Today David looks at 4 potential buyout scenarios, and names 3 stocks in each that—for better or worse—look ripe for the picking. While it's fun to see stocks pop at the news of a buyout, in most cases we'd rather see our businesses continue as independent, pure-play investments.
Rule Breaker Investing
How To Spot A Potential Buyout
This episode of Rule Breaker Investing is brought to you by Rocket Mortgage by Quicken Loans. Rocket Mortgage brings the mortgage process into the 21st century with a fast, easy, and completely online process. Check out Rocket Mortgage today at QuickenLones.com/Fool. (upbeat music) - It's the Rule Breaker Investing Podcast with Motley Fool Co-Founder, David Gardner. (machine whirring) - And welcome back to Rule Breaker Investing. I'm David Gardner. Very pleased to have you with me. This is the, I don't know why I keep track of these tests. This is the 47th weekly podcast that we've brought you. That means we're coming up on 52 sometime in late June. It's been a really wonderful year almost together. And today I've got a really fun topic. It's buyouts. I press this last week, talked about how I wanted to talk about buyouts. Before I do, I want to mention a fun event in Alexandria, Virginia, where the Motley Fool is based. And that is our annual Fool Fest conference. So we are inviting members from our services in, and they come usually 700 or more, it seems, sometimes from around the world. And to meet with other fools, something that you need to be a member of one of our services, generally are probably our higher end services, to get an invitation. And I know some of you listening to me right now are probably flying toward Alexandria and others are wondering, how can I do that? And the answer is maybe join something like Supernova, which is open this month, probably the last time it'll be open in 2016. But so Fool Fest, maybe I'll have a story or two coming out of it next week. And by the way, next week is mailbag on this podcast. So get your questions out there, rbi@fool.com. That is our email address, or just @rbipodcast on Twitter. We're consistently getting more questions than I can possibly cover. I always feel disappointed or don't want to disappoint you if I don't get to your question. But we're picking the best, most relevant and entertaining ones. And if you can fit the bill there, love to feature you maybe next week. All right, so enough about Fool Fest and mailbag. Back to our topic. So one of the recurring funny questions that comes up from new members of the Motley Fool Stock Advisor service, especially discerning members who love checking out scorecards and are willing to click links deep to figure out how things work. And this is the recurring question that I'll get just a few times a year. It'll start something like this. Hey, Fools, new member here, my name's Bob. And I think you've got an error because you're showing on your scorecard that you bought Disney in 2002. And you guys are showing a cost basis of $1.92 for Disney shares in 1992. You say you bought it on June 7th at $1.92. And guys, Disney was trading above $17 to share that day. In fact, ironically, at $17.92. So did you guys drop the seven there? Also, PS, Bob might write. Makes me question some of the other numbers on this service. I mean, if you're not even getting the cost basis right for Disney in 2002, why should I trust anything at Motley Fool Stock Advisor? So the question will come in something like that. And it's a completely understandable question because in fact, we do represent our having paid $16 less on June 7th, 2002 for Disney shares than they trade today. And since they're up at about $100 a share today, a $16 difference in a cost basis, the difference between $2 a share and $18 a share is a huge difference. And to all the Bobs and anybody else who ever comes to Stock Advisor, looks at the scorecard, checks it out. I wanna make sure you know ahead of time why that's the case. And here's why. On June 7th, 2002, I recommended Marvel. Marvel Comics, Marvel Enterprises. And the stock that day was around $5 a share. And between 2002 and 2009, Marvel was a great stock. It went from about $5 a share. It went up more than 20 times in value. And Disney helped it because right in August 2009, Disney acquired, as most of us know today, Marvel paying a 25% premium or so. And that caused Marvel to be an amazing investment from about a split adjusted two to 50. And then with that buyout of our Marvel shares, Motley Fool Stock Advisor members patiently holding out stock. We advise them. It's translating into Disney. Just keep those Disney shares. And here we are now seven years later and Disney has been a great investment. So here's the trick. Here's the magic trick to getting Disney at a buck 92 when everybody else is paying 1792. The answer is find the companies that big dogs are gonna buy out. At the time, we didn't know that or expect that. We had had some experience with that. In fact, Disney is now on the Motley Fool Stock Advisor scorecard six times the single most recommended company that I've made with my monthly pick month and a month ad now since March of 2002. So hundreds of picks, it's the single most picked stock. And here's the beautiful irony of it. I never once actually picked Disney stock. Four of those six slots are Marvel and the other two were another fun stock advisor recommendation a company I loved that Disney bought out. And that would be Pixar. In fact, Pixar didn't last as long on our scorecard. It was bought