Back on June 18, I published an extensive and exclusive issue for Wide Moat Confidential, Wide Moat Research’s small-cap service. The article was titled “50%-Plus Annualized Potential With My Neighborhood Diner.”
In it, I recommended Denny’s (DENN). I’m sure that was probably surprising to subscribers. Denny’s, after all, is a humble diner chain. It certainly didn’t seem like the type of company that could produce exciting returns.
But I also saw something else. Denny’s was dirt cheap. And, despite its recent troubles in the wake of the COVID-19 era, it still had several assets the market was underappreciating.
It seemed likely that somebody would step up to buy it. As I told readers in our June issue:
I could see a firm like Roark Capital acquiring the whole company, splitting Denny’s and Keke’s into separate entities again. Denny’s could be consolidated into Roark’s Inspire Brands holding company, while Keke’s, staying independent, could be grown further before being taken public as a faster-growing, and thus more richly-priced, restaurant company.
The eventual buyer wasn’t Roark. But, sure enough, Denny’s agreed on Monday evening to be taken private by a group of investment firms. The deal values the company at $620 million, which seems like a very fair price for the buyer.
Denny’s board of directors didn’t object either. It unanimously approved the offer, which involves stockholders receiving $6.25 in cash for each common share they own. Yesterday, we officially closed the Denny’s trade in the Wide Moat Confidential portfolio for a 45% return in four and a half months.
The potential for an acquisition wasn’t the only reason I recommended DENN back in June. In fact, I never recommend buying any company based on its likelihood of being a takeover target. If it happens, great. But that alone shouldn’t be a reason to buy a stock.
With that said…
There are a few things investors can do to put themselves in a position to get lucky. Companies that are acquisition targets have, in my experience, a few things in common.
In honor of this latest success with DENN, let’s cover what big businesses look for when hunting for acquisitions.
M&A Is Back
I covered the mergers and acquisitions (M&A) scene not too long ago. On August 27, I wrote about how “Big bad Blackstone” (BX) was “on the move.”
Blackstone, the world’s largest alternative asset manager, is well known for buying up companies that can grow its already enormous profit base. On August 26, for instance, it made inroads in its quest to buy up energy holding company TXNM Energy.
The week before that, it agreed to acquire Shermco, which sells full life-cycle electric equipment services. And not even a month before that, it made definitive moves to purchase data analytics platform Enverus.
As I also mentioned:
I’ve been covering Blackstone for over a decade now. Since my first recommendation, shares have returned over 808% versus 239% for the S&P 500.
But my readers haven’t just benefited from big, bad Blackstone itself. In recognizing its real estate focus and attraction to acquiring smaller real estate investment trusts, or REITs…
I’ve also been able to point out likely takeover targets before they were announced.
This has included industrial REITs like PS Business and campus housing landlords like American Campus Communities.
That list also includes:
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Shopping center owners like Retail Opportunity Investment and Excel Trust.
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Multifamily operators like Preferred Apartment Communities, AIR Communities, and Bluerock Residential.
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And lodging REITs like LaSalle Hotel Properties and Condor Hospitality, not to mention data-center REIT QTS Realty and life-science REIT BioMed.
Nor has it only been Blackstone acquisitions that I’ve successfully called. I also pointed out Retail Opportunity Investment, Urstadt Biddle, and Spirit Realty as buyable entities… before they were indeed bought out.
It’s just that Blackstone is constantly on the prowl with enormous amounts of cash at its disposal. So, it’s better positioned to pounce at will, unlike smaller entities that have to exert more caution.
Really, figuring out which companies are willing and able to acquire entire businesses isn’t that difficult. Just look for firms with a history of buyouts and a whole lot of cash.
The real trick is to identify their likely targets. It takes time and practice, but once you know what you’re looking for… you’ll see it everywhere.
The Buyable Business
At Wide Moat Research, we prioritize quality. We want to own businesses that:
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Have competent management
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Sturdy, competitive advantages (wide moats)
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Steady, reliable earnings that result in steady, reliable payments to investors
Then, we consider valuation. We’re happy to buy fairly valued businesses. We’re ecstatic when we get the chance to buy them at irrationally low levels.
At a very high level, that’s more or less the same formula an acquiring company will look for in a target. But a large private equity firm – or any acquirer, for that matter – has an advantage over the individual investor. Once they acquire a business, they can make changes to how it’s run. After all, they own it. By comparison, the individual investor can only hope management will do the right thing.
That’s why, in addition to the qualities listed above, many takeover targets have another feature – the business can be significantly improved with a few changes.
In the case of Denny’s, the company had fallen low in the wake of COVID-19 and the changing preferences from consumers. But the ship could still be righted. And Denny’s had several levers it could pull to reignite growth.
The company owns a faster-growing restaurant chain called Keke’s. With the requisite investments, Keke’s could very well grow into a national brand and perhaps a standalone, public company.
Denny’s also still holds the corporate headquarters – a relic from a time when the company was part of a large conglomerate – on its balance sheet. That building can and should be sold. The capital from that sale can then be reinvested in the business where it will produce a higher rate of return.
Those are some of the things Denny’s should do to rekindle growth. And I’m sure the new owners see that as well. And since they’ll soon own the business, I wouldn’t be surprised if they moved in that direction in the coming quarters.
Finding takeover targets – the kind of stocks that get bought out with a significant premium – isn’t always easy. But it’s also not rocket science. There are plenty of once-great businesses that, with a change of direction, could be great again.
If I can see them, so can you. And so can large buyers with cash on hand to do something about it.
Regards,
Brad Thomas
Editor, Wide Moat Daily
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