Megacap catalysts

01Jun06

In previous posts we have noted the case that megacaps were undervalued relative to their small cap cousins. The problem was that this had been the case for quite some time and there had been little reason to believe a catalyst was in sight that would change the situation. That might be changing.

With seemingly endless piles of cash finding their way into private equity firms of all stripes it seems the age of the megacap management buyout is upon us. Gregory Zuckerman in the Wall Street Journal summarizes the situation succinctly.

In recent weeks, a number of large corporations have received takeover offers from their own top officers. With private-equity firms sitting on huge sums of money and eager to join in such transactions — and with the balance sheets of many companies strong enough to support the additional debt that usually comes with these deals — investment bankers predict more management-led buyouts.

The article goes on to identify a number of companies with lagging stock prices and ample debt capacity that could be suitable buyout candidates. The increased demands on management stemming from Sarbanes-Oxley is also adding to the attraction of a management led buyout. In addition, some companies may take steps short of a full-scale buyout, i.e. the Tribune (TRB) dutch auction style stock buyback.

The bottom line is whether a wave of buyouts will be enough to expand the relative valuations of the large cap sector. The recent market swoon exhibited large cap outperformance. In another sense it is a race against time. Since most buyouts would require significant debt financing they are in part dependent on the solicitude of the high yield market.

Successful investing requires many traits, one of which is patience. For those who have been waiting for a large cap catalyst it may very well be here. If unimaginably large management buyouts continue apace, the valuation disparity for this sector may be coming to a end.

DealBook also weighs in the WSJ article.

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