5 Deal-Ready Stocks Loved by Hedge Funds
Every quarter hedge funds and large investors file their holdings with the Securities and Exchange Commission, revealing value picks, cyclical bets, growth opportunities and activist pushes.
Reading between the lines, the holdings of some of the mightiest investors in the U.S. also give insight into 2012 expectations for the still lukewarm M&A market, which is expected by many to pop at some point this year.
There are several surprise bets that poker-faced hedge funders made in the fourth quarter. For instance, some fund managers flocked to struggling Yahoo, while struggling bank bull John Paulsondumped his holdings in America’s largest banks and some managers unveiled big recovery bets.
But after reading the “tea leaves” on what holdings say about companies, sectors and the economy, it’s also worth looking over portfolio changes for companies that may cut deals in the coming year. After all, when major deals like Kinder Morgan’s acquisition of El Paso, Google’spurchase of Motorola Mobility Holdings andDuke Energy’sdeal for Progress Energy are announced, it’s not much of a surprise to see the likes of Carl Icahn, Jana Partners, and AQR Capital Management among the large shareholders benefitting from a premium-priced takeover.
For instance, with slumping markets and some companies struggling to grow the top-line in 2011, shareholder activists like Icahn, Jana Partners, Bill Ackman-run Pershing Square Capital Management, and Daniel Loeb-run Third Point pushed for business line divestitures and asset value realization strategies that provided a big lift to shares.
Overall, because of shareholder activism and consensus in C-suites that smaller may be better and more valuable, tepid deal markets didn’t temper a 2011 spin-off boom. Across all sectors, corporate divestitures were a bright spot for deal makers, rising 165 percent from 2011 and representing 5 percent of all deals activity, according to Dealogic.
Poring over filings and top investor holdings shows some funds are buying the deal rumor and are positioned to reap big rewards from any future announcement, as investors jockey for 2012 positioning.
It’s especially the case because some funds are looking to improve on a mediocre 2011. Hedge funds posted their worst year since 2008 as market volatility proved to be a challenge even for pro investors. Hennessee Group, an adviser to hedge fund investors, said in January that its Hennessee Hedge Fund Index dropped 4.3 percent in 2011, compared to a flat performance for the Standard & Poor’s 500 . It was the second year in a row hedge funds failed to beat equity indices.
A look through this week’s filings show some investors are making big bets on deal activity, with the potential for a quick and sudden jolt to their portfolios. Here are five deals to watch for in 2012.
Dish Network, long in the M&A rumor mill, is now increasingly the target of hedge fund and activist investors as the company mulls over both acquisitions and asset sales.
The satellite pay-television provider and Chairman Charlie Ergen spent 2011 in the M&A market, buying up $1.38 billion worth of spectrum from bankrupt TerreStar Networks, which paved the way for a similar deal to buy wireless spectrum from , a satellite communications company also in bankruptcy. With the spectrum purchases, DISH Network emerged as a deals favorite at the end of 2011, as a $39 billion mega-merger between AT&T and T-Mobile USA was iced by the U.S. Department of Justice on antitrust concerns.
With hedge funds and activists now known to have jumped into the company’s shares, it’s especially important to consider whether the investors are targeting an M&A-based stock boost.
After AT&T and T-Mobile walked away from what was the largest merger of the year, DISH Network Chief Executive Joe Clayton said that the company could look to continue its acquisition spree or accept a takeover offer. “We could be acquired or we could be the acquirer,” said Clayton in a Jan. 11 Bloomberg Television interview.
One possibility that DISH had looked at was an offer for NBC Universal’s Hulu Web video business, according to October reports. However, the popular Web video channel canceled a sale process, leaving the business in the control of its parent NBC Universal — which is majority owned by Comcast and part-owned by General Electric. (Comcast is the parent of CNBC and CNBC.com.)
When the AT&T deal went bust, Dish Network was both seen as an aggressor in the wireless market, potentially taking a majority stake in T-Mobile USA itself in a partnership to build out a stronger national network. Additionally, its recently acquired spectrum was also seen as a target of wireless capacity-hungry AT&T.
Immediately after the merger block, Stifel Nicolaus analyst Christopher Kind said AT&T could acquire Dish for its wireless assets, or a T-Mobile and Dish partnership could emerge.
“Dish has expressed interest in combining with T-Mobile, and AT&T could look at acquiring Dish, with spectrum a key consideration,” King wrote in a Dec. 20 research note. In a Jan. 19 note, JPMorgan Chase analyst Philip Cusick proposed a Dish and T-Mobile joint venture would be a more financially viable way for Dish to slowly take ownership of the U.S. mobile arm of Deutsche Telekom.
On Thursday, The Wall Street Journal reported that AT&T is looking at new deals such as an acquisition of Leap Wireless International,MetroPCS or DISH to help the nation’s second largest carrier boost its access to airwaves, benefitting high-data load smartphone services.
