Buy Dress Barn to Profit From Small-Cap M&A Revival

Dress Barn Inc., the women’s clothing seller, is among 30 potential takeover targets in the Russell 2000 Index whose returns may beat the gauge of smaller companies, according to Credit Suisse Group AG.

The investment strategy has climbed an average of 4.4 percent quarterly since 1990, beating the 2.9 percent gain in the Russell 2000, and is likely to outperform the U.S. small-cap stock index by a larger amount when mergers are increasing, Credit Suisse analyst Pankaj N. Patel wrote in an Aug. 6 note.

“We anticipate that if the baseline scenario for the economic recovery plays out, large corporations will be looking to deploy their cash to buy out small to mid-size companies,” wrote Patel, who is based in New York. “We select the Russell 2000 (excluding financials) as our universe as it makes for a very logical space in which acquirers seek potential targets.”

Companies, excluding financial firms, in the Standard & Poor’s 500 Index had a record $836.8 billion in cash and short-term securities in the first quarter of 2010, according to S&P analyst Howard Silverblatt. That’s equivalent to corporations in the benchmark index for U.S. stocks holding 10 percent of their market value in cash, according to S&P data going back to 1980.

“High cash levels are great for liquidity but it’s a poor vehicle for future returns especially in a low interest rate environment and a rebounding economy,” Patel wrote. “We’re primed for a recovery in the M&A activity in the small- and mid-cap space. The major risk to this scenario is a sharp decline in global economic activity.”

Cash Flow

The Zurich-based bank used predictable cash flow, low takeover value, low cost of financing available, secure market position, potential for cost reductions and a possible exit strategy for the acquirer as criteria to identify the most attractive targets among publicly traded small-cap companies.

The list of stocks in Credit Suisse’s recommended buyout portfolio include Revlon Inc., the cosmetics maker controlled by financier Ronald Perelman; Triumph Group Inc., which builds and repairs aircraft companies; LIN TV Corp., the owner and operator of 27 local television stations in the U.S., and The Children’s Place Retail Stores Inc., the youth apparel chain.

Corporate executives have regained enough confidence to pave the way for a rebound in M&A, Andrew Garthwaite, a global equity strategist at Credit Suisse, wrote in a separate report last week. Data such as the Conference Board’s index of business sentiment, which has rallied from a record low within the past 24 months, are “good lead indicators of corporate spending,” he wrote, adding that they tend to start rising about two years before dealmaking accelerates.

No Chance

Credit Suisse economists earlier said there is no chance the U.S. economy will fall into its second recession in three years. The S&P 500 has gained 4.6 percent since July 12, when Alcoa Inc., the largest U.S. aluminum producer, reported profit that surpassed analyst projections. The Russell 2000 has risen 6.1 percent.

The stock indexes fell on Aug. 6 after weaker-than-forecast growth in U.S. company payrolls cast doubt on the strength on the economic recovery. They rallied today amid speculation slower jobs growth will prompt the Federal Reserve to say it’s prepared to combat further weakening of U.S. growth.

“A small company in a highly concentrated industry is an ideal takeover candidate for an acquirer as it exhibits solid performance in an industry with a high barrier to entry,” Patel wrote.

     Credit Suisse said the following Russell 2000 stocks are
takeover candidates:

The Dress Barn Inc. (DBRN US)
Buckle Inc. (BKE US)
The Children’s Place Retail Stores Inc. (PLCE US)
Wet Seal Inc. (WTSLA US)
Lin TV Corp. (TVL US)
Ruddick Corp. (RDK US)
PriceSmart Inc. (PSMT US)
Revlon Inc. (REV US)
Village Super Market Inc. (VLGEA US)
REX American Resources Corp. (REX US)
Chemed Corp. (CHE US)
Odyssey HealthCare Inc. (ODSY US)
Amedisys Inc. (AMED US)
LHC Group Inc. (LHCG US)
PharMerica Corp. (PMC US)
Almost Family Inc. (AFAM US)
A.O. Smith Corp. (AOS US)
American Superconductor Corp. (AMSC US)
Triumph Group Inc. (TGI US)
AAR Corp. (AIR US)
M&F Worldwide Corp. (MFW US)
Aerovironment Inc. (AVAV US)
Dolan Co. (DM US)
Cymer Inc. (CYMI US)
Hecla Mining Co. (HL US)
Arch Chemicals Inc. (ARJ US)
Capital Gold Corp. (CGC US)
KMG Chemicals Inc. (KMGB US)
General Communication Inc. (GNCMA US)
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