AIM's most obvious takeover targets

High profile overseas takeovers such as SoftBank's bid for ARM are highlighting the attractiveness of many UK quoted companies to a foreign bidder. It is not just larger companies that will come under the scrutiny of international companies, there are plenty of companies on AIM, in the technology and other sectors, that have strong market niches and could be snapped up by predators at an attractive price.

Of course, it takes some time to plan a takeover, so the ARM bid will not have happened purely because of the market uncertainty surrounding the 'leave' vote in the EU referendum and the subsequent decline in the sterling exchange rate. Whether or not bidders were already analysing potential bids, the present conditions will provide opportunities.

There has already been some Mergers and Acquisitions (M&A) activity from foreign bidders for AIM companies. North American software consolidator Constellation Software has tabled an offer for Bond International Software, which is in the process of selling off its businesses with the intention of returning cash to shareholders following a strategic review. This bid, though, has been brewing for some time.

Multinationals may look to acquire UK companies with strong positions in their marketsConstellation made the approach following the ending of a standstill agreement late last year and it originally tabled the potential offer of 105p a share prior to the EU referendum, although there had already been some sterling weakness earlier in the year.

The bid values Bond, whose board has rejected the offer, at £44.2 million. This bid appears increasingly attractive for Constellation following the further decline in sterling after the referendum.

In May, Bond sold Strictly Education for £7 million plus £4.3 million to be paid within six months and there were plans to distribute some cash to shareholders. It was after this disposal was announced that Constellation converted non-voting shares and this gave it nearly 30% of Bond, which recently announced the sale of its payroll division for £27.4 million plus the assumption of £2 million of debt.

This deal requires shareholder approval and Constellation intends to vote in favour, but it is a condition of the bid that no deal is made to sell the recruitment software division.

These are good businesses whether or not they attract a takeover offerIt is not just consolidators that will be interested in acquisitions. A multinational can pick up UK companies that have strong positions in their markets that is not reflected in their ratings.

Here are some AIM companies that could be potential targets for larger overseas companies. This does not mean to say that they will attract a bid, but there is a chance that someone may consider an offer.

All of these companies have significant international earnings and they will benefit from the weakening of sterling against the US dollar in particular. Most importantly, they are good businesses whether or not they attract a takeover offer.

IQE - 22.88p

Epitaxial semiconductor wafers supplier IQE is a technology company with a low rating and strong growth prospects from new product areas. It would require a significant investment to replicate the production facilities that IQE has in the UK, US and Asia.

The interim trading statement confirmed that revenues and profit will be higher in the first half of 2016 thanks to a strong performance from photonics, which along with other newer product lines has offset the lack of growth in wireless.

IQE will be an important component supplier for the Internet of ThingsRevenues are currently dominated by wireless, where the market has suffered a dip in recent times.

This is still a growth market, as newer phones include more chips, and the other parts of the business, which are at an early stage, will accelerate group growth. Importantly there is spare capacity to cope with growth.

IQE is, and will be, an important component supplier to high growth areas, such as the internet of things, medical technology, energy efficiency, including solar and LED, robotics and unmanned aerial vehicles.

Full-year pre-tax profit is expected to increase from £17.6 million to £19 million and the business is cash generative even after capital investment. That puts the shares on a modest eight times earnings.

Semiconductor-related businesses tend to be cyclical so IQE is unlikely to be on an exceptionally high rating but the growth prospects for the newer product areas and the US dollar revenues make the shares look undervalued.

Gooch & Housego - 900p

Gooch & Housego is a world leader in the photonics technology market with manufacturing bases in the UK and US. The company covers the whole spread of activities from research to manufacturing components and systems for customers. The customer base covers, aerospace, defence, life sciences, industrial and scientific markets.

There are not many opportunities to acquire a business like Gooch & HousegoIndustrial still dominates revenues, but defence and life sciences are both growing strongly.

Nearly three-fifths of revenues are generated in US dollars from North America and Asia Pacific. This year the company had a weak first quarter but stronger trading since then means that there will be profit growth this year.

Gooch & Housego has one of the higher ratings among the companies in this article, but there are not many opportunities to acquire this type of business with its spread of activities and sectors.

Recent add-on acquisitions have widened the group's capabilities and increased exposure to the defence sector. Net cash will still be £12 million at the end of September 2016 even after these purchases. The shares are trading on 22 times prospective earnings for the year to September 2016, falling to 20 next year.

The shares are not a bargain on the basis of the short-term prospects, but this is a quality business that deserves a rating that reflects its strong market position.

Instem - 232.5p

Instem is a consolidator in the life sciences IT market. The company provides software and services to help pharma companies to develop commercial drugs more efficiently and also to enable them to fulfil reporting and compliance regulations.

Growth is coming from the implementation by the Food & Drug Administration (FDA) in the US of the Standard for Exchange of Non-clinical Data (SEND), which has to be adhered to by all drug developers.

SEND became mandatory at the end of 2014 and Instem won the majority of the SEND business during 2015. Instem's strength in the SEND market would make it a good add-on for a rival.

Instem pays dividends and has net cash that will continue to grow from operationsThere is always plenty of regulation to provide opportunities for Instem. The European Medicines Agency (EMA) is implementing the standard developed by the ISO for the identification of medicinal products (IDMP). Companies will have to submit information and data on medicines and medical products in line with this format.

At the end of May, Instem acquired regulatory information management services provider Samarind for up to £2.5m, which brings new customers to the group and is earnings enhancing. The software can be cross sold to SEND customers. This helps to offset the dilutive effect of raising £5 million from a placing earlier in the year in order to finance acquisitions.

Instem pays dividends and has net cash that will continue to grow as cash is generated from operations. A pre-tax profit of £2.2 million is forecast for this year, rising to £2.8 million in 2017. The prospective 2017 multiple is 18.

Cello - 98p

It is not just technology companies that could attract a bid. Marketing services provider Cello has built up a small but highly significant business focused on providing market research and services to the health and pharma sector. The acquisitions made in order to build up the division have been combined under the Cello Health brand in the UK and North America. Start-up costs for new operations have held back short-term profit.

Prospective yield is now 3% and Cello is considering a more generous dividend policy.Cello Health has 21 of the top 25 global pharma companies as customers and it is increasingly putting resources into the biotech sector and digital services where growth is fastest.

The main focus is medical communications, marketing, analytical support and market research. Few competitors cover all of these areas so Cello could be a good fit for a rival, particularly one owned by a multinational marketing company.

Margins have been improving at Cello Signal, the smaller, corporate-focused marketing services division, and trading has been going well in the first half of 2016.

The Cello share price has been held back by a VAT dispute with HMRC. Cello had provided for a £3.2 million charge relating to the charging of VAT on charities business, which had been thought to be zero rated.

In May, this was increased to £5.3 million, including penalties and interest, but this should be the final figure and some could be recovered from clients. Net debt was £4.2 million at the end of 2015 but the VAT payment will increase that figure.

The prospective yield is currently 3% and the board is considering an even more generous dividend policy. The shares are trading on 11 times prospective 2016 underlying earnings before restructuring and VAT costs.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.