In February, an upstart spectrum service called LightSquared was dealt a near-death blowwhen the Federal Communications Commission ruled it interfered with GPS signaling, fanning speculation the company’s owner, Philip Falcone-run Harbinger Capital Partners, may look to unload its radio spectrum assets to avert a bankruptcy. LightSquared investors include David Tepper-run Appalosa Management, Farallon Capital Management, and Carl Icahn, who own pieces of the company’s debt, revealing an alternative way to invest in wireless markets.
But speculation on any spectrum deals is complicated by AT&T’s shifting views on spectrum waivers with federal authorities, in addition to a dearth of consolidation possibilities in the strictly regulated wireless market. While, AT&T is hungry for more spectrum, it’s still unclear if the Justice Department has a next antitrust target in mind.
AT&T, once defensive against spectrum waivers approved such transfers or leases, signaling a ‘change of heart’ that may make the nation's second largest carrier an acquirer of Dish Network, according to a Credit Suisse note on Jan. 30.
Look for new hedge fund investors in Dish, especially activist investors to help Dish Network chose on an M&A strategy. Dan Loeb-run Third Point, an activist fund that pressed for a handful of corporate shakeups in 2011, jumped into DISH in the most recent quarter ended in December, taking a $116 million stake representing nearly 2 percent of a company's shares. Third Point was DISH’s largest share buyer in the quarter.
Other funds like Pyramis Global Advisers, Two Sigma Investments, and York Capital Management also built stakes in Dish, potentially on takeover speculation or a merger with T-Mobile, among a host of considerations.
Dish is expected to earn $14 billion in revenue and $137.1 million in 2011, according to consensus estimates of analyst polled by Bloomberg, with a $30.83 a share price target. In fourth-quarter earnings due on Feb. 23, Dish is expected to earn 61 cents a share, according to consensus estimates polled by next Zacks. Analyst estimates show that in 2013, Dish’s revenue is expected to grow, while earnings and profit margins fall.
The Colorado-based company’s shares rose over 20 percent in the quarter, bolstered by takeover speculation. Dish Network shares are up just over 1 percent year-to-date, underperforming major indices.
After announcing a second phase of its epic dismantling, Tyco International is now set to both be a value proposition for shareholders as it spins its ADT and flow control businesses and an M&A target, potentially motivating some hedge funds to jump into shares of the industrial giant.
On Sept. 21, Tyco announced it would spin its ADT residential security business and its flow control business into separate publicly traded companies, adding to the de-consolidation of Tyco from an industrial conglomerate with a near $100 billion market cap . In 2007, the company spun its Covidien health-care business and its Tyco Electronics business in two shareholder spins. If the September spins and one announced by Covidien in December were to pass, the empire could be whittled down to six child companies.
Shareholders in an spin or an exchange offer may benefit from the growth of a leaner Tyco International and the growth of child entities, while the separated businesses may also become easier to swallow as M&A targets, potentially adding a catalyst for shares.
After ABB announced a $3.9 billion deal to buy electrical equipment manufacturer Thomas & Betts, Morgan Stanley analyst Nigel Coe cited a post-split as the “most likely” takeover target, just as the engineering industry enters in the biggest M&A cycle in a decade.
In filings released this week, hedge fund Westfield Capital Management unveiled an over four million share position in Tyco International, or a near $200 million stake. Meanwhile, Maverick Capital added over three million shares to its Tyco holding, more than doubling its stake to nearly $300 million. Westfield Capital Management seems to have a fancy for companies that need or are considering de-consolidation plans. The company has top 10 positions in Valero and Tesoro, both which announced 2011 spins. The fund also has stakes in Oracle, United Technologies and Vertex Pharmaceuticals, which all tried their hand at the deals game. In the most recent quarter, Westfield built the bulk of its stake after paring a June position of 1.6 million shares almost completely, signaling a bet on strong value in the spin or possible M&A.
Maverick Capital Management’s share buying also reflected a re-ignition of interest in Tyco International as a key investment. The fund held 6.3 million shares as of the quarter ended in Sept. 2010, but it liquidated that stake by December of that year. From June 2011 through September, Maverick returned to Tyco, buying up over 2.8 million shares. With its fourth-quarter buying, Tyco International is now Maverick’s fourth largest holding, only surpassed by Apple, Marvell Technology Group and JPMorgan Chase.
James Dinan-run York Capital Management is making a similar, albeit smaller Tyco play as the company proceeds with spin plans that may generate strategic interest. Once a holder of over 5 million Tyco International shares, York Capital Management slashed its stake from June through September, but fourth-quarter purchases signal that the company is a value play.
Tyco International is expected to earn $18.8 billion in revenue and $1.7 billion in profit in 2012, with those figures growing to $18.9 billion and $2 billion respectively in 2013, according to consensus estimates of analysts polled by Bloomberg. Those analysts give Tyco International a price target of $55.47 a share.
