Art of the Potential Deal

In fishing for investments, Charles M. LaLoggia tries to think like a shark.

As editor of the newsletter Special Situation Report, he attempts to identify companies that will be taken over. If he spots these targets early enough, big profits can result.

Over the last 18 months, as the takeover business has boomed, La-Loggia has correctly picked 17 targets--often smaller, little-followed firms.

LaLoggia, 46, started his newsletter in December 1974, barely a year after he graduated from Syracuse University with a triple major in accounting, finance and economics. In between, he spent a year at Merrill Lynch as an aide to the brokerage’s top market strategist--his only Wall Street experience.

He researches and writes the letter from his native Rochester, N.Y. He was interviewed by Times staff writer Thomas S. Mulligan.

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Times: Why do you focus on takeovers?

LaLoggia: With takeover targets, the stocks are often selling below their intrinsic value as a business, so you can make money in any kind of market, especially in a bad market.

If you look at the fundamentals, many of these companies appear uninspiring. Many operate in industries where there’s very little research coverage. Many have flat or erratic earnings. Some are losing money. But these are precisely the places where takeovers tend to occur, because a profitable company whose stock is selling at a high price-to-earnings multiple can make a bid for an underachiever in the same industry. And they’re neglected by mainstream Wall Street research.

Times: Why is that?

LaLoggia: Mainstream Wall Street firms are playing to an institutional audience--pension funds, mutual funds and so on. Many of these firms won’t even recommend a stock with a market capitalization of less than $1 billion. And if you get down to $300 million or lower, there’s no interest because their institutional clients can’t get in and out without affecting the stock. Therefore, what’s the profit in following them?

So as the market gets more institutionalized, more and more stocks are falling by the wayside.

Times: People used to delight in telling stories about their small-company stocks because they felt that they were making a discovery that required a little detective work. Is that a thing of the past?

LaLoggia: People don’t seem to tell stories about stocks anymore. They tell stories about mutual funds. They seem to have forgotten that you can buy individual stocks. It’s almost become a lost art.

I’ve been publishing this newsletter for 23 years, and as time goes on, it’s becoming easier for me to pick takeover targets. It should be becoming more difficult. I think the reason is that fewer and fewer people are thinking about individual stocks, and the mainstream Wall Street research is thinking about micro-cap and small-cap stocks even less.

I’ll give you an example. In March of 1996, a company called Laidlaw in Canada owned 24% of ADT, the security-alarm monitoring company. And Western Resources, a utility company, bought half of that stake, 12%, with an option to buy the other 12%. At that time ADT was selling at $15.

It seemed obvious that Western Resources was eventually going to make a bid for ADT. They already had a security-alarm monitoring business, the utility industry had just been deregulated and they were looking for new growth areas. And yet when Western Resources bought this stock, ADT barely budged on the news.

In July 1996, ADT got a takeover bid from Republic Industries, one from Western Resources and one from Tyco International, which eventually acquired them in April 1997. Within one year, ADT had doubled in price and got three takeover bids. And yet you could’ve bought ADT all day long at $14 or $15, for weeks, months.

Here’s an example of something going on right now. I recommended American Classic Voyages last May at $11, because Chicago real estate investor Sam Zell and his group have been buying that stock consistently on the open market. They own about 53% now. There’s also been a trend toward consolidation in the cruise ship industry. I recommended it at $11, and you could’ve bought it at under $10 for weeks after that. All of a sudden the stock is $19.75.

Times: So an informed buyer is one of the signals you watch for. What are some other signals?

LaLoggia: One is looking for cash-rich or debt-free companies in industries where there’s already a trend toward takeovers. Another is looking where there were multiple bidders for a previous [target]. You can only have one winner, and the bidding companies left at the altar are probably going to look around for something similar.

Times: Do you always take a personal stake in the picks you cite in the newsletter?

LaLoggia: Sometimes yes, sometimes no. I have no policy on that, except that I’d never do it before it appeared in the newsletter.

Times: Are you a top-down picker? Do you try to spot a hot industry first and then target a particular company?

