Waking up in the morning to find that one of your holdings was a stock buyout can really make your day. When a buyer purchases a stock company, the company gives up control to the buyer. For the buyer to convince the seller’s board of directors to give up the company, it offers to buy the company shares for more than the current share price—sometimes significantly more.

When the buyer or seller announces the stock buyout to the public, investors rush to buy shares while the stock price is below the buyout price. All that buying usually causes the share to spike until it approaches the buyout price.

Investors who bought the stock before a stock buyout announcement get a quick and handsome return. If you’re like me, you wish you could repeat the process over-and-0ver again. Unfortunately, there is no sure-fire way to see stock buyouts before they happen.

Stock buyouts can seem like random occurrences, but there are some signs that one may be brewing.

Signs of a Stock Buyout

A company thinking about making big changes may show signs of a stock buyout. For instance, a press release or presentation by management might show that the company is looking to make big changes.

In the documents, management might say something like, ‘We’re reviewing strategic alternatives.’ Reviewing strategic alternatives is industry jargon that signals the company may be thinking about making sweeping changes.

Keep in mind that, although a company review of strategic alternatives may be a sign of a stock buyout, it could also mean many other things. For example, the company may sell only a part of the business or a subsidiary. It could also mean the company may simply be thinking about changing its strategy.

Another sign of a stock buyout is when an activist investor pressures a company to sell. An activist investor is a person or investment firm that buys a large percentage of a company’s stock.

Because the activist investor is such a large shareholder, it can more easily get the attention of the company’s board of directors. The strategy of an activist investor is to use their investment muscle to make changes at the company to improve the stock price.

One way to improve the stock price is to push the board to seek out a buyer for the company’s shares. Many times, activist investors work behind the scenes, and there may never be a sign of a stock buyout. On occasion, though, the activist investor and the board of directors do not see eye-to-eye.

When that happens, the two parties may bring the conflict to the public’s attention. This information is made public with form 13D, filed with the Securities Exchange Commission. Read 13d filings carefully. They may be a sign of a stock buyout.

Stock Buyout Examples

There are many stock buyout examples from over the decades. One recent example is the buyout of R.R. Donnelley & Sons. On February 25, 2022, the company completed for $10.85 per share in cash. The buyer was Chatham Asset Management, a private equity firm.

For years, Chatham had been a large shareholder of R.R. Donnelley & Sons stock. In 2021, Chatham filed multiple 13D forms. The filings complained of management’s inability to increase value for shareholders.

On August 2, 2021, R.R. Donnelly filed a 13D letter in response to Chatham’s letter. The response included recent moves the company made to add value to the company for its shareholders. At that time, shares were about $6. The shares later fell to nearly $4.

Later, on October 12, 2021, R.R. Donnelley & Sons put out a press release saying it had received a stock buyout offer from Chatham. The bid was for $7.50 per share in cash. That’s when things got interesting.

A few weeks later, R.R. Donnelley put out another press release saying that Atlas Holdings would buy it out for $8.52 in cash. After that, Chatham came back with a $9.10 per share bid. A bid of $10.00 per share from an unnamed strategic party on November 27, 2021.

The bidding didn’t stop there. On December 1, 2021, Chatham came back with a bid of $10.25. A week later, Atlas increased its original bid up to $10.35. Finally, on December 14, R.R. Donnelley & Sons received the winning bid of $10.85 from Chatham.

Opportunistic investors that bought shares of R.R. Donnelley & Sons when shares were in the $4 to $5 range would have more than doubled their money in about six months.

What is a Leveraged Buyout?

Popular in the late ’70s and early ’80s, leveraged buyouts (or LBOs) are still common today. In a typical leveraged buyout, the buyer borrows money to fund a stock buyout purchase price and takes the company private.

Most of the time, the buyer borrows 80% to 90% of the purchase price of the target company. By putting very little of their own money into the buyout, the buyer can increase the return on their investment.

The strategy of many leveraged buyouts is to use cash flow from the newly acquired company to pay down its debt as quickly as possible. By paying down debt as fast as possible, the buyer helps their return in a few different ways.

First, paying down debt increases the buyer’s equity in the company. This concept is the same as building equity in your home by paying down your mortgage. In addition, because the buyer uses such a high percentage of debt to fund the buyout, it comes with a high interest rates. So, paying down the debt can save the buyer on interest payments.

Finally, investors of leveraged buyout targets may sell the company again down the road. If that is the case, the profit that the buyer receives comes from the equity in the company. The more debt it pays down, the higher the equity in the target company.

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