Healthcare M&A Activity: Three Healthcare Small Caps Primed For Takeovers

by Louis Basenese, Small Cap & Special Situations Expert
Thursday, October 22, 2009: Issue #1121

With the healthcare debate still raging in Washington, this should shock you…

Healthcare mergers and acquisition (M&A) activity is at an all-time high.

You’d think with so much uncertainty surrounding the future of the industry, the dealmakers would be as lonely as a geek on prom night.

But that’s just not so.

• Based on the dollar value of transactions, roughly one-third of all deals in the United States this year involved healthcare companies – considerably higher than the historical average of 10%, according to Dealogic.
• And based on the number of transactions, about 13% of all deals in 2009 have involved healthcare companies. Again, that’s notably up from the historical average of 9%.

Let me share why we can expect the record-setting activity to continue – and, of course, three ways to capitalize on it.

What’s Greasing the Skids for Healthcare M&A Activity?

At first glance, you might question the savvy of healthcare executives to make acquisitions in such an uncertain climate. After all, healthcare stocks have significantly lagged behind in the S&P 500 rebound, rising only 9.6% compared to a 20.8% increase for the Index, year-to-date.

But rest assured, they’re not buying blindly. In fact, the companies at greatest risk of cost cuts (and, in turn, less profits) – insurers, hospitals and nursing homes – remain on the sidelines.

Instead, it’s companies in other categories – like drug makers, research labs, equipment manufacturers and healthcare technology companies – that are so acquisitive. Here’s why…

Regardless of the end result of the legislation in Washington, one thing is glaringly obvious: millions more Americans will get healthcare coverage. And that represents millions more potential customers.

Companies are simply jockeying for position, so they can capture a larger share of the new demand. And takeovers represent the quickest way to do so.

Healthcare Takeovers Expand Market Share Cheaply

In addition to being quick, takeovers are also a cheap way for healthcare companies to expand their market share.

Consider that the average healthcare stock now trades for roughly 12 times earnings – a bargain, considering the average stock in the S&P 500 trades around 20 times earnings.

So with healthcare reform imminent, companies don’t need to waste the time and money, or take the risk to try and expand organically. Not with so many attractive targets trading on the cheap.

And the fact that financing remains available for healthcare deals only makes the growth-via-acquisitions strategy more irresistible. You see, while banks shy away from lending to other sectors, they’re all too amenable to lend a hand to a completely recession resistant industry with strong growth prospects.

Case in point: Pfizer (NYSE: PFE) and Merck (NYSE: MRK) secured tens of billions in financing to fund their acquisitions during the darkest days for the market (in January and March).

With more healthcare M&A likely, here are three healthcare companies I strongly believe are takeover bait…

Put These Three Healthcare Stocks on Your Watch List

~ Bristol-Myers Squibb (NYSE: BMY): When Pfizer ponied up $68 billion to acquire Wyeth in January, it set the stage for more Big Pharma tie-ups. Sure enough, Merck stepped up to purchase Schering-Plough for $41 billion in March.

And making the case for someone to buy Bristol-Myers is easy…

• It recently divested non-core assets.
• It’s sitting on $8 billion in cash, which acts as an instant rebate.
• It boasts a solid pipeline of cancer drugs, which hold the potential for faster FDA approval and higher margins.
• Multiple suitors exist including Sanofi-Aventis (NYSE: SNY), GlaxoSmith Kline (NYSE: GSK), AstraZeneca (NYSE: AZN) and Johnson & Johnson (NYSE: JNJ).

The fact that BMY shares trade at their lowest valuation in a decade only makes a deal more likely. And it doesn’t hurt that we get paid a 5.4% dividend yield while we wait.

~ Onyx Pharmaceuticals (Nasdaq: ONXX): If you’re looking for the next biotech deal, Onyx could be it. In Nexavar, it boasts the first FDA-approved drug for liver cancer, the third-deadliest form of cancer. And it just made a move to strengthen its pipeline by acquiring privately held Proteolix. The potential for additional applications for Nexavar should entice the company’s current partner, Bayer AG, to make a move to acquire ONXX before someone else does.

~ Medidata Solutions (Nasdaq: MDSO): The $787 billion federal stimulus package includes roughly $20 billion for healthcare information technology (IT) – a sum that only serves to accelerate the trend to bring the healthcare industry into the digital age. And that bodes well for Medidata.

I’ve outlined the fundamentals for Medidata here before. In short, its products eliminate millions of dollars in waste from each clinical trial. And suitors would be buying the fastest growing company in the space – the company’s revenues jumped 32% last quarter.

