Has The Economy Finally Recovered?

Mergers and acquisitions are always positive in the eyes of retail investors. M&A activity signifies economic confidence on the part of companies. After all, if companies did not believe that things were going to get better economically, then they would not purchase companies.

This goes double for financial buyers. Financial buyers are those who are not looking to integrate targeted firms within themselves to make a larger, combined entity. Private equity firms are financial buyers, as they attempt to streamline a business after purchasing in order to sell them for a higher price at a later date. In order to achieve this objective, private equity funds have to ensure positive cash flows during the life of holding the portfolio company. If the portfolio company is cash flow negative, the private equity firm has to hold onto it for a longer period or even sell it at a loss.

Therefore, private equity firms only make large investments when they are positive that overall economic conditions are not going to disrupt cash flows of a newly acquired company. When Thoma Bravo announced that it will purchase Blue Coat Systems Inc BCSI for $25.81 per share, the stock immediately moved up higher. The transaction is valued at about $1.3 billion.

Thoma Bravo's action does not mean that the economy is fine, since the firm could be completely wrong about Blue Coat Systems. Blue Coat may also be extremely undervalued, and may be able to weather a financial crisis should one emerge in the next few years.

Blue Coat Systems is a company that develops and distributes software and services that caters to streamlining business practices. For example, some of its products attempt to streamline internal networks within each client company. It is also actively delving into the cloud computing space. Investors, however, want to know why Blue Coat may actually be a good idea.

One of the first things that Thoma Bravo would have analyzed was how income grew at Blue Coat. Revenues have grown consistently over the years, although it dropped slightly in 2011. While this occurred, the company has managed to continuously increase margins. This means that the company is able to adapt to fluctuations in revenue streams, which is always positive in uncertain economic times.

Furthermore, the company has managed to keep operating expenses down to a minimum when times get tough. For example, it has cut research and development slightly in 2011 along with salaries and marketing costs. Through these actions, Blue Coat Systems has managed to continually increase operating margins over the years. As is expected, net income and EPS have been increasing, and the company has managed to earn a diluted EPS of $1 in 2011, higher than $0.97 in 2010.

Along the same token, the company's cash flows has continuously increased year over year. The only problem comes down to the fact that a lot of the cash flows come from working capital changes. Current assets increased in the last year, so current liabilities had to have increased even more to create a positive inflow of cash. Some of the cash flow is also attributable to stock-based compensation, but the primary factor in the sudden increase from 2010 to 2011 is working capital.

Capital expenditures and other investments by the company were very minimal. In terms of financing activities, the company has not issued debt for several years. It has, however, repeatedly issued equity over the last few years, meaning that return on equity is continuously being diluted over time.

Blue Coat Systems appears to be a steadily growing company that is operating in a growing industry. Thoma Bravo clearly believes that it is strong enough to be able to weather any economic downturns in the future. It may also streamline the company's operations and make it even stronger. While investors are late to invest in Blue coat right now, they may be able to find similar companies that demonstrate strong growth.

Blue Coat Systems Inc is currently trading at about $25.20, down over 15% for the year.