Two Mid-Caps Ripe for a Takeover Bid

03/31/2011 4:37 pm EST

Focus: STOCKS

Charles Carlson

Editor, DRIP Investor

With dealmaking on the rise, Cabot and Molex boast the sort of fundamentals buyers like, and should outperform the market, writes Charles Carlson in the DRIP Investor.


The urge to merge is growing among global corporations.

According to Ernst & Young’s Transaction Advisory Services, global merger-and-acquisition (M&A) deal volume in 2010 totaled approximately $2 trillion in value, up slightly from 2009 levels but still a far cry from the historical highs of $4.7 trillion in 2007.

The positive trend in deal activity should continue this year. Corporations’ near-record cash holdings, improved stock markets over the last two years (which lifts the value of a prominent M&A currency—stock), and increased regulations (which often drive consolidation) should fuel an increase in deal activity.

Already in 2011, a number of prominent deals have been announced, including a takeover of Lubrizol (LZ) by famed investor Warren Buffett’s Berkshire Hathaway (BRK.B) for $135 per share in cash.

[Carlson recommended Lubrizol shares ten months ago, when they were trading in the 80s—Editor.]

While I don’t recommend investors buy stocks simply because they represent attractive takeover stocks, having the added kicker of takeover appeal can be a nice bonus.

A useful tool for searching for takeover candidates is the “enterprise ratio.” The ratio looks at a stock’s enterprise value (the value of equity and debt, minus cash) divided by EBITDA (earnings before interest, taxes, depreciation, and amortization.)

In a nutshell, attractive takeover candidates are those companies in which the buyers have the ability to pay for the deal via cash and earnings in a fairly short period of time. Thus, the lower the enterprise ratio, the more quickly the
acquired company’s profits can pay for the acquisition.

Among the stocks that screen as attractive takeover candidates based on enterprise value, Cabot (CBT) deserves special mention as an interesting acquisition play among mid-cap stocks. The firm’s market capitalization
is $3 billion, so the company is certainly at a size that would not overwhelm a buyer.

Cabot provides rubber black products for tires and industrial products. The firm also produces a variety of alloys used in the electronics and chemical processing businesses.

The company has handily beaten the consensus earnings estimate in three of the last four quarters, and I look for profits for fiscal 2011, ending in September, to approach $3.20 per share, up from $3.04 per share in fiscal 2010.

This puts the stock, which traded near $46.50 Thursday, at 14.5 times the current year’s earnings. The stock has held up well during the recent downturn, and I like these shares for the next 12 months.

Staying in the mid-cap space, Molex (MOLX) is another interesting takeover play. To be sure, the company, a manufacturer of electronic components, would only be involved in a friendly takeover given that some 40% of the company shares are held by insiders.

Still, Molex is the right size for a deal, at about $4.3 billion in market capitalization.

The stock has come off its 52-week high of $28.51 per share and, at Thursday’s mid-afternoon price of $25.19, offers attractive value—less than 14 times the fiscal-2011 (ending in June) estimate of $1.83 per share.

The stock, yielding nearly 3%, should outperform the market over the next 12 months.

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