Two good candidates
Dell’s motives for going private were understandable. While the company struggled amidst the stagnating PC market, it was still a solid generator of free cash flow with approximately $11 billion in cash on the balance sheet. It appears that companies in private equity deals have some common characteristics: namely, the companies tend to be strong cash flow generators with well-known brands that are in the stages of a turnaround.
One candidate that fits this description is Pitney Bowes Inc. (NYSE:PBI). The company that provides postage meters and mail services has had a rough ride over the last few years. Pitney Bowes began falling from $40 before the Great Recession, and unfortunately for investors, hasn’t stopped falling. The stock now trades in the low teens, despite the fact that the company is a Dividend Aristocrat, having increased its dividend for 30 years in a row.
In addition, the company generates strong free cash flows from operations, and trades for only 5 times its enterprise value to earnings before interest, taxes, depreciation, and amortization (EBITDA). The company reported full-year adjusted earnings per share of $2.18, meaning the company trades for a trailing price-to-earnings ratio of just 6 times. The stock now yields over 10% at recent prices. Clearly, the company isn’t getting much credit from the public markets for what it does well: big free cash flow generation and a high dividend.
Another candidate might be Best Buy Co., Inc. (NYSE:BBY). Rumors of the “show-rooming” effect, whereby consumers go to Best Buy’s stores to look at items only to leave and purchase them more cheaply online, as well as declining sales, have caused a dramatic decline to this company’s stock price. Trading well over $40 as recently as early 2011, the stock now trades in the teens, at a valuation of 2 times EBITDA.
Best Buy going private seemed very likely in recent weeks, on news that its founder and CEO Richard Schulze wanted to go in that direction. However, it’s now far from a foregone conclusion, with recent news that the company rejected the CEO’s initial offer and that Schulze is experiencing trouble getting banks to line up the necessary financing. In a Feb. 13 Wall Street Journal article, it’s being reported that now Schulze might instead try to align a group of investors to make a minority investment in the company.
It’s clear that Best Buy can’t continue under the current business model of operating gigantic stores with items more expensively priced than discount retailers and online competitors. The company is a solid cash flow generator and has a valuable brand name. It might do the company (and its shareholders) well by going private and allowing management to being taking the necessary steps to turn the business around.
The bottom line
Unfortunately for long-term investors, Wall Street is notoriously fickle and short-sighted. Stocks are frequently held hostage to their quarterly results. There’s very little forgiveness awarded to a company in the midst of a turnaround. All that matters to the analyst community is whether the company hits its quarterly revenue and earnings targets. Miss by a penny or two, and a company’s shares can crater in the public markets. Even if the reasons for such a miss are due to a company’s management making necessary decisions to save its future, turnaround stocks frequently suffer low valuations.
Like Dell, Pitney Bowes and Best Buy have well-known brand names with solid free cash flow generation. Both Pitney Bowes and Best Buy offer shareholders big dividend yields, but both stocks are being punished with very low multiples of EBITDA. It makes a lot of sense for these two companies to go private, thereby affording them the ability to turn themselves around without constantly being held under the harsh spotlight of Wall Street analyst expectations.
The article Could These Two Companies Follow Dell’s Lead? originally appeared on Fool.com and is written by Robert Ciura.
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