Are we on the brink of a recovery in merger and acquisitions (M&A) activity? Optimists such as investment bankers clearly see more deals ahead, while pessimists argue business confidence is still too fragile and global economic uncertainty too high for a wave of M&A activity.
The answer is probably somewhere in between. After a dearth of corporate activity in 2012-13, there are signs of renewed appetite for M&A. Mining services group Miclyn Express Offshore, financial services group The Trust Company, and mortgage lender RHG are subject to takeover offers.
Meanwhile, Challenger signalled its intentions this month to acquire other investment groups, and engineering group Sinclair Knight Merz is being bought by a US firm for $1.3 billon.
It is too early to know if these deals are the start of a spate of takeovers this financial year. A stubbornly high Australian dollar and weakening domestic economy could thwart market hopes of blockbuster takeovers that have a positive ripple effect through the market.
Against that, business confidence should continue to improve given the Coalition’s resounding win in the Federal election and amid more signs of a strengthening global economy. Talk of two interest-rate cuts by March 2014 has quickly changed to the possibility of the next rate move being up.
Greater policy certainty under the Coalition and more tangible evidence of steady global economic recovery could be a catalyst for boards to approve more deals. With rates low, the sharemarket fully rather than excessively valued, and balance sheets in good shape, the case to boost growth through acquisitions is strengthening. And you know some CEOs are just itching to do a deal.
Renewed takeover activity would be a big positive for the market, not only through higher share prices but by indicating boards are more confident in the outlook. How often do we see takeover deals encourage other companies to follow suit and acquire before it’s too late?
Investors, of course, should never buy companies on takeover potential alone. Portfolio investors should always seek high-quality, undervalued companies that are good long-term investments in their own right, and treat a takeover offer as the cream rather the cake. Speculators might get more adventurous punting on takeover targets, but it’s a high-risk game.
Here are three pockets of the market primed for higher M&A activity.
1. Internet stocks
Few industries are so dominated by the leading player in a segment: think REA Group for property ads, Carsales.com for car ads, Seek for job ads and so on. Given the importance of scale, and size, it’s hard to see too many second-tier internet stocks having long stints as prosperous standalone companies.
Property portal OnTheHouse Holdings, featured in this column, fits the bill as a takeover prospect. It has raced from 45 cents to 64 cents in the past month after reporting solid operational progress in its recent profit result, but is still well down on peak prices. OnTheHouse could be more valuable in the hands of a bigger player looking to beef up its position – and traffic – in online property services.
iCar Asia has also shot higher in recent weeks. The micro-cap stock is rapidly acquiring and aggregating car advertising websites in South East Asia. Since floating at 20 cents a share in 2012, iCar has raced to 80 cents and attracted a 19.9 per cent shareholding from Carsales.com, which looks the most obvious buyer when iCar’s owner decides to make a full or partial exit.
2. Mining services
For all the talk about the fading resource investment boom, M&A activity in resource services has so far been notably absent, with M&A in Miclyn Offshore Express a recent highlight. That has to change as smaller mining-services companies are smashed by declining working and lower profit margins. Horror profit reports Boart Longyear and others show the sector’s pain.
Amid several contenders as mining-service takeover targets, NRW Holdings, one of the high-quality, better-run mining-services providers, undervalued after being smashed this year. There’s too much sector risk chasing low-quality mining-service stocks on their knees, or punting any short-term recovery in the sector.
3. West African gold stocks
Experience peculators might back a recovery in the former mining hotspot, and more seasoned observers could conclude aggressive consolidation in the West African gold stocks is long overdue, and that the worst of the gold-price fall is over.
For all the pain, some Australian gold companies in Africa have huge reserves and resources and clear plans for production – although having to raise large slabs of equity capital to fund feasibility studies and build a mine is a huge turn-off in this market.
Still, big gold companies with deep pockets and long-term outlooks could see great value in African gold stocks trading at a fraction of former prices – and be prepared to wait for better times, and back what are higher-risk ventures.
Consider Gryphon Minerals: it has a maiden ore reserve of 1.05 million ounces and a global mineral resource of 4.9 million ounces. Having fallen from peak prices around $2 in early 2011 to 18.5 cents, Gryphon is capitalised at $74 million.
It has $52 million in cash and an enterprise value of just $13 million. On an enterprise-value-per-ounce basis, Gryphon looks dirt cheap, but many brokers that have had bullish recommendations have been caught out this year.
The same could be said of Middle Island Resources. It has a strong portfolio of exploration assets, good management, and a share price that has tumbled from above 60 cents in early 2011 to 18 cents. At some point, bigger players will see companies such as Gryphon and Middle Island as a cheap entry point into African gold resources, but it may take more confidence in the gold price before there is a wave of consolidation in the sector.
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis are at September 11.2013.
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