Looking for the next tech takeover targets
From the chip sector to software, analysts say there are plenty of buyout opportunities in tech for private equity firms.
NEW YORK (CNNMoney.com) -- Cash-rich private equity firms are knocking on Silicon Valley's door, and there's plenty of bait to keep the deals coming, analysts say.
Two separate investor groups - with some of the biggest names in private equity represented on each side - are reportedly bidding to take semiconductor firm Freescale (Charts) private in a $16 billion leveraged buyout that would be the largest ever in the technology sector.
And buyouts can be incredibly lucrative for shareholders. Freescale's stock soared 20 percent Monday on news of the potential buyout. In the $21 billion blockbuster deal of the year, hospital chain HCA agreed to be purchased at a nearly 17 percent premium to its share price before talk of the deal first surfaced.
Loaded with cash, buyout firms have been on a rampage, sealing megasized deals at a rapid pace. Eight of the 10 biggest U.S. private equity deals have been proposed since 2005.
While there have been huge deals in health care, energy and retail, tech hasn't been targeted as much, according to Richard Peterson, a senior researcher at Thomson Financial.
The sector is "ripe with opportunity" for leveraged buyouts, or LBOs, Peterson said. The big draw: Many tech companies have positive cash flow and strong balance sheets - which make it easier for private equity firms to pay off the gobs of debt they take on to finance these sorts of deals.
A favorable lending environment also makes it possible for buyout firms to borrow more money and take on larger deals, according to Bob Filek, a partner in the Transaction Services group of PricewaterhouseCoopers.
He expects LBO activity to increase in the tech sector in the next six to nine months and for the deals to get bigger as buyout firms team up to go after targets.
The offer for Freescale, a former unit of Motorola, could also change the way the game is played.
Buying Freescale would be a clear signal that the appetite for risk is rising, according to Scott Kessler, who heads up the information technology research group at Standard & Poor's Equity Research.
"You're talking about a large company in what some would argue is the most cyclical of the tech sub-industries," he said.
Who's up for grabs?
But buyout targets extend beyond chips. Filek thinks mature firms in the hardware and software sector could be especially attractive since they have healthy user bases and generate strong cash flow.
While it made sense for tech firms to load up their balance sheets with cash when they were expanding furiously, the pace of growth is slowing now, said Toan Tran, an equity strategist at Morningstar.
He thinks security software company Symantec (Charts), which generates well in excess of $1 billion in free cash flow every year, could be a potential target. Other companies, such as data storage firm EMC (Charts) and video editing software maker Avid Technology (Charts), also could be appealing, based on their low debt-to-equity ratios and healthy balance sheets.
If companies want to avoid being targeted by buyout firms, they'll have to reengineer their capital structures, analysts said. They can do that by taking on more debt, buying back shares or paying out a dividend.
So the growing interest of private equity investors could spur tech companies to create more value for shareholders, Tran said. Adding debt would obviously not be a shareholder-friendly move, but buying back stock or paying a dividend would be.
"What firms in mature industries should do is give back cash to shareholders. Companies have an imperative to go out and do something with their money," Tran said.