by Disney in 2006. Six positions, all Disney positions today, not a single one of them was a Disney recommendation. But as both of those companies, Marvel and Pixar were bought out over the course of time, we just advised members to keep their holding going, convert over to Disney stock, which is how it was handled. And the rest has been history today. Disney is the second best pick on Motley Fool Stock Advisor. Over the course of history, I've had four 45 or better baggers, four stocks rising 45 times or more. Disney's one of them, but it's really Marvel now, you know, the second best performer of 52 baggers since original recommendation. So I wanna talk about buyouts this week. And I'm gonna start by talking about four ways to think about buyouts, four approaches to take or four things I'd like you to have in your mind about stocks that get bought out or acquisitions or even deciding ahead of time to invest in something that you think might get bought out. So four thoughts there, then I'm gonna close it out with four categories of types of companies that typically get bought out. And I'm gonna give three specific examples from Motley Fool Stock Advisor and Motley Fool Rule Breakers, my supernova universe, three specific examples of the types of companies that could get bought out in future. And so you'll have 12 new stock ideas in addition to, I hope better ways to think about buyouts. Thought number one, my first thought this week is that we rarely ever pick a stock thinking or hoping it'll get bought out. You will never see me on one of my services recommending a stock, I should never say never, by the way, 'cause as soon as I start to pigeonhole myself, I try to break out of any kind of stereotype that I'm setting up for myself, any box that anyone wants to build around me. I have this, I think it's a character fault, but it might be a strength as well. I don't ever like to be pigeonholed. So you will almost never see me recommending a stock in Motley Fool Stock Advisor or Rule Breakers because I think or hope it will get bought out. After all, most of the time, since we're looking to invest sustainably over long periods of time, we're looking for the winners. We're looking for the companies that are leaders, and usually the leaders aren't getting bought out, they're doing the buying out. So I'd much rather, as an investor, be buying and becoming a part owner of a company that I think is substantial and strong and can last independently, I hope sustainably, for a long time, that I am hoping to get in before some inside information gets passed to somebody else about how some deal might be done and a stock starts rising based on takeover rumors. And then perhaps a day or two or a year or three down the line, the stock actually gets bought out. The reason buyouts are exciting for many people is because the little company that gets acquired, usually the smaller company, not always, gets bought at a premium. The new acquisitor has to pay up to entice shareholders to vote for that. And so you'll see a premium attach and it's exciting, right? Your stock all of a sudden is up 22% this morning before you've even finished your morning coffee. And that instant hit that get rich quick feel is enticing. There's no question about it. But number one, to close this one out, we rarely ever pick a stock thinking or hoping that it'll get bought out. Number two, number two is you're often gonna do better in that upstart if it doesn't get bought out. Marvel, now Disney has been an amazing investment for Motley Fool Stock Advisor members. However, I suspect that Marvel would have been an even better stock had it been allowed to remain independent. After all, at the time, when we first recommended Marvel, there was extreme skepticism that superhero movies were anything more than a fad. Some people pointed back to those old enough. I turned 50 this week, those on around my age. May remember there was an earlier generation of superhero movies. Some Batman, some Superman didn't really pan out that well over the course of time for the movie studios that initially brought Michael Keaton to the silver screen as Batman. Those didn't seem like a big ongoing business. So the market could look back and say these things look like a fad. And I recommended Marvel after that very first Spider-Man movie. And it was a wonderful movie. But ironically, Marvel stock kind of buy on the rumor cell on the news. Marvel stock was selling off over the course of that summer as box office rewards kept going up for the movie. In fact, Marvel's market cap at the time we recommended it was $170 million, which wasn't that much more than a few weeks of the box office of that Spider-Man movie. Now Marvel at the time was only getting about 5% because it was licensing out Spider-Man. It wasn't actually owning the whole property. But now today, we can see how many superhero movies. I haven't yet been out to see Captain America Civil War. But outstanding reviews for many of these movies that have come to market. And by the way, some bad movies over the course of time. I'm not sure, in retrospect, Ben Affleck is glad that he was daredevil back in the day. That wasn't a great superhero movie. Ang Lee's The Hulk, a disappointment to many, the critics generally included. Not every single movie for Marvel has worked out well, but look how wonderfully well that business has worked out today. Now years and years later, and I think we as investors would be doing even better. We'd have more than a 52 bagger