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Thursday, September 30, 2010 - 17:44
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Thursday, September 30, 2010 - 17:01
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Thursday, September 30, 2010 - 17:44

+60% Upside for This Takeover Target

Thursday, September 30, 2010 - 5:44pm

I recently came across an insightful article that boldly detailed how the Internet is changing the world. The piece offered a number of stats and detailed that 750 tweets are written from Twitter every second, 2.5 billion photos are uploaded to Facebook every month, and overall Internet traffic is growing +40% a year -- which is impressive, given that traffic has grown like gangbusters for more than a decade now.

With this growth comes an ever-increasing need to store, retrieve and protect the data being posted on the Internet. Start-up firms are well aware of this fact, as are the larger technology firms that have survived the dot-com bubble and have grown into industry bellwethers. The titans of industry are focused on research & development to come up with their own products to address these needs, but they are also flush with cash, which means they can gobble up smaller players to bolster organic growth.

Recent activity is a case in point. Hewlett-Packard (NYSE: HPQ) has announced three successive deals to acquire a data-storage firm and two that provide Internet security software. In a somewhat surprising move, computer chip giant Intel (Nasdaq: INTC) announced it will buy Internet security firm McAfee (NYSE: MFE) for $48 per share in a $7.7 billion deal, saying that security is one of the most fundamental aspects for business and individuals that desire an online presence. McAfee sells software that provides antivirus, firewall and related Internet security.

The Intel deal represented a +60% premium from McAfee's share price just before the deal was announced. The stock of its archrival, Symantec (Nasdaq: SYMC), has jumped more than +20% since the McAfee deal was announced, but still sits well below its highs for the year and has actually been flat for a number of years now over anger from a major acquisition gone bad.

Given the M&A activity in the industry, Symantec stands out as a potential buyout candidate.
It was a pure play Internet security firm, but undertook an ambitious acquisition of VERITAS Software in 2005, which added storage management as a major focus. Storage and server management accounted for nearly 40% of total sales last year. Sales of consumer items, including the well-known Norton Antivirus software, made up 31% of last year's sales, while security and systems management sales to business customers accounted for the rest.

The acquisition of VERITAS didn't pan out as planned. As a result, Symantec had to take a hefty $7.4 billion charge to write down the value of the acquisition in 2009. Internal growth and acquisitions have kept sales growth in positive territory in the past few years, and profitability recovered last year to $0.87 per diluted share after the hefty charge the previous year. Analysts project $1.31 in earnings for this year.

Action to Take ---> Free cash flow reached an impressive $1.82 per diluted share last year and is better than reported earnings in reflecting Symantec's capital generation capabilities. At the current share price, this equates to a trailing free cash flow multiple below nine. The forward P/E is also quite reasonable -- less than 12 -- when considering McAfee was acquired for nearly 19 times earnings expectations.

Symantec's stock would appreciate nearly +60% to get to this multiple. It also has more cash than debt on the balance sheet -- for a net cash balance of about $1.2 billion, or close to $1.50 per diluted share. A low valuation, strong secular market growth trends and a net cash position that an acquirer could factor into a buyout make it difficult to see why a larger tech rival would not be interested in gobbling up Symantec. Investors stand to benefit as the market starts to realize this value and could see huge gains even if the firm isn't bought out.

P.S. A takeover or buyout is just one of many 'catalysts' that can shoot a stock's price upwards in no time. But this isn't the only catalyst editor Nathan Slaughter looks for in his Market Advisor newsletter.

Ryan Fuhrmann does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of SYMC, HPQ in one or more of its “real money” portfolios.