Moreover, a measly market cap of $362 million makes a takeover more compelling, as suitors could easily buy MDSO with cash on hand.

And remember… investing in a stock before a takeover announcement results in an average gain between 43.5% and 53.7%, according to the number-crunchers at FactSet MergerStat. So clearly, it’s a strategy worth pursuing.

Good investing,

Louis Basenese

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Trailing Stops & Position Sizing: Two Tips to Avoid Letting a Bad Stock Sucker-Punch You

by Louis Basenese, Small Cap and Special Situations Expert
Thursday, October 8, 2009: Issue #1111

I confess… I got it wrong with gold.

Unlike some stockpickers and newsletter analysts, who proudly trumpet all their winners, while shuffling the losers under the rug, I have no problem admitting when my calls go against me.

And to the delight of all the naysayers, this happened just a couple of days ago when gold prices shot to a record high. That triggered my sell-stop and, rather than let my pride come before a fall and hang on, it’s time to move on.

Don’t get me wrong, though… I’m still convinced that the yellow metal could suffer a correction for three main reasons…

• So far, inflation hasn’t reared its ugly head. If it stays in hiding much longer, disillusioned investors will probably head for the exits.
• If the U.S. economy recovers quicker than expected, investors will be inclined to abandon the safe haven of gold and reinvest in equities.
• The technicals point to a drop. The last four times gold spiked near or above $1,000 per ounce, it quickly (and sometimes precipitously) corrected.

However, giving into these convictions – and doubling down on gold – would mean abandoning two core investing disciplines that I swear by – position sizing and trailing-stops…

Have You Considered Using Trailing Stops & Position Sizing?

I know… you’ve heard about them countless times before. But indulge me for a moment, as I explain an aspect of both trailing stops and position sizing that you’ve probably never considered…

• When I speak at investment conferences, I always like to ask people to share their biggest loser. Heads go down and nary a hand rises.
• Conversely, when I ask them to share their biggest winner, it’s like I just offered free candy to an auditorium full of kindergarteners. Everyone’s hand shoots up and there’s a chorus of anxious, “Oohs!”

Nobody likes to talk about losing investments. Instead, we want to thump our chest over the latest 1,000% gainer. The reason for that is obvious, so let’s focus on the fear about talking about our losers.

Many investors turn their biggest loser into a total loss. Instead of employing a trailing-stop and exiting a trade as the price tumbles, they make it a long-term investment to save face. Or worse, they invest more at lower prices. Most times, the stock goes belly up and they lose even more.

Even the professionals can’t claim immunity here.

• For instance, take Bill Miller, the famous manager of the Legg Mason Value Trust Fund (LMVFX). Although Miller beat the S&P 500 for 15 consecutive years, he refused to man up to his mistakes when the market took a nosedive in 2008. He kept averaging down in stocks like Countrywide, Bear Stearns, Freddie Mac, Merrill Lynch, Washington Mutual and AIG.
• He revealed the true depth of his arrogance when he was asked how he knew when to stop buying a falling stock. “When we can no longer get a quote,” he replied. In other words, the only price at which he was unwilling to buy more was zero.

Here’s my point…

Avoid Losses With A Position Sizing & Trailing Stop Discipline

When I joined The Oxford Club, I immediately stopped worrying about my losses. That’s because we religiously adhere to a 25% trailing-stop discipline and a position size of no more than 4% in any one investment. Thus, losses are always contained.

The beauty of such a simple, disciplined approach is two-fold…

• The results add up, decidedly on the plus side. Case in point: The independent Hulbert Financial Digest has ranked The Oxford Club newsletter (The Communiqué) among the top five in the nation. That’s based on 10-year returns, too.
• A trailing-stop and position sizing policy allow me to keep making bold calls without regret. The bolder they are, the smaller my position size.

For instance, for my short gold call, I only invested 2%. For a hypothetical $100,000 portfolio, that means investing  $2,000 and losing $500, or less than 1% of the total portfolio value.

Bottom line: I don’t ever let an investment turn into an unacceptable loss. And I never put too many eggs in one basket. Sure I might lose 25% here or 25% there, but when I keep my position sizes small, in the grand scheme of things, it’s no big deal.

Such a strategy leaves me with plenty of capital to re-deploy and keep gunslinging. And while gold didn’t work out, some other contrarian bets are already making up for the loss and then some.

