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As Nontech Shares Swoon, LBOs Appear Set for a Rebound

A weak market outside of tech is making plenty of good companies cheap.

There was a time when investors saw value as a good reason to buy a stock, but lately that just hasn't been the case.

Outside of technology, the shares of most companies have suffered badly since the middle of last year. Banks, pharmaceuticals, basic materials, consumer cyclicals, retailers -- all of these are down. And yet, while their stocks have suffered, many of these companies continue to generate good revenue and earnings growth. In some cases, you might even consider the intrinsic value: Perhaps buying the stock might not seem like a good idea, but buying the business outright could make a lot of sense.

And for many American companies, it looks like that is exactly what is about to happen.

"If the public markets won't validate a strong business model, the private markets usually will," says

J.P. Morgan

market strategist Doug Cliggott. "As some very well-run companies start to trade at three or four times earnings, I don't see how we won't see a groundswell of leveraged buyouts."

Clearing Out the Junk

That groundswell might be a little higher on the Richter scale, and might have rolled in earlier, if the junk bond market were in better shape. Junk, or high-yield, bonds are the currency of choice in leveraged buyouts (LBOs for short). A group of investors will buy a company and then turn around and issue bonds in it to finance the transaction. Because junk bonds have been suffering, along with the rest of the bond market, the cost of issuing junk for an LBO has been seen as onerous.

There comes a point, however, when -- poor junk bond market be darned -- the attractiveness of taking a company private is simply too good to pass up.

Borders

(BGP)

, the beaten-down bookseller that Friday said that it is considering strategic alternatives including a leveraged buyout, may be just the

start. Junk isn't the only way to finance a takeout, after all.

"It may come down to some bank financing, Wall Street firms providing mezzanine financing," says Charles Crane, chief market strategist at

Key Asset Management

. "Maybe all that money flowing into venture capital funds -- there's a lot of cash looking for higher-return options."

Because of their relatively stable earnings streams, retailers like Borders are typical LBO targets --

Macy's

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and

Federated Department Stores

were two of the '80s big takeouts -- but even the more cyclical areas of the market may fetch interest. In a recent research note,

Sanford C. Bernstein

analysts Graham Copley and Samir Sinha calculated that a buyer could take out

Millenium Chemicals

(MCH)

at 22 per share and be in the black at year-end. Millenium closed Monday up 1 3/16 to 14 3/4. "The stock market's loss may prove to be the private investor's gain when it comes to the smaller chemical names with commodity exposure," wrote the analysts.

Sweating the Small Stuff

LBO activity has heated up a bit recently, but so far the takeouts are mostly small companies. Some reckon it will take a big deal -- one that either uses junk, suggesting that the market isn't too soft to do a deal, or that introduces some sort of new financing strategy for taking a company private -- to get things going.

"These guys hear the guns right now," says

Salomon Smith Barney

equity strategist John Manley. "When they see the opportunity, and then give the example of success, it will become progressively easier" to do more deals.

But it will not take too many big LBOs before the public market catches on to what the private market is doing, and begins to bid up beaten-down stocks. "That," says

Morgan Stanley Dean Witter

chief U.S. investment strategist Byron Wien, "will rekindle performance for the group."

Could be investors will even buy these stocks not just because they see these companies as buyout targets. Perhaps they'll come to think the companies are actually worth buying in their own right.

Or at least it is nice to think so.