After an over 10 percent fourth quarter rally on the company’s spin plans, Tyco ended 2011 up over 12 percent. With a stronger industrial and business outlook for 2012, the company’s shares have continued to rally in 2012, posting an over 4 percent gain to $48.65 year-to-date.
Like with Dish Network, hedge fund investors in Liberty Media will have to decide whether the media conglomerate will be a buyer or seller.
The quixotic John Malone-chaired cable and media conglomerate with stakes in Barnes & Noble’s and Sirius XM Radio could be a buyer or seller of companies in 2012, and that's enough to pique the interest of Warren Buffett-run Berkshire Hathaway, Tiger Global Management, Och Ziff Capital Management, and David Einhorn-run Greenlight Capital Management, among a bevy of activist and value oriented investors.
In November, Liberty Media opened a $1.5 billion credit facility, which was considered by analysts to be a financing that could lead to acquisitions. In a Nov. 11 research note, Robert Routh of Phoenix Partners wrote that the loan could be used for Liberty Media to help purchase Barnes & Noble, which it already holds a near 17 percent stake in. Previous to Liberty Media’s $204 million stake purchase, it had offered to buy a controlling 70 percent stake in the struggling bookseller for $17 a share, but the company’s chairman and 30 percent shareholder Leonard Riggio rejected the offer in May 2011.
In January, Morningstar analyst Peter Wahlstrom said Liberty Media could also look to buy Barnes & Noble’s Nook digital books unit after the company announced a spin-off plan of the fast-growing business.
Another possibility is for Liberty Media to boost its stake in satellite radio giant Sirius XM Radio, as prospects for the debt-laden and once near bankrupt company brighten. Such a move might be strongly timed for an auto-buying rebound that would benefit Sirius and its in-vehicle satellite radio business. In November, the New York Post reported that the Liberty Media chairman and near 2 percent shareholder was in talks to increase the company’s Sirius investment, which presently stands at 40 percent after a life-saving preferred share investment and $530 million loan in Mar. 2009. At that time, the auto industry was in the process of crumbling, with General Motors and Chrysler Group reeling toward bankruptcy.
Tiger Global boosted its stake in Liberty Media to nearly 2 million shares and Och Ziff Capital Management more than doubled its stake with a more than 1.4 million share position, but both moves were overshadowed by Warren Buffett and David Einhorn’s initial investments in the company.
For Och Ziff, the share buying represented a continued incremental addition to the firm’s Liberty Media stake that was opened in the quarter that ended in March 2011, while Tiger Global’s investment signaled a renewed interest in the company after paring most of a 3.5 million share stake between December 2010 and September 2011.
Meanwhile, Buffett bought over 1.7 million shares valued at roughly $150 million, while Einhorn’s Greenlight Capital took a 980,000 share stake now worth over $84 million.
A dark horse in the share buying was activist fund Jana Partners, which boosted its stake to 1.3 million shares, nearly doubling a Liberty Media stake that was opened in September 2011.
Liberty Media is expected to earn $1.6 billion in sales and $191 million in profit in 2011, according to consensus estimates from analysts polled by Bloomberg, who give the company’s shares a price target of $97.13. In 2012, the company’s sales are expected to rise to $1.9 billion, but profits are expected to fall to $117 million on shrinking margins. In fourth-quarter earnings, Liberty Media is expected to earn 32 cents a share, according to consensus estimates from Zacks.
The hedge fund investors who piled into Cytec Industries in the fourth quarter were richly rewarded when the company confirmed it had hired JPMorgan to help it decide on a spin or sale of its coating resins business. On the news of the strategic decision-making, the firm’s shares jumped, putting 2012 gains near 30 percent.
In third-quarter earnings, the maker of plastic parts used in airplanes disclosed that it would look at strategic alternatives for its coating and resins business.
“We are committed to maximizing the value of the coating resins business. The decision to explore separation options for the entire business is consistent with our strategy of focusing on our remaining profitable and growing segments,” said Cytec Industries Chief Executive Shane Fleming in a fourth-quarter earnings statement.
For Barry Rosenstein-run Jana Partners the announcement couldn’t have been timed better. The investment fund took a more than 3 percent stake in Cytec Industries, worth roughly $85 million, in the fourth quarter.
Jana Partners profited off of many of the biggest spin-offs in 2011. Among its top 10 holdings, Marathon Petroleum, El Paso, McGraw-Hill Cos. and Netflix all attempted spin-off or sale plans, with Netflix quickly reversing course.
Overall, Cytec Industries is Jana Partners’ sixth largest stake, while Liberty Media is its ninth largest holding. Since October, the Woodland Park, N.J.-based company’s shares have rallied as asset value realization strategies become more probable.
Other large shareholders benefitting from a fourth-quarter and 2012 rally, are RoundKeep Capital Advisers, Millennium Management, and Two Sigma Investments.
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