Stock Quotes in this Article: HRL, ICE, KLAC, SNA, TER

BALTIMORE (Stockpickr) -- Jumping in front of corporate buyouts can fuel lottery-like gains for your portfolio. But focus in on a couple of factors, and you can do it without the lottery-like odds.

Mergers and acquisitions, better known on Wall Street on M&A, is starting to pick up again in late 2012. The latest high-profile example is Sprint (S), whose deal with Japan’s Softbank has helped to spur a 64% rally in shares this quarter. Mid-cap cell carrier is another example -- it’s rallied more than 73% over that same period after announcing a takeover deal with T-Mobile. Small-cap Canadian energy stock Nexen (NXY) is up more than 50% after announcing that China’s CNOOC (CEO) was acquiring it.

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M&A volumes have been struggling for much of this year, with corporate managers unable to shake the scariness of stocks that’s plagued investors for most of 2012. But there are attractive deals to be found out there now, and that limits the amount of time buyers are willing to sit on their hands.

That’s why M&A deals are starting to pick up again.

As I write, interest rates are near zero, corporate debt is cheaper to issue than it’s ever been, and firms’ cash holdings are bigger than they’ve ever been. That, and a stock market that’s trailed fundamental growth for the past few years, make the perfect environment for buyouts to come back in favor. The trick is finding the firms with the biggest targets on their backs.

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To do that, we’re focusing on acquiring firms’ favorite attributes: solid balance sheets stuffed with tangible assets, consistent earnings and cash flow generation and bargain valuations. Here’s a look at five stocks that could be buyout targets as M&A activity picks up in the final quarter of 2012.

 

IntercontinentalExchange

First up on our list is IntercontinentalExchange (ICE), a firm that operates four regulated futures and OTC exchanges located in the U.S., Canada and the United Kingdom. Times have been changing for financial exchange operators, and ICE is no exception. The firm’s status as a relative newcomer to the field means that ICE is less entrenched and more flexible with the products that it carries on its exchanges. That flexibility has helped IntercontinentalExchange build an attractive niche in the energy derivatives business, a market that could grow quickly in the next several years.

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By focusing on what I call “less commoditized commodities,” IntercontinentalExchange is able to earn more for its trouble of pairing buyers with sellers -- and that shows up in the firm’s hefty net margins. The firm’s clearing business is a very attractive complement to its exchange and OTC trading arm -- it essentially lets ICE fill a role that a third-party would otherwise get a piece of.

Regulation is the biggest barrier to a takeover deal for ICE. The firm has been a takeover target in the past, taking an offer from Nasdaq OMX Group (NDAQ) that ultimately unraveled because regulators were hostile. While that fact limits the takeover options for ICE, there are plenty of potential courters in the financial sector that wouldn’t draw the same regulatory pushback. Other companies want IntercontinentalExchange’s foothold on a lucrative corner of the exchange and clearing business, and they’re willing to pay for it.

KLA-Tencor

It’s been a pretty tepid year for KLA-Tencor (KLAC). So far in 2012, shares of the semiconductor manufacturing supplier have slid around 4%. That’s significant underperformance versus the broad market. But KLAC’s inability to get any love from buyers puts this $7 billion stock in the acquisition crosshairs of bigger names right now.

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KLA-Tenor supplies process management systems for chipmakers. Essentially, that means that the firm’s business is built around helping chipmakers improve their manufacturing lines through automation and high-level monitoring. Because KLAC’s products directly reduce chipmakers’ costs, the firm’s revenues are less susceptible to industry headwinds than those of its customers. To date, that fact hasn’t been reflected in KLAC’s share price; the cyclical rut in semiconductor manufacturing is hitting this name every bit as hard in 2012.

But financially, KLAC is turning out some impressive performance. The firm’s net margins are deep in the double digits, its revenues have been growing briskly for the last four straight years, and it carries a nearly $1.8 billion net cash position on its balance sheet right now. Effectively, the cash in those coffers means that a quarter of KLAC’s market capitalization is risk-free right now. An acquisition could be in the cards for this firm.

Teradyne

Not surprisingly, with the poor performance semiconductor sales have had over the last couple of years, KLA-Tencor isn’t the only chipmaker or supplier that’s looking like a bargain. Another name is Teradyne (TER).

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Teradyne is in a similar business to KLAC. Its automation products show up on chipmakers’ assembly lines, testing chips and analyzing performance before they leave the line. The firm’s relatively new FLEX testing platform has been a popular system among chipmakers, and helped TER to reign in its costs. Instead of manufacturing the testbed in house, for instance, Teradyne opted to outsource the manufacturing and keep the capital needs of a manufacturing facility off of its plate. The early results are promising: profit margins have climbed to new highs and the firm’s balance sheet has swelled with cash.

Today, Teradyne holds more than $840 million in cash and investments, offsetting $167 million in debt. The result is that, like KLAC, around 24% of TER’s market capitalization is made up of cash. TER’s smaller size makes it a more accessible target for a semiconductor firm that wants to use a tuck-in acquisition to enter the automated testing equipment market.

Hormel Foods

Food stocks are some of the biggest players in the M&A business, frequently buying and selling brands piecemeal or whole hog (pun intended) to build exposure to a particular type of packaged food product. That’s why Hormel Foods (HRL) makes our list of potential takeover targets. In addition to Hormel’s eponymous label, the firm also owns household brands like Jennie-O, Spam and Country Crock.

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Hormel is a meat stock. The firm earns more than half of its revenues in the fresh meats business, producing ham, bacon, and turkey for grocery stores across the country. Customers are more flexible about fresh meat prices than they are with shelf stable products. That fact gives Hormel considerable pricing power at the cash register. On the other side of the equation, vertical integration has helped Hormel keep its own costs lower. Because Hormel generally raises the animals that it sells, it’s able to save costs and absorb more inflation in its cost of goods sold.

HRL’s balance sheet looks attractive right now, with more than a billion dollars in cash and less than a quarter of that amount in debt. While a brand acquisition attempt is more likely than a buyer looking to takeover the whole firm, either scenario unlocks considerable value for shareholders.

Snap-On

The last takeover target we’re looking at is toolmaker Snap-On (SNA).
Snap-On is having a good 2012. So far this year, shares of the firm have rallied more than 44%. But there’s still considerable value that can still be unlocked from shares right now, and other companies know it.

Snap-On’s target market is the professionals. It sells its tools and diagnostic equipment primarily to techs who work on cars, trucks, planes or other machines. That pro image carries over to the retail market too, though. So-called “prosumers” want to use the same tools that the pros use, and ultimately Snap-On has a big untapped market to in the retail space.

Despite some modest advertising to consumers, the firm’s bread and butter remains the professional market. A fleet of 3,200 franchised vans sell and deliver tools directly to repair shops across the U.S. That control of the product from manufacture to delivery gives SNA precision control over its costs that outsourcing rivals don’t have.

While the firm’s balance sheet is more leveraged than most of the other names on this list, Snap-On’s still in decent financial shape, especially when compared to peers. A potential suitor could unlock significant value in making a bigger retail presence from what’s already a valuable brand.

To see these takeover names in action, check out Takeover Targets Q4 2012 Portfolio on Stockpickr.

-- Written by Jonas Elmerraji in Baltimore.


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At the time of publication, author had no positions in stocks mentioned.

Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including

Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.