Jason Stipp: I'm Jason Stipp for Morningstar. It's no secret that corporate balance sheets are flush with cash and one of the things companies can do with that cash is merger-and-acquisition activity. Now, mergers aren't always necessarily the best thing for companies to use their cash on, but it can be quite lucrative for shareholders in the takeover company.
Morningstar's Footnoted team recently put out a list of their top 10 takeover targets for 2011 for their institutional clients, part of the Footnoted Pro service.
Here with me to talk about that report is Michelle Leder. She is part of the Footnoted team.
Thanks for joining me, Michelle.
Michelle Leder: Thanks for having me, Jason.
Stipp: So, when you think about takeover targets, there is always some degree of speculation. There are always rumors out there, but you folks go beyond the rumors to look for clues of possible takeover targets. Where do you look for hints that a company might be preparing itself to be acquired?
Leder: Well, what Footnoted does is we spend a lot of time digging through SEC filings and what we contend, basically, is that there is a lot of hidden signals in SEC filings that if you are paying careful attention you can find.
Stipp: So, I know that you had some examples in the last year. Can you give us an example of what some of those hints might have been in a real company that ended up being a takeover target?
Leder: So, what we look for is, it's really basically building a mosaic. We'll look at different things. We'll look at insider trading activity. We'll look at new stock option grants. We'll look at restricted share grants. We'll look at employment contracts, anything given to directors. Really, it's a gamut there; a wide range of things.
And then what we'll do is we'll put that mosaic together, take the different parts of the sausage, so to speak, put it through the grinder and see what we get, and that's really what it's about.
Stipp: Last year you had a call on a retailer that ended up being acquired. Can you give me some details about that?
Leder: Oh, sure. So, actually we made this call in March 2009, where we thought that Jo-Ann Stores, which is a popular store for crafters, was a likely takeover target, and we wrote about that in March of 2009. The news was announced just before the end of last year in December of 2010.Read Full Transcript
Now, obviously, it took a little bit longer than we would have thought for that deal to materialize, but I think that investors who had bought when we had talked about it, which Jo-Ann's at the time was trading at $14 a share, the takeover price is $61 a share. So I think waiting about a year and a half to go from $14 to $61, most people wouldn't quibble about that.
Stipp: By the time it's a rumor, it might already be too late to get that price appreciation. If you can get hints of that before it becomes known on Wall Street, for example, you can see a nice appreciation there.
And so I wanted to ask you, generally, since you're looking across filings from a wide range of companies, are you seeing more of these signals? Do you think that M&A activity might be heating up just across the board?
Leder: I think, yes. You are seeing a lot more M&A activity heating up. There was one Monday just before the holidays, where there was something like five or six deals that one day. Now granted that was a little bit probably activity related to everyone wanting to get in, get their deal announced before they went away on vacation, because deal lawyers like the rest of us like to disappear for those two weeks around Christmas and New Year's, and it is very complicated to go through all of the paperwork and stuff that needs to get done for a deal.
But with that said, I definitely see a lot more activity. I mean, just today there was a major banking deal that was announced. It just seems like everyday there are new deals that are being announced and companies, as you said, are looking to deploy the cash that they have on their balance sheets.
Stipp: So, you folks at Footnoted have an institutional-level product called Footnoted Pro, and you recently released a report through Footnoted Pro about your top 10 targets, and you have a couple of that we wanted to talk about today. One of them is in software. What are you seeing there and what signals piqued interest?
Leder: So one of the things that we liked about this--this is Lawson Software--and market cap is about $1.5 billion, and what we saw there is we saw an interesting pattern with the 13-Ds that are filed. 13-Ds for those people who are not familiar with them are basically the filings that institutional investors need to make when they disclose a more than 5% stake.
And so in this case, we saw Carl Icahn, who is no stranger certainly to the news media, really increasing his stake in Lawson. It's up over 10% right now and the most recent filing was just last week. And that definitely piqued our interest, especially in light of some of the other things that you see going on in the technology space with software companies.
Last year, there was another company that we did not find it in advance, but we did notice it after the fact with 3PAR and the fight between Dell and HP. 3PAR actually had some interesting signals in their filings before the deal was announced, and if you had been able to get in on that beforehand that also would have been a very lucrative deal.
Stipp: Have you seen the stock price on Lawson move at all, especially since Icahn has maybe been building up his stake? Have you noticed any movement there yet? Or is it still under the radar?
Leder: No. I think you are starting to see some movement. Obviously, if you are paying attention to, it would be easy enough to create a search for what Icahn is filing in 13-Ds. I shouldn't say easy enough, but it's relatively not sophisticated to sit there and have to do a search on 13-Ds and type in the name Icahn, but on the other hand, definitely I don't think it's fully baked into the price yet.
Stipp: Another example of a possible takeover target is in the energy space. What have you seen there and what has piqued interest on that name?
Leder: So this one is Pride International, and the thing that we like about that is Seadrill, which is also in the same space, roughly, has been acquiring some shares and they made some filings in the past couple of weeks where they are increasing the number of shares that they are acquiring.
Now, this will, obviously, be a strategic acquisition. You have two companies in the same space. We see this time and time again where you have a larger company, this being Seadrill, and a smaller company, Pride International, deciding that it makes more sense to be one instead of two.
Stipp: Did you see any other filings there that might give you a clue or a hint about a possible takeover or preparations for takeover?
Leder: Well, we saw some other interesting signals, too. I mean, there were some different changes with the way directors are treated and the way that other executives are treated, basically increasing the amount of benefits that they would receive if a deal happened. So, that's certainly one of the signals we like to pay attention to.
Stipp: So, maybe individually some of these signals might not necessarily indicate that it's preparing for an acquisition, but when you start to see them building up on each other the signals become much clearer.
Leder: It's all about pattern recognition, Jason. It's kind of like what you see, as you say, "Okay, I've seen this before, where have I seen this?" And that's what happens over and over again. So, you see someone like Icahn coming in and snapping up shares. He actually even said in the filing that he felt the shares were undervalued at their price and that was his primary motivation for coming in.
So you see that. You see perhaps some other sorts of changes that are going on in the corporate filings and then you kind of put it all together, you make that sausage and you say, this is what I think is going to happen.
Do I know for sure that these 10 companies are going to be taken over in the next year? Absolutely not. I don't have a crystal ball like anybody else doesn't have a crystal ball, but I think that based on some of the patterns that we're seeing, I think that ... certainly what they're doing is they're preparing. I should also make that point as well. Just because a company prepares to be acquired and perhaps gets their ducks in a row, doesn't necessarily mean that the suitor is going to come along.
I often joke around; it's like someone going out to a bar at night for a date. They can prepare and put on their best outfit and everything like that, but they may not meet Mr. or Mrs. Right that night.
Stipp: Well, Michelle, it sounds like a very interesting Footnoted Pro report. Thanks for coming in today and for showing the ideas.
Leder: Thanks for having me, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.