Takeover targets usually fall into two camps: beaten-up, undervalued or mismanaged stocks, and those swept up in industry rationalisation. Watch for a third category to emerge next year: acquisitions of service companies with a foothold in Asia.

Free-trade agreements with South Korea, Japan and an imminent deal with China are expanding Asian markets for Australian business – possibly more than investors realise. They are also putting a blowtorch on companies that have been slow to expand in the region.

Everybody talks about hard and soft commodities as the “play” on Asian growth. But Australian service companies in healthcare, aged care, financial services, professional services, education, and the internet will be the next wave to benefit.

The biggest boom of them all

Make no mistake: growth in middle-class Asian consumers in the next 20 years will be the mother of all booms. Middle-class consumers in Asia-Pacific (households with daily spending of US$10-US$100) were estimated to grow from about half a billion in 2009 to 3.2 billion in 2030, according to research cited in the Australia in the Asian Century white paper in 2012.

Imagine more Australian companies providing health and aged care in Asia, or managing superannuation there, or providing legal and other professional services to a giant, emerging market of middle-class consumers.

In spite of this potential, Australian companies, generally, have taken a cautious approach to Asia. Yes, there are standouts, such as ANZ Banking Group. However, the top 50 Australian exporters to Asia earned a median 20% of their revenue in the region, according to the BRW Asia 50 list in 2013, and that was boosted by big mining exporters such as BHP Billiton.

My hunch is cashed-up Australian and offshore companies that have low or no presence in Asia, will find it easier to buy smaller companies in the region than build a presence from scratch. They don’t have time, or in many cases, the skill. That is why iProperty Group and iCar Asia were initially included in this column, and iBuy Group was added a few months ago.

Each company was set up to build a foothold in South-East Asia that would have strategic value to an acquirer – a classic start-up entrepreneurship strategy of beginning with the exit in mind. REA Group snapped up a 17% stake in iProperty, and Carsales.com looks the obvious acquirer of iCars. Both stocks have rallied this year.

The share price of the e-commerce group, iBuy, has almost halved in the past two months. I can’t see any fundamental reason to warrant such a fall, other than iBuy being a thinly traded stock prone to the slightest disappointment. It has operations in six South-East Asian countries and 8.2 million email subscribers, and had $71.2 million gross turnover in the first-half of 2014. iBuy peaked at 70 cents and now trades at 15 cents, well down on 32-cent issue price in last year’s IPO.

I have been wrong with iBuy so far. Yet I cannot help thinking its foothold in Asia, the world’s fastest-growing e-commerce region – a combined market 21 times larger than Australia – is a valuable strategic asset for a global or local retailer. So we’ll stick with iBuy for now and kick ourselves for going too early on it.

Soft commodities have further to run

Investors latched onto the Asia story through mining stocks last decade, and more recently through soft-commodity and processed food exporters. The so-called “dining boom” still has a long way to run as billions of Asian middle-class consumers upgrade their diets in coming decades.

Australian Agricultural Company (AAC) joins the portfolio this week. The beef cattle breeder is an obvious beneficiary of rising demand for Australian meat in Asia, and a potential winner from a free trade agreement with China that opens cattle export markets.

Australian Agricultural Company (AAC)

Source: Yahoo!7 Finance, 13 November 2014

AAC has raced from $1.35 in mid-October to $1.51, yet looks better value than many agricultural stocks that have soared in the past two years. A few key shareholders would want a sharply higher price for ACC should a suitor emerge, but ACC satisfies this column’s first condition: identifying good-quality stocks that are reasonable value, regardless of a takeover.

Asia-focused service stocks will be on takeover radar

Finding ASX-listed service companies with a big presence in Asia is harder. Many small and mid-cap Australian companies have favoured expansion in the United States and United Kingdom over Asia in recent years. Slater & Gordon’s successful UK foray is an example.

Domino’s Pizza Enterprises’ entry into the Japanese market put a rocket under its stock, making its valuation too rich for this column. But Domino’s shows the potential as middle-class Asian consumers rapidly develop Western food tastes.

The vitamins provider, Blackmores, is also making good inroads in Asia. About 23% of its revenue is earned offshore, principally in Malaysia and Thailand, and its complimentary medicine is a neat fit with Eastern cultures.

After recent price gains, Blackmores is fully valued. Any takeover bid would require a decent price to interest founder Marcus Blackmore, who still owns about 26%. Blackmores is worth watching for Asian exposure alone.

Travel insurance provider, Cover-More Group, is another potential winner for growth in Asian middle-class consumers. As more travel overseas, demand for travel insurance will rise, and the Chinese travel insurance market, in particular, looks underserviced. The long-term dynamic of more baby boomers in the West, and increasingly the East, travelling overseas, and needing insurance is compelling. More brokers seem to be lifting recommendations on Cover-More, and we will examine it in greater detail in coming columns.

Monash IVF Group also has an expanding presence in Malaysia and China. Monash and Virtus Health recently noted a slowing of the Australian In Vitro Fertilisation (IVF) market, making offshore growth a bigger imperative. As Monash targets South East Asia, Virtus has ambitions in Ireland and Singapore.

It is far too early to call Monash a play on Asian demand for IVF services, given less than 5% of revenue is earned there. But Malaysia has about a tenth of the number of IVF cycles of Australia each year, despite a slightly larger population. Asian middle-class growth, and more working women delaying child birth, suggests rising demand for IVF services, as has been the case in western economies in the past two decades.

Monash IVF Group (MVF)

Source: Yahoo!7 Finance, 13 November 2014

I add Monash IVF to the portfolio this week, mostly because it looks undervalued after falling from a peak of $1.97 to $1.49, and trading below the $1.85 issue price. Monash has latent strategic value in its world-class intellectual property and brand, and an excellent record.
It would not surprise to see a larger healthcare service company (Primary Health Care, perhaps?) view Monash IVF as an entry to the fast-growing Asian IVF market in coming years.

Portfolio update

The portfolio has had mixed results since its latest publication in September. The median gain was almost 3%, better than the ASX All Ordinaries Index’s 2% fall since then. Within the overall performance was significant volatility in some stocks, and a few annoying results. Remember that many small and mid-cap stocks in this column suit experienced investors who can tolerate higher risk.

iBuy was the biggest disappointment, down 46% since September 10. NRW Holdings and Tiger Resources fell 28%, Reckon shed 13%, and Westoz Investment Company lost 12%.

Device maker, Reva Medical Inc, was the standout, up 110%, after positive capital-raising news, followed by a 27% gain in Nearmap, a 13% lift in Vision Eye Institute, and a 10% gain in NIB Holdings.

Among other stocks, Ten Network Holdings gained 3%, amid media speculation that several suitors are circling. It looks a question of when, not if, for the troubled TV group to fall to a predator, provided the acquisition price gets Ten’s key shareholders over the line.

iiNet rose 3%. Vocus Communication’s tilt at Amcom Telecommunications shows the potential for more rationalisation among telcos. Automotive Holdings Group added 2%, and OxForex Group, Onthehouse Holdings, and iSelect were flat.

Westoz has been dropped from the portfolio: with so many Listed Investment Companies (LICs) listing on ASX this year, takeover seems a more remote possibility. Australia Agricultural Company and Monash IVF are added.

Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis are at November 11. Price calculations are between September 10 and November 11, and returns do not account for any dividends paid during this time.

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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