Identifying Further M&A Targets

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This story features COMPUTERSHARE LIMITED, and other companies.
For more info SHARE ANALYSIS: CPU
The company is included in ASX50, ASX100, ASX200, ASX300, ALL-ORDS and ALL-TECH

-Cheap financing, need for scale driving M&A
-Oz companies both targets and acquirers
-Need to use high $A, Macquarie advises
 

By Eva Brocklehurst

The value of merger deals keeps rising and Macquarie thinks management will increasingly fear missing out if they don't act. The broker believes the upturn in global mergers and acquisitions (M&A) has a long way to go. The broker made the call early, when the value of deals lagged the rise in share prices, but believes anyone buying shares in investment banks on the basis of that call would have outperformed. The advisory pipeline is growing, and Macquarie thinks investors should expect more big deals on the M&A front, particularly in the US. Credit Suisse notes there have been around 54 deals in the US$1bn-plus target range, globally, so far this year, considerably higher than for the same time last year.

Support for such deals is ultimately driven by the improving economic cycle and Macquarie notes the US is in the mid-cycle expansion stage, typically when the largest acceleration in M&A activity is seen. M&A deals tend to lag the cycle, while equities start to rise in the late stages of a contraction the growth in mergers doesn't accelerate until mid cycle. Other markets will take their cue from the US. The broker notes the pool of equity-linked advice fees is running at US$36bn and the size of the pool is slowly rising. As a result, Macquarie is bullish on investment banks, particularly those with US exposure. Closer to home, Computershare ((CPU)) is leveraged to the expected rises in M&A and Initial Public Offering (IPO) activity and Macquarie thinks that stock's earnings will also start to rise when the US Fed starts hiking rates in 2015.

Credit Suisse notes the drivers of M&A growth are cheap financing costs – it's cheaper to buy than build – and the fact that CEOs don't need much to be convinced a deal makes sense. CEOs of bigger companies tend to get paid more. One aspect of the current ramp-up in deals, the broker observes, is a distinct lack of pure stock-funded acquisitions. As equities are generally cheap versus cash and debt, it makes sense to use cash or debt to fund the deal. Moreover, tight stock valuation spreads suggest there's no large opportunity for equity arbitrage at present.

Morgan Stanley also considers conditions are improving for what it calls "barrel chasing" in the energy and petroleum sector, as companies seek to grow assets. In the last few months there's been a suite of cash and/or scrip offers. The latest is Horizon Oil ((HZN)) and Roc Oil ((ROC)), which have announced merger plans, with Horizon shareholders to receive 0.724 in ROC shares. Recently, Senex Energy ((SXY)) made a bid for AWE ((AWE)) and Baytex a bid for Aurora Oil & Gas ((AUT)). Morgan Stanley observes some of these stocks were among the poorest performers in 2013. What's driving the deals, in the broker's opinion, is the opportunity to buy cheap assets, amid attempts to create scale and greater relevance. Morgan Stanley thinks this increased potential for mergers among the smaller Australian energy stocks requires a re-rating of the sector. Roc Oil is the broker's key Overweight rating.

Investors should consider tilting towards M&A strategies in Credit Suisse's opinion. In April in Australia there were around $5bn in offers: Stockland ((SGP)) for Australand ((ALZ)), Woolworths SA for David Jones ((DJS)) and Wilmar/First Pacific for Goodman Fielder ((GFF)). This broker also cites facilitators of M&A and IPOs, such as Computershare, as obvious beneficiaries, along with Macquarie Group ((MQG)). Others which may benefit from bid speculation in this broker's view are Adelaide Brighton ((ABC)), where Barro Group already owns 32%, Echo Entertainment ((EGP)), where Genting already holds 6.6%, Incitec Pivot ((IPL)), which may be a good fit for Wesfarmers ((WES)) as the latter has just divested assets, and Nufarm ((NUF)), where Sumitomo owns 20%.

Credit Suisse believes that Australian companies, comfortable with the cheap cost of equity, clean balance sheets and fielding a strong currency could also be potential acquirers, naming Aristocrat ((ALL)), undergeared, News Corp ((NWS)), sitting on cash, Ramsay Health Care ((RHC)), sub-scale in France, with Telstra ((TLS)) and Woolworths ((WOW)) for their Asian acquisition potential. The broker's strategy is thus: first buy facilitators, then be overweight small caps versus the large caps because large caps tend to be the acquirers. A warning: investors need to keep an eye on valuations. Finally, get abreast of what deals have been speculated about in the past.

On the Australian scene, Macquarie believes the fading commodity boom and expected declines in mining capex suggest the Australian dollar is too high relative to the US dollar. The broker thinks Australian companies should use the strong currency to buy overseas assets to access higher growth rates in international markets. If they don't, they may find themselves a target when the Australian dollar eventually falls.
 

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