Takeover Targets

04/21/2006 12:00 am EST

Focus:

Richard Band

Editor, Profitable Investing

A self-professed "crustry contrarian," Richard Band is exceptionally adept at providing solid, unhedged advice. His workshops in Las Vegas will focus on his favorite growth and value "picks and pans" as well as his top ideas for income. Here, he looks at a pair of takeover plays.

"One of the most reliable ways to boost performance is to buy into businesses that may be ripe for a takeover, and we have found two takeover candidates that are simply too attractive to pass up. Please understand, neither of these companies has received a proposal yet. However, these outfits bear an uncanny resemblance in their financial and operating characteristics to and other takeover plays that have lined our pockets lately:

"Fifth Third Bancorp (FITB NASDAQ) earns a thumbs-down from Wall Street. Understandably so, too: Top management blundered miserably by failing to anticipate, in 2004, the Fed's march toward higher interest rates. As a result, profit margins have suffered for the past two years, and will continue to be crimped in 2006. That's a shame, because Cincinnati-based FITB boasts well-oiled retail banking franchises in the Midwest and Florida. Several executives responsible for the fiasco have left, yet the guy at the top remains. Hasn't anybody got the moxie to sweep him out gracefully?

"My guess is that Wells Fargo does. In a takeover, Wells could, without diluting its own return on equity, offer about 16% above FITB's current share price. The California behemoth would extend its geographical footprint and inherit a healthy loan portfolio. With a few minor repairs to the balance sheet, FITB's profit margins would widen again. If Wells doesn't go after FITB, Citigroup may. In the meantime, you'll earn a lush dividend of almost 4%. Buy FITB at $39 or less and, we'll track FITB in the main model portfolio under World-Class Franchises.

"Pinnacle West Capital Corp. (PNW NYSE), parent of electric utility Arizona Public Service, serves one of the nations fastest-growing regions. Customer growth consistently runs about three times the national average. The stock also throws off a juicy, safe dividend, yielding over 5%. Recently, PNW shares have languished near a 52-week low on word that the company has encountered technical problems - none posing a threat to public health - at its Palo Verde nuclear plant. While I don't welcome this kind of news, I've found, through the years, that engineering issues nearly always get resolved, sooner or later.

"Assuming the same scenario plays out in this case, the current political swirl around Palo Verde may end up as a blessing for PNW shareholders. By depressing the stock price (if only for a time), the controversy is improving Pinnacle's takeover prospects. Last summer, Congress repealed the Depression era Public Utility Holding Company Act, which hindered mergers between utilities whose territories don't adjoin each other. As a result, the takeover tempo in the utility industry is quickening.

"Warren Buffett, whose Berkshire Hathaway is in the final stages of swallowing PacifiCorp, has made it clear that he wants to buy more utilities. And he has $40 billion of loose change to do it with. At today's share price, PNW is selling well below the typical takeout price for a utility. In fact, Buffett could offer almost 20% above the current quote without exceeding the norm for utility acquisitions. Will he? If he doesn't, I'm convinced somebody else will - and soon."

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