Stocks seem to have stabilized as the trading week came to a close, but investors continue to wrestle with the market’s next move. Shares are noticeably cheaper than a few months ago, but the risks of an economic slowdown have increased. For those who see the current market as “half-full,” here are some of the most compelling stocks from StreetAuthority's daily "Winners" and "Losers" articles.
Emulex (NYSE: ELX)
Earlier in the week, we suggested that investors may have judged an acquisition by Emulex too harshly. And the more I look at the $160 million deal to acquire ServerEngines, the more there is to like. I already discussed the notion that the acquired technology will broaden Emulex’s technology platform to better enable it to compete with its rivals. I should have added that ServerEngines, the acquired company, also has a very impressive base of customers on its own. And many of those customers do business with Emulex’s rivals such as Qlogic (Nasdaq: QLGC) and Broadcom (Nasdaq: BRCM). When the deal is completed, look for Emulex to go knocking on a lot of new doors.
Also of note, Emulex’s profit margins had been below those of its rivals. QLogic, for example, has 25% earnings before interest, tax, depreciation and amortization (EBITDA) margins in 2009, twice the level of Emulex. This deal should boost Emulex’s pricing latitude, and as higher prices yield fatter margins, profit growth is likely to exceed revenue growth.
Analysts have taken a wait-and-see approach to this deal, but it looks like a classic 1+1=3. It may take several quarters, but you should look for profit forecasts to start to rise as the acquisition begins tofruit.
Action to Take --> Shares of Emulex trade for around two times trailing sales while Broadcom and QLogic trade for about 3.5 times trailing sales. As the company’s profile moves up to the level of those peers, so should the price/sales ratio, implying +60% or more upside.
Allscripts (Nasdaq: MDRX)
In keeping with the theme of “misunderstood deals,” investors really should take a closer look at the Allscripts deal to merge with Eclipsys (Nasdaq: ECLP). As we noted on Wednesday, the deal was poorly received, in part due to a complex unwinding of a relationship with Mysis that could lead to an overhang on the shares ahead of a planned equity offering.
Major investors such as mutual funds can perhaps buy into this stock a bit cheaper through a discounted price of any equity offering. (To get a deal done, bankers often need to price a deal a bit below the current trading price). But we individual investors have no such luxury.
But this is such a compelling industry opportunity. We know that doctors, insurers and hospitals have no choice but to participate in a fully-electronic records-keeping system. And we know that Allscripts and Eclipsys have built massive, complementary customer bases that support all those groups. We don’t know what profits might look like in the near-term, which is the partial reason for the share sell-off. But over time, software-based business models can throw off oodles of cash.
Action to Take --> This is a great stock to read up on. Shares may tread water until Mysis sells off its stake. Before that happens, analysts will be generally quiet about the deal (especially if their firm is participating in the stock sale). After that event has passed, look for analysts to really get behind this name.
Wendy's/Arby's (NYSE: WEN)
As the Friday trading session wound down, investors had given back half of the earlier gains in Wendy’s/Arby’s. That's partially the result of concerns that the buyout rumors were just that -- rumors.
Deal or no deal, this is an attractively priced stock with limited downside based on the current cash flow generated by the two restaurant chains. That cash flow should stay in place, unless already-weak same-store sales figures fall even further. But that seems unlikely. Instead, the odds are that as management tinkers with the menus at both restaurants, they’ll eventually strike a chord with consumers. For example, Wendy’s new boneless wings have been a reasonable success, and are just now catching on abroad.
Action to Take --> It’s unclear if a buyout is imminent. But it is clear that majority shareholder Nelson Peltz will do whatever it takes to unlock value. With a floor in place and possible +20% to +30% upside, this stock looks fairly appealing.