Picking the next ‘takeover target’
Identifying corporate takeover targets can be a lucrative strategy but avoiding rumour is critical, writes Christian Ryan.
We are currently seeing the best conditions for corporate takeovers since the global financial crisis.
Company boards are more confident to instigate corporate activity, finance is cheap and Australian companies are now more attractive to overseas suitors, thanks to a lower Australian dollar.
For investors, increased merger and acquisition activity has the potential to add significant growth to diversified equities portfolios, via specialist targeting of potential takeover targets.
Companies that attract takeover bids often trade at a hefty premium.
Consider the recent bidding war for iiNet, which immediately rallied 27 per cent following a $1.4 billion takeover bid by telecommunications group TPG Telecom last March.
After rival telecom provider M2 made a counter bid in April, iiNet's share price reached a high of $10.16, meaning a total appreciation of 49 per cent since the first bid.
Our research shows that stocks typically trade at a 20-30 per cent premium leading up to a bid over an 18-month period.
Capturing this upside using a dedicated, growth-oriented strategy can add significant value.
The challenge is being invested in a stock when a takeover bid occurs. How is it possible to avoid the corporate rumour mill and avoid chasing chickens?
Targeting takeover stocks will often produce lower volatility than the ASX300 index, while outperforming the benchmark.
The key is taking a high conviction in a relatively small stock portfolio.
The portfolio must be underpinned by quality — it is essential to only hold stocks you would be happy to hold in the absence of a takeover bid, as not every stock will attract a bid.
Any holding needs to align with a strong macro investment theme. There needs to be a strong business case and all risks need to be considered.
It is best to think of it as a quality concentrated portfolio, which may have takeover potential.
These principles have helped the takeover target portfolio to outperform its ASX 300 benchmark since 2011, even though merger and acquisition activity has been muted during most of this time.
The number of stocks in the portfolio which attract a bid can be quite low, yet still the portfolio can outperform.
This is because one or two takeovers will have a big impact, such as the iiNet example above.
Stocks need to be liquid, which is why most holdings will be in the ASX 300 — speculating on small cap takeovers is extremely high-risk due to the potential for liquidity traps.
Investors need to be comfortable with not being invested in every takeover which happens — not every company which attracts a bid will reveal the tell-tale signs; or they may not be of sufficient quality for investment.
Spot the takeover
Ideally Beulah Capital looks for several key criteria to be met before a corporate takeover is deemed suitable.
For example, we believe the presence of a strategic shareholding is one of the best indicators of an impending takeover bid.
Some of these may be a long time in the making and we pay considerable attention to strategic shareholders increasing or decreasing their stake.
Industry consolidation is another key indicator:
AP Eagers (APE), for example, currently owns a 19.87 per cent stake in fellow auto dealership company, Automotive Holdings (AHG).
Both companies regularly compete for the same acquisitions and have a similar market capitalisation of around $1.5 billion.
We expect that as the industry slowly consolidates so too may these two companies.
Another criterion is where there has been a previous takeover bid.
A previous bid, even if it failed, indicates a degree of interest, which is backed up by statistics showing companies usually attract many bids leading up to a takeover.
In late 2012, United States agribusiness giant, Archer Daniels Midland (ADM) made consecutive bids for Australian grain handler, Graincorp (GNC).
GNC initially rejected both bids but remained open to further talks.
The GNC board eventually backed a further increased $3 billion bid in mid-2013, only to be rejected by the Australian Government.
As views on foreign investment in Australia become more favourable, ADM appear poised to make another takeover offer.
Christian Ryan is Managing Director of Beulah Capital.
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