36% Gains From a Takeover -- and Two More Stocks That Could Follow

James Brumley's picture

Friday, November 12, 2010 - 11:48am

by James Brumley

Back on October 26th I suggested e-commerce software provider Art Technology Group (Nasdaq: ARTG) was an attractive buy at the then-current price of $4.39. [Click here to read the article] A few days later, the company was acquired by Oracle (Nasdaq: ORCL) at a price just under $6.00 -- a nice +36% move in the span of about a week.

So how'd I do it? Well, it was actually quite simple. I was 100% confident the company was going to continue growing its bottom line, as it had been for a few quarters. I was about 70% sure those results would translate into a rising stock, as had been the case -- mostly -- since early last year. And, I had absolutely no idea the company was going to be snagged by Oracle.

I don't say that to create any self-deprecating humility that I'll turn around later; I really had no idea that Art Technology Group was a target. I just knew it was a great company I’d want to own, and as it turns out, Oracle agreed.

I have two more acquisition candidates like Art Technology in mind, but before I share them, it may be worth explaining my thought process.

The whole experience got me thinking about some of the other M&A chatter we’ve been dancing with during the course of this year, much of which never panned out.

Take Microsoft's (Nasdaq: MSFT) rumored buyout of Adobe (Nasdaq: ADBE) for instance. A mere meeting between Microsoft's head Steve Ballmer and Adobe's CEO Shantunu Narayen sent Adobe shares soaring as much as +16% when the buyout buzz was circulated on October 7th. The stock tumbled by about half that amount the next day when the rumors were snuffed.

Fortunately, Adobe shares have since reclaimed almost all of that lost ground, but surely more than a few investors bought at the high and then defensively sold at the low of that span.

California Pizza Kitchen (Nasdaq: CPKI) is another example of a fizzled acquisition-based rally. The company effectively put itself up for sale on April 9th, and pushed shares from $18.18 to $20.74 as traders jockeyed for a piece of the company before it was bought. By July, the stock had reached a low under $13.00, having never moved above that peak of $20.74, and still no suitor in sight.

The same story unfolded again when renewed whispers of a sale shot the stock to a peak price of $20.00 on July 28th. Since then, not only have we still not seen a buyout, but investors who bought it at $20.00 on acquisition hopes have yet to see the stock hit $20.00 again.

If you're keeping score, that's two buyouts that were well-publicized, then highly-speculated on, that ultimately fizzled -- and cost investors money in the process.

Now contrast that with the acquisition of Art Technology Group, which nobody saw coming, yet managed to materialize and pay off on a big way.

Get the point? If your only goal is to step into a target company before a possible acquisition, you're likely to be disappointed more often than not -- not to mention stuck with a stock you may not want. If you focus on owning great companies, though -- as we all should -- at the very least you'll own a great company and you may just win big from an acquisition anyway.

With that as a backdrop, I can unveil my next two potential acquisition targets. The first is A-Power Energy Generation Systems (Nasdaq: APWR), and the other is Xyratex (Nasdaq: XRTX).

No, neither of these company names has been spinning in the M&A rumor mill. That's the point. They are both great companies, however, that would be as attractive to another company as they are to individual investors.

Xyratex is a data-storage player, which is an arena that's seen more than its fair share of buyout interest lately. Most of the focus seems to be on Compellent Technologies (NYSE: CML) or STEC Inc. (Nasdaq: STEC) -- I don't recall hearing Xyratex in any of the data storage consolidation discussions. Oddly though, Xyratex has been producing about 10 times the revenue that Compellent has been generating (with a similar income disparity), while Xyratex's market cap is about two-thirds of Compellent's. Better still, the stock boast's a strangely low trailing 12-month price-to-earnings (P/E) ratio of about 4.7.

A-Power Energy Generation Systems is primarily a Chinese energy management holding. It's not priced as low as Xyratex is right now, but the forward-looking P/E of about 6.1 is plenty attractive -- and plausible. The kickers for A-Power here are growing institutional ownership and a growing wave of utility and energy acquisitions this year; a sector's merger-mania often develops its own inertia.

Action to Take --> If you're only jumping on a stock because the rumor mill is suggesting it is an acquisition target, you may find yourself stuck with a lousy stock -- if you don't even want to own it for the long haul, why would another company want to? Besides, by the time you hear about an acquisition, it's probably too late to do anything about it.

On the other hand, winning the buyout lotto isn't a lost cause. Companies acquire other companies for the same reasons investors do: reliable income, leading technology, market share, etc. Find a good, undervalued company like A-Power Energy or Xyratex, and you'll do one of two things -- you'll either (1) own a great stock, or (2) you'll benefit from a buyout. Either way, it's a win.

James Brumley 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.