Topic: Growth Stocks

This growth stock’s takeover bid could bring big profits — and big risks

It pays to be skeptical of growth stocks that rely too heavily on acquisitions.

That’s because the buyer of something rarely knows as much about it as the seller. So it follows that if a company makes enough acquisitions, it might eventually buy something that has hidden problems. At some point, those problems will come out into the open and hurt the buyer’s earnings.

Big acquisitions can burden growth stocks with high debt

Acquisitions, particularly big ones, can also push up debt, which leaves the buyer vulnerable to a big setback if it has trouble meeting the payments. They can also load the buyer’s balance sheet with goodwill, an intangible asset whose value can drop overnight if it turns out that the company made a bad acquisition.

In that case, the company has to write off all or part of the acquisition’s cost against its current earnings. This can wipe out a year of a growth stock’s earnings, and devastate its share price.

We keep all of these factors in mind when we analyze growth stocks in our investment advisories, including Stock Pickers Digest, our newsletter for aggressive investing.

In a recent Stock Pickers Digest hotline, we updated our buy/sell/hold advice on convenience-store operator Alimentation Couche-Tard Inc. (symbol ATD.B on Toronto). The company has been making news on the acquisitions front.

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Successful takeover would increase this growth stock’s share of the U.S. convenience-store market

Alimentation Couche-Tard is the largest convenience-store operator in Canada, with over 2,000 outlets. It also has over 3,500 U.S. stores in 43 states.

The Canadian stores operate under the Couche-Tard and Mac’s banners, while the U.S. stores mainly use the Circle K banner. The company also has about 3,600 Circle K-licensed stores. These outlets are mainly located in Asia.

In April 2010, Couche-Tard launched a hostile, $1.9-billion takeover bid for Casey’s General Stores (symbol CASY on Nasdaq). However, Casey’s management rejected Couche-Tard’s all-cash, $36-a-share bid as inadequate and is fighting the takeover.

Casey’s owns 1,507 convenience stores in the U.S. Midwest. The stores offer a wide variety of food and non-food merchandise, as well as gasoline, under the names Casey’s General Store, HandiMart and Just Diesel.

Couche-Tard now plans to take its offer directly to Casey’s shareholders. It also plans to nominate nine candidates to replace Casey’s current board of directors. The company normally holds its annual meeting of shareholders in September.

Casey’s is now trading at $35.93, which is just below Couche-Tard’s offer. That suggests investors may not be expecting a significantly higher bid.

Couche-Tard could handle the risks of buying Casey’s

If successful, this would be a big purchase for Couche-Tard. The offering price represents 54% of Couche-Tard’s current market cap (or the total value of all of its outstanding shares).

However, Couche-Tard’s total debt of $858.4 million is a low 24.5% of its market cap, so it could afford to cover the cost of the purchase with additional borrowings or share issues.

Moreover, Couche-Tard has a history of successfully integrating the companies and assets it buys. To top it off, the company’s strong balance sheet and steady cash flows would help it manage any additional debt it would have to take on to buy Casey’s.

We’ll keep a close eye on the Alimentation Couche-Tard’s hostile takeover attempt and update our buy/sell/hold advice accordingly in Stock Pickers Digest. When you subscribe today, you can get one month absolutely free. Click here to learn how.