had Marvel not got bought out. So I try not to get too excited about this prospect of some big, quick premium I could get with a get-rich, quick move for one of my stocks because some of our very best companies, Pixar, probably another one, have been bought out under and away from us. And so we couldn't continue holding stocks like Catamaran, which was a wonderful company for Motley Fool Rulebreakers, or A Quantum, which was our very first spiffy pop. Also, Motley Fool Rulebreaker Company and one that Microsoft bought out. So we think we'd be doing better often in these companies if they were allowed to have just continued on independently. Thought number three. Thought number three is that it is often sweet vindication when your company is bought out. This one was suggested to me this week by talented Motley Fool Stock Advisor analyst Jim Mueller. I was mentioning to Jim I was gonna do this week's podcast on biots and he said, you know, one thing that I do feel that you should say on air, David, is that there is a bit of vindication that you're looking the right way for companies to invest in. You're not the only one to notice it and take advantage of it when some big dog comes in and pays 30 or 40 or 50% more than what the stock traded at the day before, seemingly justifying your own view of the world, that it was that attractive as a stock. There is a sweet feeling often when you see a stock all of a sudden, Zipcar was a down and outer for us, but Zipcar all of a sudden trades up at a significant premium as Avis buys that Zipcar a few years ago. It hadn't been a great stock. It didn't end up being a great stock even after the buyout, but there is that feeling of sweet vindication. So when you do have a company taken away from you, and sometimes you're still holding onto its pant leg as it's being pulled away from you by the man, whoever the man is, it still can be a sweet feeling to think, you know, I had it right. Thought number four. Thought number four is that for some of the best of these, there's a natural transition that can occur. Maybe it's a rule breaker. I've talked about this certainly on this podcast over the past year, that the dream of every rule breaker is that it can eventually transition into a rule maker. So as a rule breaker, you come along, you break the rules, you're doing business or a product or a service better than is done or cheaper than is done by the status quo, you find a new market, you find fans, you disrupt the world, you break the rules, you become a success, you maybe become a public company, you have a great stock, we talk about you on this podcast, and then at a certain point, rule breaker doesn't fit anymore. And rather than be Henry V, Prince Hal, the ne'er-do-well crown prince, you decide, you know what, as a business, it's time for us to start making the rules. And so, princes and princesses become kings and queens, and this is kind of the dream for me as an investor and how I think about business. One day I'd love the Motley Fool to be a rule maker, but we're definitely in early rule breaker phase right now. But every great business, if it goes on, eventually it'll start making the rules because the world will have conformed to it. Everybody will be buying from Amazon, and all of a sudden Amazon won't be just Earth's biggest bookseller. So there's a growth instability that can occur with these acquisitions, these kinds of companies. I was talking with Michael Robinson, another talented Motley Fool stock advisor analyst, and he was talking about Montpelier Re, which was a reinsurance company, one of our recommendations on Motley Fool stock advisor, we had it for years, and it was bought out fairly recently by Endurance Specialty, which is a fellow insurance company, and they kind of, it wasn't exactly a merger of equals, but it wasn't a really big company buying a really small one today. It's about a four and a half billion dollar company, we kept the investment recommendation in, it's E-N-H Endurance Specialty. And it's a recent example, Michael said of an acquisition that we liked, and then we held, in fact the stock is the best buy now, right now, Motley Fool stock advisor, will still participate in the upside, potentially have more downside protection, given the increased diversification among, in this case, lines of insurance and reinsurance now at Endurance Specialty. So when a company gets bought out, or even when a company buys out, there is a process of becoming a little bit more of a king, as opposed to merely a prince, and that's an attractive aspect to acquisitions, and being a passive consistent shareholder through thick and thin, owning these kinds of companies. So yes, you and I, if we were buying a small cap out of favor back in 2002, called Marvel, today we're one of the crown jewels of a very large, one of the best companies in the world, Disney, and to watch that growth and have participated, and really to learn from it by observing it, and being in the game on it, that's one priceless lesson that those of us who've been patient with Marvel, Pixar, and Disney now for 15 years have benefited from. So that's thought number four, that there's that rule breaker to rule maker transition that can occur in these instances. Okay, now coming up, I'm going to look at four simple categories of the types of companies that tend to get bought out, and provide you with three present examples of companies that I think could conform to each. Before I do, time to pay the piper. This episode of Rule Breaker