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Stock Strategist

Restaurant Stocks Still Look Ripe for Buyouts

Despite the recent turmoil, we still see takeover plays in restaurant stocks.

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With fears of a subprime contagion, credit spreads have risen sharply in the junk bond market. This means private equity firms no longer have easy access to this cheap money, which helped fuel much of the leveraged buyout boom. Still, we do not believe that mergers and acquisitions will come to a screeching halt. The junk bond market is not the only form of financing available to private equity firms, which still have plenty of cash to deploy. After taking a back seat to financial buyers, corporations could also play a larger role in buyouts, especially since they have record levels of cash.

We think several undervalued restaurant companies with strong brands, steady cash flow, and solid balance sheets (and in some cases, valuable real estate) would make attractive takeover candidates. Sale and leaseback financing on real estate can still help fund the purchase of some restaurant companies. Furthermore, a creative form of financing that involves the securitization of income from franchisees has remained cheap, despite tightening elsewhere in the credit markets. Therefore, we believe acquisitions of some restaurant companies could still be leveraged with debt.

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John Owens does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.