LaLoggia: Yes. You’ve got to know which industries are having takeovers, and start from there. For current examples, I’d use the security-alarm monitoring industry. That bid for ADT was just the first. Also, companies that supply and support the aerospace industry; hotel-casinos; long-distance telephone companies, and--believe it or not--grocery store chains.

One company on our list is Great Atlantic & Pacific Tea Co. It is partly owned by a German supermarket company, Tengelmann, which just a month ago bought more shares on the open market.

Similarly, Smart & Final [a California retailer] is 61% owned by Groupe Casino, the largest supermarket company in France.

Times: Obviously, not every takeover pick pans out. Where have you guessed wrong?

LaLoggia: Generally, where I go wrong is where I try to be an economist or an interest-rate analyst, an industry analyst. I try not to do that anymore. I try to follow [investors] who should know a lot more than I do.

One example is in the gold mining industry. I thought gold prices would go up and that all gold mining companies would follow the price of gold. I also thought there would be takeovers as the reserves of these smaller companies became more valuable. I was making a macroeconomic judgment, but I was wrong on gold prices.

Times: Have you ever been burned by a “takeunder,” where a bid for a company comes in, but right at the market price or under it instead of at a premium?

LaLoggia: I’ve had a couple of those recently. RoTech Medical was an example. Although I recommended the stock at $9, the takeover bid was worth around $19 or $20, which is just about what the stock was trading at when the bid took place.

I just had another one where that happened: Riviera Hotels. I recommended it at $14. You could have bought it as low as $12 if you were nimble. They got a bid at $15, so it was hardly worth the effort. The reasoning was correct, but there wasn’t much money in it.

Times: Are the deals you predict being paid in stock more often than cash these days?

LaLoggia: An increasing number are being paid in stock because if you are the proud chairman of a company that is in vogue and has a [stock] price-to-earnings ratio of 35 or 40, you can turn around and buy a smaller company that has stagnant earnings.

For example, say you’re a CVS or a Rite Aid, your stock is at 35 times earnings, and you see a Longs Drug Stores. It sells at an uninspiring multiple of 18 times earnings, which is about half the multiple of the big growth drug-store companies. Longs is debt-free, earnings are stagnant, they’re in this industry where there is increased competition from the big chains--that to me adds up to a takeover candidate.

Times: Name a few other industries or companies you like.

LaLoggia: In the security alarm business, Alarmguard Holdings. There are multiple bidders for these security-alarm companies.

In the defense area, United Industrial is on my list. It’s essentially debt-free, similar to Logicon, which was one of my successful takeovers.

I also like Renal Treatment Centers in the kidney dialysis industry, where there have been multiple bidders for previous targets.

For more information on LaLoggia’s newsletter, phone (800) 836-4330.

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On the Block?

Here are some of the companies that takeover-stock specialist Charles M. LaLoggia believes may eventually be snapped up by other companies as the global takeover wave continues.

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Company Mon. (Ticker symbol) close LaLoggia’s comments Alarmguard $8.63 Alarm company is takeover candidate (AGD) in view of recent takeover bids for ADT and Protection One. American Classic Voyages (AMCV) 18.44 Takeover legend Sam Zell is chairman, and a company of his has been buying shares and now owns 53%. City National Bank 30.88 So. California bank is a potential (CYN) target as industry takeover wave con- tinues; company is buying back stock. Frontier 23.31 Fifth-largest long-distance company (FRO) is a takeover candidate as this industry consolidates rapidly. Great Atlantic & Pacific (GAP) 32.00 Supermarket chain is 54.5%-owned by Germany’s Tengelmann Group, which bought 50,000 more shares in August. Healthy Planet Products 3.56 Small greeting-card company has (HPP) created niche by marketing “cause” -related cards and stationery for Sierra Club, others; company has no debt Longs Drug Stores 26.88 West Coast drug storechain is one of (LDG) the smallest public drug store companies and a logical takeover candidate in rapidly consolidating industry. United Industrial 11.00 Highly liquid, virtually debt-free (UIC) company provides military training and simulation systems; big defense companies have been on buying binge.

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Source: Special Situation Report