Recurring Revenues as Takeover Bait... You Decide Who's Next

This originally appeared at Empire Financial Research.

? With the market having been whacked – especially some of the highest fliers – there's a new popular pastime...

Guessing which companies will get acquired.

Predicting takeovers is generally little more than luck. It's the ultimate fool's game – often sparking by wishful thinking or intentionally planted rumors steeped in little more than fantasy... especially after a stock has plunged.

But one attribute some beaten-down companies have that makes them more attractive than others is a somewhat predictable, steady stream of revenue... It's the very reason that home fitness company Peloton (PTON) is rumored to be attracting suitors, including e-commerce giant Amazon (AMZN).

This "recurring revenue," as it's called, is usually in the form of a subscription that customers keep paying month-in, month-out, because it's something they want, need, and use.

? When the market was flying, many of these companies didn't deserve the high prices their stocks commanded...

But at sharply lower prices, they suddenly can get interesting... if not for investors, then for potential buyers.

In the old days, the ultimate in subscriptions were newspapers and magazines, but 85% of revenue came from advertising. (It's more complicated than that, but you get the idea.)

Cable TV totally disrupted the model, with just the opposite – 85% coming from subscriptions.

And then...

Silicon Valley took it to an entirely different level, with software companies reinventing – dubbed, Software-as-a-Service, or "SaaS," which became "the cloud."

? These businesses were pure subscription, with prices set by demand and with no ties to advertising...

Among the pioneers… Salesforce (CRM), with its software geared to helping salespeople keep better track of their relationships.

The model then morphed in every direction... with old-line software companies, like Microsoft (MSFT), shifting entirely away from the old software-in-a-box to the cloud for everything, like the Microsoft Word program that I used to write this essay. To use Word, which I do on my Mac – even though Apple's (AAPL) word processor program Pages is free – I have no choice but to pay up. Or if I want an advanced version of Adobe's (ADBE) Acrobat... or Photo Shop.

Or newer companies like Peloton... The company doesn't make the money on the bikes that it sells, but rather on the "connected fitness." That's a fancy way of saying the online video-streaming classes its users subscribe to.

It's all part of the à la carte world we now live in, where jokingly everything is “a service,” with many having value to a potential acquirer... at a price, of course.

?? The lower prices go, the more they become potential targets...

Here's are a few...

Just before the latest round of Peloton rumors started swirling, I was going over this with my friend Katherine Spurlock, who spent many years as a short seller, but now plays both sides of the street. She tends to be an out-of-the-box thinker.

We were chatting the other day when she started talking about battered companies with recurring revenue, and she was wondering... now that the stocks of many have tumbled, which are the most likely to be acquired?

To which I responded with something like, "Good luck with that."

? But after some thought, I thought we could open it to the floor to readers for their picks of the most likely takeovers of companies with recurring revs… and if they’re good enough, share them in a future essay.

So, the question: Which fallen cult stocks will not be independent a year from now? The one thing they have in common – recurring revenue.?

Peloton is the easiest example, given the rumors. But other companies that could fall into the vulnerable bucket, assuming their valuations aren't still too high, could include...?

• Online education company Chegg (CHGG), whose stock is down more than 70% from its 52-week highs due to the company's plunging revenue growth. Chegg's market cap is currently around $3.8 billion. But... its deferred revenues remain robust. It trades at 4.2 times forward sales.

• Online pet product retailer Chewy (CHWY), whose stock is down around 60% from its 52-week highs. Instead of deferred revenue, the company reports "Autoship subscription" revenue, which has been steadily rising. As of last quarter, this hit a new high of 70.6% of revenue. With a market value of around $20 billion, it trades at less than 2 times forward sales.?

These are just wild thoughts but should serve as a jumping off point. If you have other ideas, let me know by emailing me at [email protected]. If we get enough good or interesting ideas, I'll publish the list. And as always, if you're on Twitter, feel free to follow me there at @herbgreenberg. My DMs are open. Of just post your idea below. I look forward to hearing from you.

? Meanwhile, reader feedback on manias and meme stocks...

? "Herb, thank you (and everyone else at Empire Financial) for all of the knowledge and advice that is shared in Empire Financial Daily!

?"I just wanted to add a quick note on the topic of manias... If you or others are interested in learning more about the psychology of manias, I highly recommend the book, Devil Take the Hindmost: A History of Financial Speculation, by Edward Chancellor. The book discusses how human psychology and actions continue to repeat, albeit in slightly different forms, throughout the various manias of the past few centuries.

"While I was reflecting during and after reading the book, it seems to me that the same human psychology and actions described it the book are again at work in the manias of today. The book also helped me recognize and understand my own FOMO emotions when it comes to investing.

"Thanks again for all the great work!" – Drew K.

? "Thanks, Herb, for mentioning Charles Mackay's 1842 work in connection with contemporary 'meme madness'. It brings to mind a book from about 100 years later, 1940 — Where are the Customers' Yachts? Or, A Good Hard Look at Wall Street by Fred Schwed

"The Audible version of Fred's book is narrated with a touch of humour." – Rob D.

Herb comment: Thanks for the comments and input, Drew and Rob!

? "Hello Herb, What is your definition of a meme stock? In Europe nobody knows it yet. Many thanks." – Philippe J.

Herb comment: Philippe, this is the best definition I've found – anything and everything you wanted to know about memes.