Although trying to front-run Bill Ackman’s next investment is likely not the wisest strategy, Ackman’s criteria is enough to generate some interesting investment ideas.
Ackman’s hints
Ackman’s target sounds like a company Warren Buffett would covet.
According to a Bloomberg report, it’s a large American company with a simple and predictable business. It has high barriers to entry, is free cash flow generative, its customers have relatively high switching costs, and the stock trades at a discount to its competition.
Moreover, based on the fact that Ackman is looking to commit about $3 billion worth of capital, it can be inferred that the company has a market capitalization of no more than $60 billion.
FedEx Corporation (NYSE:FDX) trades at a discount to UPS
Shares of FedEx Corporation (NYSE:FDX) surged on Tuesday, as market participants speculated that FedEx Corporation (NYSE:FDX) could be Ackman’s target.
In many ways, the company fits the bill. Its market cap is about $32 billion — $3 billion would net Ackman a little less than 10% of the company, enough to stir things up. It’s profitable, and operates in an industry with high barriers to entry. At the same time, contractual agreements give its big business customers switching costs.
It trades at a discount to its chief rival, United Parcel Service, Inc. (NYSE:UPS), whose stock has outperformed FedEx significantly in recent years.
FedEx Corporation (NYSE:FDX)’s business is far from simple, although the corporation as a whole is dedicated to one-end: delivering packages.
JPMorgan downgraded the stock in June. Analysts at the bank noted that the company’s network is orientated towards speedy, costly delivery — the market is increasingly favoring the cheaper, slower option.
If Ackman does buy a stake, perhaps he could pressure management to be more aggressive in its efforts to transition the company.
ADT Corp (NYSE:ADT) is a simple company
Like FedEx, shares of ADT Corp (NYSE:ADT) also popped on Tuesday amid rumors Ackman could be interested in the home security firm.
ADT Corp (NYSE:ADT) fits many of Ackman’s stated criteria, although to a lesser extent than FedEx. ADT has no major publicly-traded competitors (it lists a variety of private competitors on its 10-K), so it’s hard to see how Ackman would conclude that it trades at a discount to its competition.
Nevertheless, ADT Corp (NYSE:ADT)’s business is fairly simple and straightforward. It’s a profitable company, and once its home security system is installed, it’s difficult for its subscribers to switch.
ADT Corp (NYSE:ADT)’s market cap is under $10 billion, so with a $3 billion investment, Ackman could have a lot of leeway in reshaping the company.
As for what an activist might want to do, it’s possible that ADT could be attractive to a larger company. Some of ADT Corp (NYSE:ADT)’s competitors, like Monitronics, are owned by larger companies, and having a home security division could be attractive to telecom providers.
Comcast Corporation (NASDAQ:CMCSA), the nation’s largest broadband Internet provider, has begun to offer a home security system of its home (Xfinity Home). Perhaps Comcast’s competitors could be interested in following suit.
Time Warner Cable as a takeover target
Shares of Time Warner Cable Inc (NYSE:TWC) have rallied in recent sessions on speculation that the company could merge with Charter Communications, Inc. (NASDAQ:CHTR). There’s no guarantee that any deal is forthcoming — and perhaps that’s where Ackman could come in.
Companies on the verge of a takeover have attracted activists in the past. Most recently, Michael Dell saw his going-private plans spoiled by Ackman’s rival Carl Icahn, who has been pushing for shareholders to get a better deal.
Time Warner Cable Inc (NYSE:TWC) is mostly involved in providing cable TV services to its millions of subscribers — a relatively simple, predictable business. It’s making money, and though its customers can switch, it is often a pain to do so.
With a $33 billion market cap, $3 billion could provide enough firepower for Ackman to shake things up. Its price-to-earnings ratio of 16 is less than Comcast’s 18 — although only slightly.
Front running Pershing Square
Whichever company Bill Ackman ultimately targets, it’s likely that its shares will rally — at least in the short-term. Still, trying to guess probably isn’t wise. Shares of ADT and FedEx Corporation (NYSE:FDX) should fall if it turns out that they aren’t Ackman’s target.
Still, Ackman has laid out interesting criteria for stock picking. Profitable, large American companies with simple businesses, switching costs and high barriers to entry often make good investments — activist involvement or not.
The article 3 Companies Bill Ackman Could Target originally appeared on Fool.com and is written by Salvatore “Sam” Mattera.
Joe Kurtz has no position in any stocks mentioned. The Motley Fool recommends FedEx. Salvatore “Sam” is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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