News that Suncorp Group and Bank of Queensland held preliminary talks earlier this year to create a fifth force in Australian banking further, along with speculation this morning that Carsales.com.au will make a play for iCar, confirms the desire of large companies to get bigger through mergers or acquisitions – and the looming opportunity for investors.

The recently concluded reporting season also confirmed that top-line revenue gains are hard to find for many companies, and that cost-cutting remains the main engine of profit growth.

In this scenario, the need for mergers and acquisitions that create scale makes great sense, although Australian companies probably need to look overseas for assets, rather than buy more of them here. There’s only so far that companies can grow in a small market such as Australia.

These trends strengthen the case for higher M&A activity this year and next. But this column’s guiding theme is to identify undervalued companies that are good investments at the current price in their own right. Think of any takeover as a bonus rather than the prime reason to buy.

The team

The 12 takeover targets identified in this Takeover Targets series (Reckon, NIB Holdings, iiNet, NRW Holdings, Ten Network Holdings, On The House Holdings, iBuy Group, Nearmap, OzForex Group, Tiger Resources, Westoz Investment Company and Reva Medical) are up an average 2.7% since the column last reported on August 13 – in line with the market’s overall gain.

Property information group Nearmap has been the standout with a 46% gain. We added Nearmap on August 18. NIB Holdings is up 4% after another good full-year result. iBuy Group, also added last month, was an early disappointment, down 21%, and iiNet has shed 3% after strong earlier gains.

We will stick with the 12 stocks for now. Even if a takeover does not eventuate, they look interesting at current prices. Just beware that several of them are micro-cap companies that suit experienced investors comfortable with higher risk.

New addition

iSelect joins the list this week. The insurance information group was among the worst floats in recent years, raising $215 million at $1.85 a share on ASX through an Initial Public Offering in June 2013. iSelect slumped to a 52-week low of $1.01, thanks to a shock revenue downgrade soon after the float, and as the corporate regulator queried aspects of its prospectus.

It is hard to think of a float that was more on the nose with investors than iSelect. The stock was deeply out of favour, with most brokers having hold or sell recommendations. Downgrading forecasts within months of listing is an IPO sin – and a good reason to ignore a stock.

I like iSelect at the current price for a few reasons. Hefty premium increases on health insurance will work in its favour as investors use comparison sites to find cheaper policies. Higher energy costs will also encourage more consumers to use its EnergyWatch service to find a better deal.

For all its post-listing problems, iSelect still has a prominent brand and strong market position in online comparison of insurance, energy, broadband, home loans and other products.

Credit Suisse published an interesting note on iSelect on August 29. Unlike most brokers who are negative or neutral on iSelect, Credit Suisse has an outperform recommendation and a $1.70 12-month price target, compared with the current $1.40 price. If the Credit Suisse target is right, iSelect would be trading significantly below its intrinsic value.

Its share register is reasonably open and a local or offshore predator will know how hard it would be to replicate iSelect’s market position, and how online markets tend to be dominated by a key player, with daylight to the nearest rival: think REA Group, Carsales.com and Seek.

The right setting

My guess is there would be plenty of IPO investors eager to recoup some of their losses in iSelect through a higher share price from a takeover or merger. Credit Suisse wrote: “iSelect remains poorly understood, but we believe it has numerous factors that warrant attention. Revenue growth is strong and consistent … supported by favoured trends in key operating metrics (leads, conversion, revenue-per-sale).”

It added: “(iSelect) brand awareness is strong and solid private health industry drivers support another strong performance in the health division. We expect strong growth in the energy (division) in FY15.” Credit Suisse said iSelect’s FY14 result met expectations, and had encouraging trends.

I have a similar view of iSelect. Its stock was in demand during the IPO as fund managers paid $1.85 to gain exposure to another promising internet company. At $1.40, few investors still want to know iSelect – just the right setting for an astute predator to swoop.

– Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at September 10, 2014.

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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