Dow Industrials Regain Ground on Buyout Wave from the WSJ ($)
The WSJ writes about how the Dow is being driven by buyouts. Some priceless quotes, then the commentary.
What's driving the run-up? It isn't the economy. Economic growth has been slowing. Instead, it's the ocean of cheap loans available to private investment funds that's permitting them to buy publicly traded companies and take them private, bidding up share prices in the process. The current wave of buyouts has swelled to a point that, in many ways, it now dwarfs the buyout frenzy of the 1980s.
Wall Street has embraced the trend. Most major brokerage firms now put together detailed lists of potential buyout targets, whose stocks they often urge clients to buy. Analysts have begun rating a stock's value based not only on factors like the company's profit outlook, but also on the chance that it might be bought out.
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Investors have begun to seek out potential buyout targets, hoping for a takeover that would sharply boost the stock's price. And, in many cases, companies are responding to the new climate by issuing debt and buying back their own stock to boost share prices and placate shareholders hungry for bigger returns.
"The enormous amount of money the [buyout] firms have puts a safety net under the market," says Byron Wien, chief investment strategist at hedge fund Pequot Capital Management.
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With investors hankering to benefit from the next leveraged buyout, "screening" for companies that could be possible buyout targets has become commonplace on Wall Street. The shares of such companies -- often singled out because they are laggards or are otherwise vulnerable -- have shot up so much that fewer and fewer of them fit the bill.
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Mr. Stocking likes to evaluate stock prices based on factors like the companies' sales, profits, cash flow and breakup value. Since late 2005 or early 2006, he says, his group has added buyout prospects to that equation. When companies in fields such as real estate, health care or manufacturing are taken private, he asks the firm's analysts to find similar companies that might be bought out in the future.
So, to summarize:
1) The most liquid and transparent equity market in the world (USA) is now valuing companies not on their profit prospects
but instead
2) On the possiblity that certain private funds (large, but a fraction of the size of the overall stock market) will buy these companies at a premium
then
3) Do things that can't be done by management (mostly layer on debt, perhaps some tough operational decisions)
then
4) IPO back to the same public markets, again at a premium
This is not going to end well.
While not doubting the formidable abilities of the top buyout firms, it is very hard to believe that 100 senior MDs in New York and London can meaningfully improve the management #3 of enough major firms simultaneously to offset the premiums in #2 and #4, particularly given that public market investors are now trying to jump in front of the PE train before it arrives at a company and subsequently driving prices up in the process.
To be fair to the WSJ, they note the same:
That's what happened in the buyout craze of the late 1980s, when fund managers were grabbing shares of companies whose stock prices were thought to be trading below potential buyout prices. What were known as "private market value models" flourished until October 1989, when financing troubles in a planned buyout of United Airlines parent UAL Corp. helped send the Dow down 6.9% in one day.
Some worry that the market's current preoccupation with buyouts could be setting it up for another bout of trouble if buyout demand fades.
