5 Stocks With Takeover Appeal

Any shareholder of a company that has been bought out can tell you that takeovers are often lucrative propositions, often delivering quick double-digit gains.

But overall, acquisitions have a reputation for destroying shareholder value at the acquiring company. Studies place the failure rate at between 60% and 70% of all deals. The main reason for this is that companies usually pay too much when buying another company and can stem from too much optimism on supposed synergies from a merger, getting caught in a bidding battle with another acquirer, or a target thinking their company is worth far more than the going rate for the business.

Fortunately for investors, a high failure rate has done little to temper enthusiasm for deal-making activity. And the current market environment is ideal for acquisitions. Tepid economic growth means it has become very difficult to grow organically, or by growing sales internally. Acquiring market share is a primary means toward growth these days and will continue to be as long as global economies remain stuck in neutral.

With that, here are five companies that stand out for their takeover appeal. 

#-ad_banner-#1. Avery Dennison (NYSE: AVY)
Business: Printing of pressure-sensitive materials
Forward P/E: 13

Avery Dennison sells labels for products that help identify their purpose and location as they make it from the factory floor to consumers. Examples include self-adhesive labels, specialty tape and packaging that can withstand extreme pressure or temperatures. For the coming year, the company should report close to $6.5 billion in sales and more than $3.00 a share in earnings for a net profit margin in the mid-single digits.

The mundane, but necessary nature of Avery’s businesses could be a great fit for 3M Corporation (NYSE: MMM). 3M is a very acquisitive-minded industrial conglomerate that sells thousands of products, including Post-it Notes, tapes and even screen filters. Avery’s problem is that it isn’t growing sales very rapidly. In the past five years, sales have grown only about +5%. Earnings, however, have grown more than +15%. 3M could likely boost sales by adding Avery’s products in its sales mix and could cut costs to further boost profitability, as it does dozens of times every year with other buyouts.

2. Zebra Technologies (Nasdaq: ZBRA)
Business: Tracking Labels
Forward P/E: 21.5

Zebra also sells labels, but the uses are targeted more toward tracking products and materials while in transit. The Zebra reference in the company’s name is to bar codes that are placed on merchandise and other devices so that they can be scanned in a warehouse or on their way to a customer location. With a current market cap of just over $2 billion, it would be easy for a company such as 3M to swallow.

Zebra’s operating results are opposite of Avery Dennison in that its sales growth has been impressive, but management has not been able to leverage this into faster profit growth. In the past five years, sales have expanded close to +27% annually, but earnings growth has been less than +20% each year in this period. Robust top-line growth with the ability to boost profits should definitely appeal to an acquirer.

3. Stryker (NYSE: SYK) and Zimmer Holdings (NYSE: ZMH)
Business: Hip and knee replacements
Forward P/E: 16

Stryker and archrival Zimmer Holdings are the market leaders for hip and knee replacements. They have also branched into other areas, including devices to assist and repair spines and other joints.

Demographic trends due to an aging population support future growth for these firms, but they were surprised to see that individuals held off on elective surgery during the recession. This has knocked earnings multiples to multi-year lows and should appeal to a larger healthcare firm interested in growth, as the long-term trends for these businesses are still quite appealing. Sales are projected to pick up soon and could represent a timely acquisition for a larger rival. 

4. Discover Financial Services (NYSE: DFS)
Business: Financial services
Forward P/E: 18

Discover was spun off from Morgan Stanley back in 2007, just before the credit crisis kicked into high gear. Discover has survived easily, and though credit card losses hit the double digits in terms of total loans outstanding, it has succeeded in staying profitable and operating as an independent firm.
Though Discover trades at a seemingly lofty forward P/E of 18, earnings for the next year are projected at more than $1.80 per share and suggest a P/E closer to 10 within a couple of years. This would make it an affordable buyout candidate for a big bank looking to beef up its credit card portfolio and add a company with high brand recognition. Bank of America (NYSE: BAC) snapped up MBNA and its credit card business a few years ago, while Capital One Financial (NYSE: COF) bought a couple of banks to go with its credit card business. The point is that banks and credit cards make a good combination, and this suggests Discover’s days of independence could be numbered.

5. True Religion (Nasdaq: TRLG)
Business: Designer jeans
Forward P/E: 12

True Religion is a very popular jean brand that has seen sales and profits grow briskly. Its market cap is under $600 million and would be an easy acquisition for a firm like VF Corp (NYSE: VFC), that already owns the Wrangler and Lee jean brands. VF Corp has a history of acquiring smaller competitors and already owns a higher-end jean brand in the 7 For All Mankind label.

True Religion would be a logical fit for a firm like VF Corp, or another competitor looking to buy a fast-growing brand at what is a pretty low overall valuation.

Action to Take —>
If global economies continue to tread water in 2011, look for acquisition activity to increase as larger firms seek to grow and satisfy demanding shareholders.

The stocks with lower valuations mentioned above stand the best chances of getting bought out. This includes Avery, Zimmer, and True Religion. Valuation matters less, though, in the tech space, which has seen a high number of buyouts so far this year. Any of these companies are good candidates to consider on their own merits, making a possible buyout that much more appealing.