News Analysis date published New: 
Monday, March 4, 2013 - 08:30
New Date created: 
Wednesday, March 6, 2013 - 14:43
New Date last updated: 
Monday, March 4, 2013 - 08:30

3 Deep-Value Stocks to Profit From

Monday, March 4, 2013 - 8:30am

Sometimes opportunities in the stock market are where you least expect them. When a company sees a spike in share price on news of a buyout that ultimately fails, that stock is left for dead by most investors...

But you can actually find deep value here.

Let me explain...

After a series of stumbles throughout 2011, the board of directors at health care information provider WebMD (Nasdaq: WBMD) realized that the company may be better off in the hands of a larger digital information company.

An announcement at year's end helped to give fresh life to shares, as they quickly rebounded toward the $40 mark.

But few companies were interested in buying WebMD at that price, let alone at the 20-40% premium that shareholders typically expect in a buyout offer. The company's board announced that plans to sell the company were off the table in the near-term, sending shares quickly to fresh multi-year lows. Eventually, this company dropped off the front page, and its shares fell below $15 as investors moved on to other, timelier opportunities.

Yet it's worthwhile to keep tracking these companies after the crowd has moved on. For example, even in the absence of near-term buyout prospects, value investors started to move back in to WebMD, pushing shares up more than 15% in January. That was a wise move as WebMD recently announced stellar quarterly results, helping shares to post a heady 50% in the past three months to about $22.

As the WebMD example shows, companies need to seek a buyout when they have momentum, and they must have a realistic view of the value of their company. WebMD's board misread the tea leaves on both counts. But the company still plays a major role in the health care information sphere, so this stock, which remains more than 60% lower than where it stood in early 2011, has ample room to move higher as sales and profit trends improve.

Here are three other stocks that have recently pulled back as buyout talks have faded.

Digital Generation (Nasdaq: DGIT)
This company, which provides advertising management services to TV broadcasters and leading websites, has really vexed investors. After its shares swooned from above $40 in early 2010 to below $10 last spring, investors started to pay closer attention after media reports suggested industry rival Extreme Reach offered to buy Digital Generation for $20 a share. That deal might have eventually been met with anti-trust concerns, so Digital Generation's board allegedly rebuffed that offer, though it did hire Goldman Sachs to find other buyers.

That move angered several key shareholders, as concerns grew that Digital Generation was really holding out for an even higher offer than the one Extreme Reach had proposed... these investors would have been happy to see this company sell for even $15 a share.

Yet just a few weeks ago, Digital Generation's board decided to pull the plug on any moves to sell the company. Shares plunged to about $6.50 as a result. Yet, after that drop, shares managed to rebound slowly for six straight sessions -- for a simple reason: Those activist investors likely haven't gone away, and pressure is likely building for a sale of the company, even it comes in the $10 to $15 range. This saga is definitely worth tracking.

Merge Healthcare (Nasdaq: MRGE)
In a similar vein, this provider of digitized medical-imaging software also decided to end talks to sell the company after its investment bankers couldn't secure a sufficiently robust bid. Shares surged toward the $3.50 mark near the end of 2012 on hopes that a buyout offer would soon be forthcoming.

Hopes were dashed on a Feb. 19 conference call as CEO Jeff Sturges said the company had received several nonbinding "indications of interest," but that the board had determined the valuation ranges "did not appropriately value the company."

Shares have now fallen to about $2.50, which represent solid value. That's because Merge is still facing a tremendous growth opportunity as doctors, hospitals and other health care providers move to create digital medical records for all patients. The positive industry trends are already underway: Later in that call, Sturges noted that in the fourth quarter of 2012 "we saw one of the strongest selling quarters in Merge's history." The company's backlog grew an impressive 82% last year.

As Merge Healthcare announced 2012 fourth-quarter results in mid-February, Sturges and another insider bought a collective 40,000 shares (at about $2.30 each). Insiders have been steady buyers of this stock in recent years, and with shares now trading for less than one time trailing sales (which is quite low for a subscription-based software provider), that buying could prove to be a smart move.

Joy Global (NYSE: JOY)
Though this provider of mining and construction equipment didn't formally explore a sale of the company, it's worth noting that shares quickly spiked toward $70 in early January as buyout rumors circulated. We have no way of knowing whether Joy Global is holding buyout talks outside of the media glare, but in the absence of any further news, shares have drifted back down toward the $60 mark.

At the current price, this is surely a stock worth tracking. My colleague Amber Heslta-Barnhart recently discussed the considerable potential upside for this stock and suggested an intriguing income-generating strategy for this stock.

Risks to Consider: Two of these three stocks only recently put their companies up for sale (without a positive outcome), so it may be quite a while before they heat up again -- at least using the buyout angle.

Action to Take --> The key is to focus on companies that appear attractive on an fundamental basis, regardless of any buyout angles. All three of these stocks trade much lower than their two-year highs and are capable of building solid growth on their own -- before any suitors eventually emerge.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.