Potential M&A targets to buy

Financial journalist
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The $1.2 billion “proportional” bid for Leighton Holdings by its major shareholder, the Spanish-controlled German construction and engineering giant Hochtief, has not only sent Leighton shares surging, but pricked up interest in the mergers and acquisitions – or ‘M&A’ – space.

Coming on the back of the extraordinary three-way battle for control of dairy producer Warrnambool Cheese and Butter (WCB), and the federal government’s blocking of the $3 billion bid by US agribusiness leader Archer Daniels Midland for GrainCorp (GNC), investors have been forcibly reminded that M&A activity can galvanise a share price quick-smart, and do away with the slower process of organic growth.

It is very rare that shareholders hit the jackpot like WCB’s did, and see a spectacular escalation of a three-way bidding war almost triple their share price in 12 months, but as a general principle, if you can find a potential takeover target your upside, if you choose correctly, can be very substantial.

This is particularly so if the bidder needs to offer a significant premium to dislodge a controlling stake.

Market activity

Picking companies that might be taken over is a difficult game: while all listed companies are up for sale, every day, prediction is plagued by hindsight – takeovers often look logical after the fact. The market is expecting an increase in takeover activity, for two main reasons.

The first is that in a potentially lower-growth environment, but with record low interest rates, companies finding it difficult to generate growth, can buy it cheaply – even at relatively high price/ earnings (P/E) ratios.

As Geoff Wilson of Wilson Asset Management points out, a company borrowing at 7% pre-tax is paying about 4.9% for that money: if it can buy another company with an earnings yield of at least 4.9%, the result should be earnings-per-share (EPS)-positive straight away.

“That means an acquiring company can pay up to 20.4 times earnings (the earnings yield is the reciprocal of the P/E) and still be EPS-positive on an acquisition,” says Wilson.

The second is that for overseas companies, an Australian acquisition is cheaper now. “It’s about 15% cheaper for them than it was a year ago, says Wilson. “The worry there, though, is that they would not want to make a move now and have the exchange rate get even cheaper.”

The targets

In looking at potential takeover targets, investors often focus on situations that look like they will happen at some point, because the logic seems clear – particularly if there has been interest previously expressed. A case in point is David Jones (DJS), which was approached last year by rival Myer (MYR) with a proposal to merge to create a mega-department store group worth $3.2 billion on the market.

Myer is known to be still keen; for its part, David Jones has said it is not opposed to a deal in principle, and has run the numbers on a merger or acquisition of Myer itself. But it did not feel the 2013 proposal was adequate.

So while investors think, rightly, ‘where there’s smoke, there’s fire,’ and wait for a revised offer to come – from either party – a better bet could well be to consider David Jones as a possible ‘currency play’ takeover target, with US-based private equity firms more likely than Myer to make a bid for the hounds-toothed one – and an offshore bid that needed clearance from the Foreign Investment Review Board (FIRB) would arguably stand a greater chance of clearance than a domestic department-store merger would of getting past the Australian Competition and Consumer Commission (ACCC).

Hydrocarbons heavyweight Santos (STO) is another potential foreign-exchange takeover play: but in a rare display of realism, the company is perfectly OK with this conjecture. Chief executive David Knox admits that Santos is an increasingly attractive takeover target, as its massive $21 billion Gladstone liquefied natural gas (GLNG) project – of which Santos owns 30%, along with partners Petronas, Total and Kogas – gets closer to making its first shipments in 2015.

Knox says he knows that Santos is well and truly on the radar of offshore oil and gas majors as GLNG gets closer to the starting line, but says that’s a compliment.

Other potentials

Agribusiness is expected to continue to be a potentially active field for M&A: with WCB in Saputo’s hands, frustrated WCB bidder Bega Cheese (BGA) is considered likely to play some role in further consolidation of the sector. New Zealand dairy heavyweight Fonterra – which owns about 10% of Bega – could be the source of interest here. Another company considered likely to interest larger agribusiness players, is animal feed provider Ridley Corporation (RIC), which is both a perennial takeover target nomination and a serial under-performer on the stock market.

Other situations commonly discussed are Woodside Petroleum (WPL) moving on Oil Search (OSH) – an offer that, if it got out of the hypothetical, would have to be pitched at a hefty premium – and the very similar situations at mortgage broking company Mortgage Choice (MOC) and mortgage lender Homeloans (HOM), where Commonwealth Bank (CBA) owns 22% of MOC, Macquarie Group (MQG) owns 19.8% of HOM and National Australia Bank (NAB) owns 17.8% of HOM. Those shareholders must be considered potential bidders.

Another is Tabcorp (TAH), after big UK bookmaker William Hill entered the Australian market last year through the purchase of the Sportingbet and Tom Waterhouse operations. William Hill chief executive Ralph Topping has been very vocal about how he would “shake up” Tabcorp if he got his hands on it – assuming the FIRB would let him.

The real estate investment trust (REIT) sector is also virtually certain to go through further consolidation. There, Investa Office Fund (IOF) and the poorly performing 2013 float GDI Property Group, are top of the analysts’ watch list for corporate action.

In the resources sector, South Australia’s Cooper Basin is a potential hot spot for M&A activity this year, with Beach Energy (BPT) strongly tipped to be involved – but the question is, as an acquirer or a target? It’s hard to tell. In gold, where there has been quite a bit of activity recently, Saracen Mineral Holdings (SAR) is thought to be an obvious target.

Lastly, in media, don’t be surprised if Ten Network (TEN) attracts some M&A attention at some stage this year – because brokers and analysts won’t.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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