Investing is brought to you by Rocket Mortgage by Quick and Loans. If you've ever bought a home, then you already know how frustrating and time consuming, getting a mortgage can be. Rocket Mortgage brings the mortgage approval process into the 21st century by taking all the complicated time-consuming parts of applying for a mortgage out of the equation. With Rocket Mortgage, you can easily share your bank statements and pay stubs at the touch of a button, helping you get approved in minutes for a custom mortgage solution that's been tailored to your unique financial situation, even better. With Rocket Mortgage, you can do all this on your phone or tablet. So if you're looking to refinance your mortgage or buy a home, check out Rocket Mortgage today at quickandlones.com/fool. Equal housing lender license at all 50 states, nmlsconsumeraccess.org number 30-30. So I have four categories for you this week of the types of companies that get acquired. I hasten to add two things before I get there. Number one, there are other categories than these four. These are just four that occur to me. If you're kind of into pattern recognition as I am, I bet you can think of a fifth, the sixth, or seventh. And if you want to tweet it out at RBI podcast, let me know of another category this week that you think often these kinds of companies can wind up in. So that's number one. There are more than just four categories. And number two, in each of these cases, these are not companies that I'm specifically saying will or should get bought out. Some of these will be really companies I love and stocks I hope won't get bought out. In fact, I hope sometimes I suspect, by the way, Bob Iger was a Motleyful Stock Advisor member 'cause he's out there buying my best companies, Pixar, and Marvel, and I've even said to Bob, you should take a look at Discovery maybe at some point, but whether or not Bob was ever listening to the Motleyful Stock Advisor, I'm almost reticent to put these company names out there because one of you other people working in some other companies might find your interest peaked and eventually buy one of these. And I've already made a point earlier about how we prefer not to have these taken away from us. So with those two points aside, category number one, and I'm gonna call this one the innovating upstarts. So these are companies typically that are out there, they're innovating, they're upstarts, and the big dogs see we will never catch those guys. We do admit it, what they're doing is attractive, even if publicly we're saying it's too small for us to care. But often you're buying an innovative leader, somebody, an entrepreneur who got it started and you might want to make that person in your executive team and you're buying a technology that you didn't develop in has yourselves and it's these kinds of companies. When I talked about earlier, zip car, that's kind of an example of an innovating upstart. So three companies that I see today will just go alphabetical order with all these R and I'll give each, with a company name and a ticker symbol, bank of internet holding BFI, B-O-F-I, Shopify, S-H-O-P, and Zillow, whose ticker symbol is Z or Z-G, depending on which flavor of share we don't really care too much about that these days that you're interested in. So each of these companies, bank of internet, Shopify, and Zillow is an innovating upstart, whether you are creating a pure online only bank, skipping all the bricks and mortar, or you're enabling on Facebook primarily, craftsmen or other entrepreneurs to start their own shops, which is what Shopify does today, or you have gotten a map of America, thanks to Google Maps, and started laying down real estate prices, predicted prices for every property like Zillow does today. Each of those are companies that are clearly innovating, and these kinds of companies can get taken out from time to time when it becomes evident that what they're doing, no one's really gonna catch 'em, and what they're doing is valuable. A second category I'm gonna call the out and out leader in a closed situation. In our first book, The Motley Fool Investment Guide, I wrote the chapter, Tom wrote some of them, I wrote some of them, I wrote the chapter on open and closed situations, and this was specifically about shorting stocks, which is something I haven't really talked too much about on this podcast, I don't do that much anymore, but I think is a very interesting thing to do and to learn. And so back when I used to short stocks, I liked to find specifically companies that didn't have a wide open possibility, not a lot of optionality for where they could go in this world. It was kind of, I would call it at the time, I called it a closed situation. So it's like a one widget company or a one geography company or whatever it is, it's not gonna be able to break out of what it's doing. And therefore, if you're short this stock, especially you don't need to fear that all of a sudden, and we'll go back to Amazon again, that all of a sudden Amazon is gonna open up a whole new product category or a whole new business that you weren't counting on with your backward looking valuation causing you to short what you thought was an overvalued stock. And so those are always the situations to avoid. I've never shorted an open situation with lots of optionality. So these companies, the ones that can get bought out, second category, kind of they're the leader, but it's in a rather closed situation. Alphabetically, I have for you this week, Amerco, whose