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5 Ways Investors Benefit From More Buyouts

Private buyouts trend bodes well for your portfolio.

By Jeff Reeves of InvestorPlace



) -- On Columbus Day, Bain Capital offered to pay a 50% premium on

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shares to take the children's retailer private for a total of $1.8 billion. This comes a little more than a month after

Burger King



high-profile buyout by investment firm 3G Capital for $3.3 billion.

Bain Capital, which reportedly outbid Apollo Management, KKR and Irving Place Capital for Gymboree, has a strong track record of sprucing up retail chains. Past retail investments include

Toys 'R' Us

, which is making waves right now with its innovative "pop up" retail shops around the holidays and plans for an IPO in the near future. Other properties Bain has turned around include the craft haven

Michaels Stores

, music shop

Guitar Center

and clothing retailer

Burlington Coat Factory

-- all of which were bought in 2006 and 2007.

2010 has brought a lot of focus on the merger and buyout scene -- both in the private and public arenas. But behind those big numbers, it's important for individual investors to understand what the buyouts mean for them.

Here are five reasons why buyouts -- specifically, private equity acquisitions that take a public company off the market -- are good for your portfolio.

1. PE Buyouts Show Credit Markets Have a Pulse

Whether buying fast-food also-ran Burger King or the embattled specialty retailer like Gymboree seems wise to you is unimportant. After all, as an individual investor you can't share in a private company's success or failure anyway. Rather, investors should focus on the fact that these deals are happening at all. The fact that private investors can scrape together a few billion for such buyouts proves that credit markets are functioning once more.

According to a

recent Bloomberg report

, the value of private equity takeovers -- typically executed by borrowing upwards of two-thirds of the total price tag -- more than tripled in the third quarter to $59 billion from 2009¿s third quarter. Granted, low rates mean that these leveraged buyouts are not quite as leveraged as they used to be, but the rapid increase shows we've come a long way from the "credit freeze" fears of 2008 and early 2009. What's more,


reports a record $195 billion of high-yield bonds sold this year in the U.S. through the third quarter -- surpassing the all-time annual tally with three full months to go in the fiscal year.

2. Buyouts Mean Big Business

It's worth pointing out that the increase in buyouts doesn't just mean increased business for the credit markets. It means a bustle of related economic activity. When a private equity firm takes over a large operation like Burger King or Gymboree, it doesn't just post flyers with a new mission statement and hope for the best. It writes checks to investment banks and lawyers to oversee negotiations, hire consultants to reorganize workflow, and pay marketers to rebrand products and stores.

Need some hard numbers? According to

estimates from Thomson Reuters and Freeman Consulting

, global investment banking fees year-to-date reached $56.1 billion, with M&A fees accounting for 36% of that pool in the third quarter. And for the first nine months of 2010, fees related to buyouts increased 40% over the first nine months of 2009. That's not chump change.

3. Buyouts Mean Big Paydays for Shareholders

In case you needed a dramatic example of the power of a buyout, just look at the Gymboree buyout, which commanded a 57.4% premium over its "unaffected" share price on Sept. 30 before rumors of a buyout were circulated and a healthy 23.5% premium over the previous trading day's close. This came after Gymboree lowered its guidance and saw same-store sales slide in its mid-August earnings report amid a bleak retail environment. A buyout was literally the only way GYMB shareholders would see returns like that within the next few years -- and they tallied those gains in just a 10-day stretch.

4. Buyouts Reflect Market Realities

When stocks took off from the March 2009 lows through Christmas 2009, a lot of junk stocks rose on a wave of bargain buying. The market has struggled to find its way in 2010 as good stocks have held on to their gains and the bad stocks have fallen back to earth. Just take a look at the Dow: Components


(CAT) - Get Report



(DD) - Get Report

are up around 40% year-to-date, but the index is flat in 2010 thanks to losses of about 20% in


(MSFT) - Get Report



(HPQ) - Get Report



(AA) - Get Report

.What does this have to do with private equity buyouts, you ask? Simply this: If investors approached a corporation in March 2009 with a buyout offer that was a 50% premium over current share prices, no shareholder or executive in his right mind would be friendly to such an offer. After all, a 50% drop from March 2008 to March 2009 was par for the course for even the best stock, and there was reason to expect a rebound. Now, the cold reality of a post-recession Wall Street has set in.

That means individual investors can largely judge a stock on the merit of its own financial performance or growth prospects; no more excuses about the financial crisis, and no more softball year-over-year comparisons. The good companies will succeed as they attract buyers and the bad stocks will continue to suffer -- or like Burger King and Gymboree, attract private buyers who are convinced they make a tidy sum cutting costs and restructuring the companies.

5. Buyouts Are a Bullish Sign

Say what you want about specific deals and their specific price tags, but you have to admit that any buyout by a private equity firm is done with the anticipation of bigger profits down the road, whether that is two years or ten years into the future.

Buyouts make sense right now, for several reasons. Interest rates are low so financing is cheap, values are still fairly low so there are bargains to be had, cash is nearly worthless and better used spent than sitting in the bank, and so on. But the bottom line is that no private equity firm would ever put good money into a company without the expectation of making a profit on the investment.

Unlike public M&A deals, which often involve buyouts to replace organic growth or strategic mergers to join operations, private buyouts rarely involve rolling two complementary companies together to improve scale and cut costs. The biggest reason PE firms choose to take public companies off the market is because they believe there is untapped shareholder value to be achieved. That value frequently comes from new ownership, new management and new capital structures as well as a fresh strategic focus. And since changes rarely incite immediate success and always incite immediate uncertainty, such maneuvers can only be achieved off Wall Street and away from the pressure of quarterly earnings.

In a nutshell, the PE firm thinks the company it is buying is a good outfit that just needs to be run better. That means these investors expect growth to come from within by working smarter, not from slashing costs or juicing sales by acquiring a fleet of new products. Or even more simply, a private buyout indicates the PE firm is optimistic about the future -- if only about the specific company being purchased.

So whether the specific deals of the day turn out to be profitable or not in the long run, individual investors should take notice now that private equity buyouts are back. The trend could be very good news for their portfolios.

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