This Attractively Valued Stock Looks Like a Takeover Candidate

I remember watching the movie Gung Ho in 1986 and wondering along with the rest of the country if Japan was going to buy the red, white and blue in its entirety.

The movie was about a Japanese acquisition of a Pennsylvania auto factory, but at the time it seemed the land of the rising sun was buying up just about every other sector as well.

[ad#Google Adsense 336×280-IA]It was most evident in real estate, with massive buying of commercial properties on the West Coast.

According to the LA Times, Japanese buyers poured nearly $17 billion into U.S. property at the peak in 1988 and owned almost half (45%) of the premium downtown office space in Los Angeles by the early 1990s.

The real estate frenzy helped the FTSE NAREIT U.S. Real Estate Index jump an annualized 15.6% over the decade through 1989, sending prices and investor sentiment higher.

The index is up less than half that at an annualized pace of 7.4% over the decade through 2015 but that may be about to change.

New buyers have emerged from the east and it’s starting to look like the 1980s all over again.

Commercial Real Estate Has A New Deep-Pocket Buyer

Falling interest rates and lackluster returns on domestic stocks led the Japanese to look offshore for investments in the 1980s. Higher rates and a stable property market brought them to the United States with billions in investment.

Now it looks like history is repeating with another economic power.

Property prices have surged in China after deflating stock prices drove investors to look for other assets, and many are looking to the United States for better prices and stable cash flow. Six interest rate cuts since November 2014 have driven down yield on other investments, making domestic and foreign property a preferred play. Prices in the Shenzhen business hub have jumped 50% over the last year, and Beijing has reported a 10% increase in property values.

The search for better deals in the United States has made news lately with the $12.9 billion unsolicited bid for Starwood Hotels & Resorts (NYSE: HOT) by Anbang Insurance group. The bid follows the company’s $6.5 billion acquisition of 16 luxury resorts and hotels from Blackstone Group (NYSE: BX) earlier in the month.

But the Anbang Insurance offer is just the beginning of a real estate buying binge from Chinese buyers looking for yield. Deals in the first three months of 2016 have already reached $26 billion, nearly half of total 2015 volume, and it could be one of the biggest themes over the next few years.

Chinese insurance companies have been particularly quick to make deals even if it means paying higher prices. Total insurance assets grew at a 19% annualized rate to $1.83 trillion over the five years through 2015, making it the third-largest market in the world. According to the China Insurance Regulatory Commission, industry profits surged at an annualized 27.5% over the five years to $43.1 billion last year. Insurance companies spin off a lot of cash flow and assets must be matched with long-term liabilities, this makes real estate and excellent investment which can provide stability as well as current yield.

Hotels look to be a common target of Chinese insurance buyers, attracted by higher equity return and strong cash flow. While cash flows for hotels is more cyclical than insurance, the return on equity of 20% is also well above average insurance ROE of between 5% and 12% and above the 14% ROE on general U.S. real estate operations. Chinese insurers are paying handsomely for the extra return. The offer for Starwood values the company at 2.24 times last year’s sales and 24.5 times trailing earnings.

A Best Of Breed Hotelier And Vacation Network

Within the hotel space, one company stands out on attractive valuation and the potential for upside on investor sentiment. Wyndham Worldwide (NYSE: WYN) operates the world’s largest hotel company with 7,800 hotels, a destination network of 112,000 vacation properties and more than 210 time-share resorts. Vacation ownership accounts for 51% of sales followed by vacation rentals (28%) and lodging (23%).

Franchisees run the lodging segment and contribute 99% of sales, making the revenue more stable with most signing 15- to 20-year contracts. The company has significant control in the vacation rental market with its 3.8 million vacation exchange members accounting for 60% of all time-share membership.

Wyndham’s franchised lodging model and strong brand contribute to a 55% return on equity. Shares are attractively valued at just 1.55 times sales and 14.9 times trailing earnings.

Investors don’t necessarily even need a buyout offer to profit on the shares. Wyndham pays a 2.6% dividend yield and is an aggressive buyer of its own shares, buying eight million shares last year for $658 million. The current PE multiple is well under the five-year average of 19 times earnings and the building wave of acquisitions in the space could drive investor sentiment higher, taking the valuation along with it.

Risks To Consider: While Wyndham shares look attractive on a fundamental basis and as a takeover candidate, the company is exposed to cyclical risk of a downturn in the economy.

Action To Take: Position in one of the strongest brands in the hotel and resort industry on an attractive valuation and the potential for increased buying to push sentiment higher.

— Joseph Hogue

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Source: Street Authority