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NUMBER CRUNCHER

Where cash flow is king: Scouting for takeover targets Add to ...

What are we looking for?

Takeover targets. With so many companies, from Neo Material Technologies to RuggedCom to Viterra, attracting takeover bids at lush premiums to their prior share prices, we thought it would be interesting to look at which other enterprises sport the characteristics likely to appeal to would-be buyers.

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More about today’s screen

Craig McGee, senior consultant at CPMS Morningstar Canada, created the screen. It’s designed to look for firms trading at bargain-basement valuations in comparison to fundamentals such as tangible assets, sales and cash flow.

Cash flow is especially important to a buyer, because takeovers often involve the purchaser taking on added debt to pay for the acquisition. Thus, a target company that spins off cash and can help finance its own acquisition becomes particularly attractive.

A key metric in this regard is a company’s ratio of enterprise value (EV) to earnings before interest, taxes, depreciation and amortization (EBITDA). Enterprise value is the combined total of the company’s stock market capitalization and net debt, while EBITDA is the amount of cash the firm generates before debt payments. A low EV/EBITDA ratio means a company can be acquired relatively cheaply in comparison to the cash flow it can put toward paying down debt.

Mr. McGee searched among Canadian and U.S. firms with more than $250-million in market capitalization. He looked for firms with:

--EV/EBITDA less than 6;

--EV/EBITDA at least 25 per cent less than industry median;

--Price/tangible-book value at least 25 per cent less than industry median;

--Price/sales at least 25 per cent less than industry median;

--Latest price at least 20 per cent less than the average price over the past year.

What we found

Our search turned up 16 companies with the right stuff to catch a would-be purchaser’s eye. Note, though, that cheapness isn’t everything. Research In Motion made our list, but its struggles against the likes of Apple raise the distinct possibility it could become even cheaper. Much the same goes for Encana, which is wrestling with rock-bottom prices for its primary product, natural gas. You should do your own research before investing in any of these names.

Follow on Twitter: @IanMcGugan

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