Every month or so, I queue up my set of “mergers and acquisitions targets” filters to create a watchlist of possible actions. I did this today, giving a list of 34 stocks. The best acquisition targets tend to be tech stocks, at least in terms of prevalence (read: increasing the likelihood that your stock pick will be acquired):
And so I narrowed the list down to just tech titles, leaving me with a watchlist of six. Yes (NYSE: YEXT) was on this list. But what interests me most is that the most recent Yext article here at Seeking Alpha also suggests that Yext is ripe for a takeover.
Author Gary Alexander came to his conclusion in an entirely different way than I did. His point of view is purely commercial. Mine was more statistical in nature. Still, we came to the same thesis, which tells me we’re probably onto something.
Today I want to give a more quantitative rationale for the possibility of a Yext acquisition. You can use this article in conjunction with Gary Alexander’s to determine if you think holding YEXT as a kurtosis takeover trade is worth the risk.
I used the statistical results in acquisition research to come up with my shortlist of potential takeover targets. Research on the subject has shown that companies with certain characteristics are more likely to be acquired, including a high cash-to-asset ratio, low price-to-book ratio, and negative earnings. YEXT emerged for the same reasons, such as having a price-to-book ratio around the average for acquisition targets (4.3 vs. 5), having strong sales growth (32% over the past five years) and have no debt.
Once a stock meets the financial criteria, we can then determine if the company is suitable for acquisition under popular acquisition strategies. For example, companies that are heavily overvalued tend not to be popular acquisition targets because management doesn’t want to appear to have overpaid. Acquisition targets must also bring synergy or diversification to the acquiring company. More information on acquisition requirements can be read in Professor Damodaran’s article on the subject.
In any case, Yext is good on these points. Its price-to-book valuation puts it in the middle of the software industry and is therefore not overvalued.
In addition, the business itself lends itself to significant synergies. Yext started out as a problem-solving platform for local businesses that had to manage multiple different local marketing platforms in the emerging social media ecosystem. As a paid solution, Yext allows businesses to push updates to all major local marketing platforms, such as Google Maps, Yelp, and Yahoo. In this way, a company can, for example, change its opening hours and offer new coupons via these platforms in one step instead of having to update each platform individually. These days, Yext is moving to machine learning research. The target audience is always the same: companies that want to leverage technology to simplify the marketing process.
The most obvious synergy is that Yext has access to a large customer base of local businesses. Any business with a similar customer base could benefit from an acquisition of Yext for an immediate boost in leads and marketing mix. Or, similarly, any of the platforms used by Yext could acquire Yext and give that platform preferred status, whether through marketing (explaining why the chosen platform is superior), special offers or even removing competitors from the Yext platform. For example, if Meta Platforms (FB) acquired Yext, it could start offering Yext users special offers for Facebook Ads – and only Facebook Ads, as opposed to other local ad platforms – thereby turning Yext customers into customers. Yext and Facebook Ads.
The fact that Yext’s market capitalization is less than $1 billion makes almost all of these platforms a potential buyer. Even Yelp (YELP), with its $2.5 billion market cap, has enough equity (and no debt) to justify the purchase. Of course, for a company like Apple (AAPL) or Amazon (AMZN), the acquisition of YEXT would have an inconsequential impact on the company’s balance sheet.
This month, YEXT hit an all-time low.
Almost immediately after, we saw a flurry of insider buying. This happened after an entire year of zero purchases and some insider selling.
This happened without significant positive news, by the way. The most recent earnings report was not very optimistic, at least according to my financial lexical analysis of the earnings call (more on this method here). Choice quotes follow.
“We have seen a fragmentation in our customer interactions and our ability to provide top-notch service and support. This is impacting customer satisfaction and challenging our retention and upselling moves. With Looking back, it’s clear that we were too focused on building sales capability and not focused enough on other functions that drive productivity, specifically sales enablement, training, customer success, and services.”
(Regarding customer events) “Between December and January, we lost over half of these events, just because we couldn’t do them… But certainly, when we left Q3, we didn’t expect to see this kind of disruption and it has absolutely affected bookings.”
“Where we’re really challenged and continue to be challenged is on upselling. And I think that sort of plays into what Mike talked about, about sales productivity and of continuing to improve the go-to-market approach.”
The CFO also leaves, which is usually not a reason to buy stocks. While insider buying is generally a good predictor of excess returns, it doesn’t necessarily mean that anything big is about to happen. However, it certainly increases the likelihood that insiders have private information that is good for the company.
Business idea and risks
I think the risks are pretty obvious: there could be no buybacks, Yext continues to spin its wheels without positive earnings, and the stock resumes bearish momentum. In a way, this business idea is against the grain. We view Yext as a good buyout target from both a statistical (supported by financial data) and fundamental (supported by synergistic properties) perspective, thus making a long position in YEXT a kurtosis trade. In other words, because of the potential gain that accompanies an acquisition, the risks are mitigated.
If we assume that the stock’s momentum is down barring acquisition, we can create an options strategy that is almost risk free. The idea is to sell in-the-money calls to fund in-the-money or out-of-the-money calls. This strategy allows you to profit if YEXT spikes due to its acquisition and also if YEXT continues to sell. A loss is only realized if YEXT consolidates (sideways trends).
Here is my idea:
- Sell 1 $5 call on May 20
- Buy 5 May20 calls for $7.50
At the time of writing, short calls are selling for $200 each, while long calls are trading at $35 each, meaning you can open this trade at a net premium of $25. So in the bearish direction you can take advantage of the premium, while the bullish direction gives you the equivalent of holding 400 long shares of YEXT. Essentially, you fund a long position by selling the in-the-money call option. The maximum risk here is a loss of $225, which occurs if YEXT trades at exactly $7.50 by May 20.
Let me know what you think of this strategy in the comments section below.