The Flip Side of a Frightening Market

 | Aug 06, 2013 | 2:00 PM EDT  | Comments
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One of the reasons for my recently expressed caution on the stock market is that private-equity firms are lining up to sell companies in initial public offerings. Tony Black of Apollo Global Management (APO) recently said that this is a perfect environment for selling and that his firm is selling everything in the portfolio that isn't nailed down. Blackstone (BX) has been selling some companies and recently did an IPO of its SeaWorld (SEAS) holdings.

The stock market has been climbing steadily, and many assets values are inflated, so it makes sense to sell the stuff they bought a few years ago at much lower prices. It is a valid reason for concern about stock prices.

However, even as I express my caution, I think of the famous maxim form Carl Jacobi that is frequently repeated by Charlie Munger: "Invert, always invert." Although private equity is indeed selling a lot of assets, it makes a certain amount of sense to me to dig around and see if any attractive assets are trading at prices that might attract some of the cash that these firms are raising.

I have been around a few private-equity types occasionally, and they tell me that they favor companies that can be bought at low enterprise-value-to-EBITDA ratios and which are not already too leveraged. They also want to buy things that are at or near their bottom in the economic cycle or that could benefit from substantial operational improvements.

It is pretty easy to screen for the basic criteria, and one stock that pops right out and catches my attention is Couer Mining (CDE). While it is unlikely that a private-equity firm will buy the silver miner, the valuation level is right, and the mining business certainly appears to be near a bottom. Estimates of future earnings and cash flows are all over the board for this company, but right now the stock trades with an EV/EBITDA ratio of just 3.85.

As a bonus for an asset-sensitive type such as myself, the stock trades at just 60% of tangible book value. The company has more cash than debt, so the balance sheet is in decent shape as well. If I were running a private-equity fund and had a five-to-seven-year time horizon, I would be tempted to jump into the mining business at this level. Another current holding, Pan American Silver (PAAS), also makes the grade with an EV/EBITDA ratio of 4.1.

Tropicana Entertainment (TPCA) is already controlled by Carl Icahn, and there is very little chance of him selling except at a premium price, but the numbers are right. The company owns a collection of casinos in Atlantic City, Nevada, Mississippi, Indiana and Aruba. The company is relatively unlevered for a casino, and current assets exceed total liabilities, so the balance sheet is solid, and there is room for flexibility in the future if needed. The EV/EBITDA ratio is 3.93, and the stock trades at just 80% of tangible book value, so it is pretty cheap. The safe bet here is that at some point in the next decade, Icahn will sell this company for a whole lot more than it is currently worth in the stock market.

I am surprised that more private-equity and buyout shops are not running amok in the energy sector right now. The screen of stocks trading at attractive EV/EBITDA ratios and decent balance sheets is chock full of energy-related companies. Companies such as HollyFrontier (HFC), CVR Refining (CVRR). Marathon Oil (MRO) and Hess (HES) trade at levels that will eventually interest financial as well as strategic buyers.

Swift Energy (SFY) not only trades at half of book value, the current EV/EBITDA ratio is just 4.2. I have expected a mergers-and-acquisitions wave and buyout boom for some time now in the oil and gas space. It has not happened yet, but I believe it will before too much longer. The assets and cash flows are just too cheap right now.

I am still as cautious as I ever was, but inverting my thought process allows me to focus on what is cheap and may be attractive to outside buyers. Thinking like a private-equity manager forces you to consider not what the stock market might do in the next few days or weeks but what a particular company might be worth in five to seven years. That's usually a much more productive exercise.

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