALTH

CAH

64.51

67.13

7.9%

SYMANTEC CORP

SYMC

18.05

13.54

12.5%

INTL FLVR & FRAG

IFF

33.4

40.29

5.9%

PHELPS DODGE

PD

139.62

138.54

11.0%

SEARS HOLDINGS C

SHLD

119.56

85.01

11.0%

LEXMARK INTL-A

LXK

47.8

36.71

12.1%

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