Buyout Targets - 5 Small Cap Stocks That Are Merger Material

The merger business is booming in 2010, with stock buyouts heating up and the buyout rumors getting even hotter. Kraft (KFT) kicked off 2010 with a $19 billion buyout of Cadbury. More recently, United Airlines operatorUAL Corporation (UAUA) announced a plan to buy rival Continental Airlines (CAL) in a deal totaling more than $3 billion.

But as far as investment strategies go, banking on the buyout of a blue chip is not a real plan. If you’re looking to benefit from the merger and buyout trend in 2010, your best bet is to latch on to profitable small cap stocks that are going strong -- and making a good impression among bigger rivals with deep pockets.

Take Diedrich Coffee (DDRX) which gapped up 500% across April and May of 2009 thanks to a bidding war between Green Mountain Coffee Roasters (GMCR) and Peet’s Coffee & Tea (PEET). Those kind of homerun returns can happen overnight if you get into a great small cap stock before the buyout party begins.

To help you find opportunities like this, here are five stock merger and buyout targets for the second half of this year.

Merger or Buyout Target #1 - Cowen Group (COWN)

There is no question that the entire investment banking and asset management landscape has been altered by the implosion of Bear Stearns and Lehman Brothers, as well as the emasculating of banks such as Merrill Lynch which is now part of Bank of America (BAC). Of course, we have also lost banks like Wachovia that were morphing into Wall Street players. As a result of the extinction of these big players and as a result of many of the restrictions on the big banks that received TARP funds, boutique investment banks like Cowen Group, Inc.(COWN) have been able to make inroads -- gaining market share and picking up some of the best talent on the street.

This burgeoning investment bank (that sports a meager market cap of $352 million) has specialties in mergers and acquisitions and restructuring, as well as an asset management business focusing on “hedge fund of funds” is clearly going to be the target of the major investment banks as well as the “mega” asset mangers looking to grow assets in the lucrative hedge fund space. Cowen’s head is the famed and legendary dealmaker Peter Cohen. He certainly may not want to sell -- but, as the banks start circling offering premiums to this ridiculously undervalued entity (Cowen trades at less then .9x book), then the temptation may be too great. Obvious acquirers would be BlackRock, Inc. (BLK), Legg Mason Inc. (LM), which made a buyout of Permal in 2005, and Swiss-based UBS AG (UBS) who is looking to rebuild its client base and asset management business after a tough two years of scrutiny, global market turmoil and customer defections. Of course, there are also the global investment banks that are still in business such as Morgan Stanley (MS) and German-based Deutsche Bank AG (DB).

Merger or Buyout Target #2 - GeoEye (GEOY)

GeoEye Inc. (GEOY) has a market cap of $692 million, and is a great buyout or merger target. This provider of high-resolution and low-resolution satellite-generated earth imagery and image processing services is a takeover target by the big aerospace and defense companies looking to gain a foothold in this profitable and fast-growing market. GeoEye serves the defense and intelligence sectors, oil and gas industry, environmental and disaster assessment providers, as well as architects, engineers, miners and construction companies. GeoEye also provides services to on-line mapping customers.

The most obvious interested parties include companies such as: L-3 Communications Holdings Inc (LLL),Honeywell International Inc (HON), Raytheon (RTN) and even Lockheed Martin Corporation (LMT) orBoeing (BA). Of course, there’s also Google (GOOG) -- but Google may be gun-shy of the national defense and reconnaissance aspect of the services provided.

Merger or Buyout Target #3 - Williams Companies (WMB)

Williams Companies, Inc. (WMB) primarily finds, produces, gathers, processes and transports natural gas. The company’s operations are in the Pacific Northwest, Rocky Mountains, Gulf Coast, Eastern Seaboard and the province of Alberta in Canada.

As demand for natural gas grows and the use of LNG and CNG expands, Williams could easily be a target for a big-cap diversified oil player like Occidental Petroleum Corporation (OXY) with a market cap of $65 billion,ConocoPhillips (COP) with a market cap of $81 billion or Chevron Corp. (CVX) with a market cap of $154 billion. Of course, there are also the non-U.S. players that could also jump into the bidding war to gain access to this attractive major U.S.-based operation. This could be any company from to Total SA (TOT) to Royal Dutch Shell (RDS-A) or even Chinese giant PetroChina Co. Ltd. (PTR).

Merger or Buyout Target #4 - McGraw-Hill (MHP)

The McGraw-Hill Companies, Inc. (MHP) was a big name in the “hey days” of publishing, famous for the now Bloomberg-owned Business Week, its educational group and the Standard & Poors brand. In years past, MHP was often an acquisition target by the big international publishing houses looking to gain access to the U.S. market. Of course, all those offers were rebuffed as the leader of McGraw Hill wanted to remain independent and follow a strategy of organic growth.

Now that the patriarch has died, and his son, Harold “Terry” McGraw III, is truly in control, the best way to deal with lawsuits and SEC action against S&P’s rating agency and a fading print business is to sell out to a company such as the British-based Pearson plc (PSO) -- famous for its Penguin publishing brand, the Economistand the Financial Times -- and lead by my hero, the Texan-born, Marjorie Scardino. Of course, don’t be surprised if a private equity firm such as Apollo Investment Corporation (AINV) with a break-up plan or turn-around strategy comes in and buys the formerly great McGraw Hill -- hoping to return the company to its historical level of profitability and quality.

Merger or Buyout Target #5 - HearUSA (EAR)

As health care reforms take root, there will consolidation of many of the service providers that will no longer be able to survive as stand alone entities. HearUSA, Inc. (EAR) is a micro-cap that provides hearing care to patients primarily through 180 company-owned hearing care centers -- offering a range of hearing aids with an emphasis on the latest digital technology.

Ultimately, HearUSA will see a buyout from one of its partners such as the mega-giant Kaiser Permanente or to a diagnostic service provider looking to expand into hearing aid services. This would be a company such as an imaging service provider Alliance Healthcare Services, Inc. (AIQ) that eventually may look to expand beyond diagnostic imaging or the $2.9 billion market cap, Concord Medical Services Holding Ltd. (CCM) that may look to expand into the U.S. -- and that operates radiotherapy and diagnostic imaging centers in China.