• Take Sotheby’s (NYSE: BID), for example. Back in June, I advised readers to buy shares when everyone else believed the market for investing in fine art was going into a long hibernation. The fundamentals faltered, but they didn’t collapse. As a result, Sotheby’s rallied 68% from my entry point.
• Then there’s my recommendation last Thursday to buy into the beleaguered retail sector with hhgregg (NYSE: HGG). It’s up 5.7% since then.

If I take profits on both now, my misstep by shorting gold doesn’t even matter.

The Critical Component to a Disciplined Investment Approach: Accountability

But of course, a disciplined investment approach is useless without the critical component of accountability… In terms of position sizing, there’s only one person who can keep you honest: Yourself.

But when it comes to implementing trailing-stops, multiple options exist…

• A So-So Option: Enter the stop levels with your broker. However, this is not ideal. Market makers can manipulate prices to trigger these stops.
• A Better Option: Use a service like TradeStops (www.tradestops.com). For a nominal annual fee, it will alert you via text message and/or e-mail when your stocks hit their trailing-stops.
• The Best Option: Excuse my bias, but the best value for your money is The Oxford Club. We constantly remind you about position sizing and more importantly, notify you immediately when we hit a stop-loss or trailing-stop. And our members keep each other honest.

In addition, membership also comes with a constant stream of high quality, profitable recommendations. And they make up for the occasional downer, like my short gold recommendation! To find out more, take a few minutes to read our report on how it all works.

Good investing,

Louis Basenese

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hhgregg, Inc. (NYSE: HGG): The Only Retail Stock Worth Buying Right Now

by Louis Basenese, Advisory Panelist

For the first time in six months, retail sales ticked higher in August.

Granted, it wasn’t by much – a scant 0.7% higher than July. But it’s inevitable that consumers will eventually get back to their spending ways as this recession subsides.

And if you’re looking for a way to play it, consider hhgregg, Inc. (NYSE: HGG). Here’s why…

hhgregg, Inc: This Retailer is Bucking the Industry Trend

Based in Indianapolis, the hhgregg operates 111 retail stores selling consumer electronics and home appliances. Yes, I know that’s the same stuff you can get at your typical Best Buy (NYSE: BBY), Home Depot (NYSE: HD), or Lowe’s (NYSE: LOW).

But this company is hardly typical.

While most retailers are focused on survival, hhgregg’s in full-on attack mode. It’s not pinching pennies to stay afloat. It’s not reducing the workforce. It’s not closing underperforming stores, or mothballing expansion plans.

Instead, it’s actually ratcheting up its expansion plans and hiring by the hundreds. In fact, in the next two years, the company plans to expand its footprint by 60%.

And there’s a good reason for it…

hhgregg’s “Extraordinary Opportunity” for Growth

hhgregg’s still a regional player, with countless metropolitan markets left to enter. Plus, the fundamentals make sense…

• The typical hhgregg store generates positive free cash flow quickly, within three months of opening.
• Not to mention, the company entered the recession in much better shape than most of its competitors.
• Most notably, it wasn’t overloaded with debt. In turn, management is exploiting the drop in commercial rental rates to secure prime locations, within miles of top competitors.

President, Dennis May, says, “We have an extraordinary opportunity to gain market share by taking advantage of the current rental rates and excess availability in the real estate market.”

At the same time, the bankruptcy of a once major retailer cracked open an $11 billion opportunity…

Two Ways That hhgregg Separates Itself From the Crowd

With Circuit City having gone bust, most investors expect Best Buy to scoop up all the business. But I’m convinced hhgregg will earn its fair share too, because it distinguishes itself from big box competitors in two notable ways.

1. All Commission… All Knowing: hhgregg employs an all-commission sales staff. So if they’re content to just show up, they go hungry. They need to make sales. Thus, hhgregg’s staff tends to be older and more informed about products than the hourly, 20-somethings over at Best Buy. And with big-ticket items, consumers put a premium on superior customer service.
2. Same-Day Delivery: hhgregg offers same-day delivery on most products. Instant gratification goes a long way in attracting new customers.

To be clear, however, hhgregg is sharing in the retail pain. Same-store sales dipped 14.7% in the most recent quarter. But analysts expected worse.

The key point to remember, though, is that we never buy a stock based on the current conditions. We buy based on the future. And I’m convinced that hhgregg will be locked-and-loaded for rapid earnings growth as the economy recovers.

And the fact that shares trade at a reasonable valuation of 14 times forward earnings only makes the opportunity more compelling.

Good investing,

Louis Basenese

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