Sifting Through Small-Caps for Acquisition Targets

Bank of America Merrill Lynch thinks deal activity in 2012 will surpass 2011, which saw 99 deals in the small-cap space for a total of $84 billion, along with 35 mid-cap ($2 billion to $10 billion) deals, and that the pace of M&A could rival pre-financial crisis levels circa 2006-2007. In 2006, the firm said, there were 129 deals for small caps and 42 for mid caps.

According to Bank of America Merrill Lynch, tech and healthcare are likely to see the most buying interest, as they did in 2011 when nearly half of the deals were done in these two sectors.

To try to ascertain which specific Russell 2000 components could end up in play, Bank of America Merrill Lynch looked at valuation metrics for the companies that were bought in 2011 and ran a screen to see which names currently fit the bill.

The parameters used were market cap above $200 million, trailing five-year sales growth of more than 5%, net cash as a percent of market cap over 10%, a free cash flow yield of 8% and a long term debt to capital ratio below 30%. The stock also needed to be buy rated by the firm if it was under coverage.

The screen yielded 23 names, 10 from tech and 6 from healthcare. The firm notes that: "Our analysis should not be construed as any indication that any company on the list will be an actual candidate for a merger or acquisition."

Here's the list in full, broken down by sector: Caribou Coffee(CBOU) and Systemax(SYX), consumer discretionary; Cal-Maine Foods(CALM), Medifast(MED), Village Super Market(VLGEA), consumer staples; ArthoCare(ARTC), Depomed(DEPO), National Healthcare(NHC), RTI Biologics(RTIX), ViroPharma(VPHM), Wellcare Health Plans(WCG), health care; Argan(AGX) and Cubic Corp.(CUB), industrials; Entropic Communications(ENTR), j2 Global(JCOM); LTX-Credence(LTXC), Nanometrics(NANO), OmniVision Technologies(OVTI), Progress Software(PRGS), Quest Software(QSFT), Rambus(RMBS), Synaptics(SYNA), and Xyratex(XRTX), technology.

Of the group, the three largest market caps belong to Wellcare Health, $2.5 billion; ViroPharma, $2.1 billion; and Quest Software, $1.7 billion. The five companies with largest percentage of net cash to market cap, according to the firm's research, are Wellcare, 69.5%; Argan, 67.5%; OmniVision, 52.1%;; LTX-Credence, 44.1%; and Depomed, 31.9%, The names with the highest sales growth over the past 5 years are Entropic, 95.4%; Depomed, 73%; Argan, 45%; and Medifast, 40.7%.

--Written by Michael Baron in New York.

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