M&A makeover: The bid targets of 2014
10th January 2014 13:38
Every January for the past few years there have been predictions aplenty for a revival in mergers and acquisition (M&A) activity following the drought after the financial crash in 2008.
Yet every year it has failed to materialise. Despite holding record levels of cash, business leaders have been reticent about doing anything with the pile up.
In 2013 the number of completed global M&A deals over $100 million (£60.9 million) was 720, down from 768 in 2012 and 796 in 2011.
Now pundits are once again forecasting a surge in corporate deals, so could this time be different?
One of the drivers behind the awaited upswing in activity is record stock-price performance from acquirers in 2013, which Towers Watson says lays the foundations for increased volumes and values of M&A deals in 2014.
Acquiring companies record best performance
In its quarterly Deal Performance Monitor, put together in partnership with Cass Business School, Towers Watson notes that acquirers in 2013 recorded their best performance in six years, with share prices outperforming non-acquiring companies by an average of 4.5 percentage points.
Last year there was a traditional end-of-year surge in completed deals in the last two weeks of December, but the total number of deals in 2013 was lower in each region than 2012 volumes.
Steve Allan, Tower Watson's M&A practice lead in EMEA, says: "In 2012 the end-of-year M&A surge, caused in part by the US fiscal cliff, did not provide any momentum or presage increased M&A activity.
"This year, however, with recovering economies and the growing confidence visible in the markets, we are expecting to see more M&A activity in 2014."
Completed deal numbers picked up steadily throughout 2013 in North America and Towers Watson predicts the region will lead the surge in 2014 too.
This brings us onto another reason M&A could actually pick up this year: a potential end point to cheap credit.
As the economic outlook improves central banks edge closer to upping the base rate and lending rates will gradually rise too.
Jonathan Jackson, head of equities at Killik & Co, says: "European M&A is currently close to a 20-year low and we believe an increase in activity will be driven by a number of factors including a recovery in corporate earnings and a pick-up in management confidence.
"Strong corporate balance sheets provide the ammunition for bidders faced with low rates of return on cash, while low funding costs and easing credit conditions in terms of bank lending provide additional support.
"Any sense that the window of cheap financing is beginning to close may spur buyers into action."
M&A motivations
There can be any number of motivations behind a merger or acquisition, including allowing companies to fill gaps in knowledge or their portfolios and to strengthen their position in the industry.
If a company has started to plateau in terms of organic growth it can act as a jump start to its top line too.
Paul Sedgwick, head of investment at Frank Investments, agrees with Jackson on the impetus provided by a potential end to value financing: "M&A will continue to pick up as chief executives see the era of 'ultra-cheap money' coming to an end. Despite the recent rise in returns to shareholders, they remain below the levels of 2008.
"Therefore the focus of corporates will also remain on returning cash to shareholders through increased dividends and share buybacks."
To find out whether dividend payments could be harming your overall investment, read: The hidden downside of dividend payments.
Martin Cholwill, manager of the , says the start of a recovery in M&A is a key theme in his fund.
, one of his holdings, announced an agreed cash offer from European pharmaceutical company Merck at a premium or more than 50% to the prevailing share price, which helped boost his fund's performance during the period.
"I think M&A is also likely to be a mounting theme this year as business confidence starts to recover against a background of improving economic activity. There was a decent pickup in initial public offering activity in the fourth quarter, with successful aftermarkets for many stocks, such as and ," Cholwill says.
Historically there has been a strong correlation between takeover activity and new issues, he adds, which is one of the reasons for his preference for mid caps over mega caps, which he views as typically bid-proof and far more likely to be doing the taking over.
Fidelity's Alex Wright is another fund manager who has benefited from a number of takeovers in the past year, but he still feels M&A has remained at fairly muted levels.
He has produced impressive returns for investors on the and , outperforming his peer group composite in six years out of six, according to FE Trustnet. Over five years his smaller companies fund has returned 419% versus 197% from the sector.
He admits mid and small caps have done very well over the past two years, outperforming their larger brethren by some margin. But at the helm of his latest mandate, , which he inherits from Sanjeev Shah, he will still have a bias to the smaller end of the market.
There is a pressing need for companies to enhance or defend their competitive positions, Wright says, with "sensible and accretive add-ons".
"Often it is the cheaper companies further down the market capitalisation spectrum that fit the bill the best. While this is never a starting point for analysis, I hold shares in a number of companies that must look very attractive to potential acquirers," he adds.
Engineers ripe for the picking
Naming potential takeover candidates is something fund managers are not often keen to do (in case they are wrong or accused of ramping), but stockbroker Killik & Co has stepped into the breach.
Jackson stresses: "It is always difficult to identify the next bid target. However, we would generally focus on companies where there are positive fundamental reasons to hold the shares regardless of whether a takeover emerges."
In a round-up of possible targets, Jackson names , and points out the engineering space has historically been a source of M&A with bids for Charter International, Tomkins and announced over the past few years.
"There are a number of companies that are world leaders in their respective markets, which would provide an attractive add-on for an industrial conglomerate. In particular, we would highlight Weir Group, which is a leader in the supply of pumps and valves to the resources market. The company has recently been linked with of the US.
"We would also highlight , which is the global leader in in-flight refuelling systems and antennae manufacturing, and has leading positions in a number of other interesting market niches."
The recent resolution of the US budget issues may increase confidence on the part of potential buyers and spark a period of consolidation in the industry.
Another industry tipped for consolidation is healthcare, with operators looking to increase market share and protect themselves from the effects of austerity by their government customers.
Jackson highlights , which has long been the subject of takeover speculation, with reported advances from in the past.
Moving onto resources, Jackson does not envisage an active M&A arena in mining over the medium term. He says companies in the sector have bowed to shareholder pressure and embarked on a period of capital discipline.
In oil and gas there is a different atmosphere, however, with and touted as potential targets by virtue of their attractive assets.
Finally Jackson names a number of stocks that have either been the subject of a bid or bid speculation in the past, highlighting , which is rumoured to have been a candidate for buying and carving by the other big players in the tobacco industry.
and are the last two firms on his list. InterContinental is said to have been the target of US hotel group Marriot International in the past and a recent New York transaction has seen it reduce the intensity of its asset base.
Meanwhile, Sainsbury has a strong property asset backing and was the subject of a failed bid in 2007.
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