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Place Your Bets, Please:  Takeover Wheel Spins
By Gregory Zuckman
The Wall Street Journal
Wednesday, November 22, 2006

Who's next?

That's the question on the lips of investors, traders and investment bankers on the heels of a deluge of mergers and acquisitions.

Some say consumer-oriented stocks, health-care providers, gaming and tech companies could become acquisition targets in the months ahead. Some point to Sprint Nextel, Hilton Hotels, and home builders such as Lennar, Ryland Group and D.R. Horton as possible targets. Private-equity firms are circling home-service company ServiceMaster, say people familiar with the matter.

Others are focusing on companies with steady cash flows and a large percentage of shares owned by company executives, or companies run by older executives who may be willing to sell out. 

There has been so much deal activity this year that it looks like anyone could be fair game. Targets have included companies with stable cash flows but poor growth prospects, even in sectors that haven't seen many mergers in the past.

"Deals tend to feed on themselves," says Sam Schwartz, a managing director at Credit Suisse. "Financial sponsors who have purchased companies [in leveraged buyouts] soon are going to look for exits, through initial public offerings of stock or mergers and acquisitions, as long as the financing market remains robust."

But investors shouldn't get carried away betting on possible takeovers. Not only are they tough to predict, these deals also are somewhat less lucrative than they once were. The average premium paid over market prices for shares of companies subject to an acquisition bid this year is 17%, down from 25% in 2000, according to Thomson Financial.

Some analysts say the acquisitions are a sign that stock prices remain reasonably priced, despite the recent run-up in the market that has pushed stock indexes to new highs. Some short sellers -- investors who bet on stock-price declines -- have become cautious. They are reluctant to establish big positions against even stocks with weak outlooks, worried that any wager against a company will turn into a loser on word of a lucrative deal. This wariness is adding to the market's upward momentum.

Mostly, all the wheeling and dealing stems from lots of money sloshing around the global markets, as interest rates remain low. Investors are shoveling money at private-equity firms, which buy public companies or businesses with an eye toward reselling them later at a profit, and at high-yield but risky loans and junk bonds backing acquisitions. That suggests many deals are financial bets, not strategic business moves, perhaps reducing their chance for success.

The bankers who say well-known, consumer-oriented companies and some real-estate investment trusts could see more offers note that some of these stocks have been weak amid worries about how troubles in the housing market will affect various companies. Some private-equity specialists are focusing on companies with strong brand names, steady cash flows and valuable real estate.

Amid all the activity, the total dollar value of takeover offers by U.S. companies is down 1% so far this year compared with the same period last year, according to Richard Peterson, senior researcher at Thomson Financial. Meanwhile, the value of leveraged buyouts -- deals by private-equity firms financed by debt backed by the target's assets and repaid with its cash flow -- has nearly tripled.

More than 40% of the $1.28 trillion of announced U.S. mergers this year has come from private-equity firms or foreign buyers, up from less than 24% last year, Thomson says. Five of the six largest U.S. acquisitions unveiled so far this year were by leveraged-buyout firms.

Some companies once considered too big to become private-equity prey now are seen as possibilities, as private-equity coffers grow. Among them: Sprint, whose shares have dropped almost 12% in the past year but still has a market value of $58 billon, as well as Hilton and Avis Budget Group Inc.

Their stock prices have climbed in recent months. Sprint shares are up more than 25% since hitting a 52-week low in late August. Hilton has jumped more than 33% in three months, giving it a market value of almost $13 billion. Avis Budget, which hit a 52-week low in mid-August, is up about 19% since then, for a market value of just over $2 billion.

A report this month from analysts at Morgan Stanley ranked Lennar, Ryland and D.R. Horton atop its list of leveraged-buyout candidates, based on various metrics such as volatility of free-cash flow.

Home builders have grown by buying smaller competitors in recent years, but have generally shied away from big acquisitions. Although the sector's volatile cash flows can dissuade private-equity firms, some analysts say that as housing slows and these companies do fewer new projects, they will generate more cash flow that might be used to repay debt in a leveraged buyout.

Spokesmen for Sprint and Hilton wouldn't comment. Representatives for Hilton, Ryland, Lennar and D.R. Horton couldn't be reached.

It had been thought that the gambling sector would be immune from the LBO wave, in part because it can be a challenge to obtain a gaming license. Last month's proposed purchase by Texas Pacific Group and Apollo Management of Harrah's Entertainment for about $15 billion suggests the challenges can be surmounted. Casino companies sometimes own valuable real estate that can be used as collateral to raise debt for a leveraged buyout, bankers note.

Bankers say there have been takeover talks involving health-care companies, which are seeing lower growth rates but still churn out cash flow that can be used in a deal financed by heavy debt. Some investors also expect deals in the oil patch, where companies are sitting on loads of cash but shares have slipped as energy prices have fallen. Nabors Industries, which has $9.8 billion market value, has been mentioned as a possible target. A spokesman declined to comment.

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com

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