ticker symbol is U-H-A-L, if that sounds like U-Haul, U-Bett. Second, Pandora, ticker symbol P, and third, Taser International, ticker symbol T-A-S-R. Now each of these three companies, Amerco, whether it's that U-Haul brand and business, Pandora, which is dominating free airwaves, but doesn't have a lot of places to go from there, or Taser, with its well-known eponymous product. Each of those is a leader, but in what I think of as a closed situation, so you could see another company coming in from left field and saying, we'd like to enter that business, we've found the leader, and we've talked to the management team, they see they don't have a lot of optionality or growth left, so we went ahead and bought them. Category three, this is the sad category of these four. These are the down and outers, and I've had a number of these kinds of acquisitions over the years. Usually they're gonna be bought by private equity companies at a nice premium, but unfortunately, in my experience, the stock is already well down for you, you're sitting there still holding it thinking, you know, what a shame, I made a bad call, stocks down 70%, still like the business, still owning the stock, the fools have told me to keep holding, but, and then bang, a private equity firm comes out and buys it out for 40% a premium over where it was trading the day before. Here's the problem, you were already down 70%, so when you got bought out 40% higher, you're still well down, so I've had companies that have dived, and then we end up watching them get bought out right around where our cost basis was, and we kind of throw up our hands and say, oh well, I guess that was sort of a waste of time. Three companies that conform to this kind of buyout today, alphabetically again, GoPro, ticker symbol, G-P-R-O, InvenSense, ticker symbol, I-N-V-N, and the Container Store, ticker symbol, T-C-S, each of those three businesses remain active recommendations on my scorecards, and I'm sure I'm hearing some groaning in your car, or as you're jogging, because you're way down, we are too, in each of those companies, and in my experience, these kinds of companies probably do have value, but end up getting bought out by private equity companies who think, hey, there is value there, and we're just gonna take this thing, and maybe we'll change up management, we're just gonna refashion this business, and then we're gonna loose it back on the markets at some later point or sell it to somebody else after having refurbished it. Again, no predictions for any of those three, and this week's podcast is not about predicting buyouts, it's just helping you establish some pattern recognition around when this happens and why. And finally, this week, category number four, and these are the geographical buyouts. This is where somebody is dominating in one place in the world, and somebody else in another place says, we want into that market, let's buy that company. And three that come quickly to mind for me here, alphabetically, are EuroNet Worldwide, ticker symbol E-E-F-T, Mercado Libre, ticker symbol M-E-L-I, and Yondex, ticker symbol Y-N-D-X. Each of these is a substantial business. EuroNet Worldwide is all about online payments in Europe. Mercado Libre is all about e-commerce in Latin America, and Yondex is all about the search engine for the Russian language, even though it's not actually located itself, domiciled smartly enough outside of Russia. So each of those companies feels like a geography play potentially for another company. And I'm gonna leave it there this week. I hope you enjoyed hearing some about how to think about buyouts, how we react as fools, and then some categories of typical types of these takeout situations, including some examples. We'll see if I get it right with any of them looking back on this podcast some months ago. During our Risk Rating series, I featured two companies. One of them was Virgin America. We featured them for three weeks in a row within about a month or so that company had been bought out by Alaska Airlines. So sometimes what we talk about eerily happens in the world after not that I was predicting Virgin America, we get bought out, I was not. And I'm not predicting that these will, but I'm saying these are the kinds of situations that in my experience will get bought out to close. I'm sad when a great company is bought out. I no longer have a pure play on that stock anymore. I have to look at some other stuff, either side businesses or a whole nother management team and decide, do I wanna continue holding? In general, we as fools patiently tend to hold and convert our shares. If even you get shares, sometimes it's an all cash buyout and you'll not have any shares, you just get cash back. Typically, I'm sad when that happens, but there is the excitement the endorphins hit as you see your stock rise 23% pre-market. So however you play things and however you invest, I wish you the best of luck with any future takeouts. And when I say that, it means that I hope you don't get taken out because usually it's suboptimal for us as investors. Okay, next week I'm looking forward to Mailbag. It's the final Wednesday of the month. So help us out, give me a good question, give me a good thought on next week's Mailbag. In the meantime, full on. - As always, people on this program may have interest in the stocks they talk about and the Miley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. Learn more about Rule Breaker Investing at rbi.fool.com. (upbeat music) [BLANK_AUDIO]