Revisiting takeovers

© 2024 First Samuel Limited

This week’s Investment Matters will focus on mergers and acquisitions (M&A) in the share market. M&A is often an important influence on share price performance, particularly among small-to-mid capitalisation stocks. 

We examine the drivers of M&A and discuss the outlook for the remainder of 2024. 

Read previous week’s Investment matters about Profit reporting season.

The Markets

This week: ASX v Wall Street

FYTD: ASX v Wall Street

2023 – the weakest year in a decade for M&A 

From a global perspective, M&A in 2023 was at its lowest level in a decade. The outworkings of COVID economic disruptions (i.e. delivering ambiguity around ascertaining ‘normal’ trading/profitability levels for many businesses) and rising inflation/interest rates meant that ascertaining fair valuations and access to cheap debt finance was challenging. In combination, these factors kept buyers on the sidelines in 2023. 

The chart also highlights the four sources of M&A activity.  

• Strategic refers to a company buying another company to make their combination better or more “strategic”.  
• PE refers to private equity and is usually the scenario in which the private equity firm is confident of adding value with a change of management or focus that will allow the company to be resold within a 3-7-year timeframe.  
• SPAC or Special Purpose Acquisition Company referred to a trend in mainly US markets in the 2020-2021 period, in which investors provided a “blank cheque” to a management team to source businesses to buy. And finally,  
• VC refers to Venture Capital, where a company is purchased by owners who are confident of benefiting from the future growth of the business and are confident of buying the company, often from founders, for a price lower than the VC firm’s expectations. Unlike the former categories, VC purchases do not necessarily see value being created through combination or change. 
  

However, the return of M&A activity in the latter part of 2023 and into the new calendar year has been a key driver behind the outperformance of small to mid-cap stocks relative to the top 100 ASX-listed stocks in the past two quarters.  

First Samuel’s clients’ portfolios have been a recent beneficiary from increases in share prices attributable to takeover bids in stocks such as Costa Group, PushPay, United Malt and more recently in 2024 a merger involving Paragon Care, and also a bid for MMA Offshore. 

Source: USB

Reasons for a resurgence? 

There are several reasons why M&A has picked up and may continue to support share prices, particularly in the small-to-medium market. 

Various circumstances are influencing individual deals; however, we believe the primary factors driving the pick-up in M&A are: 

1. Low growth environment. The recent reporting season revealed that driving revenue growth is complex and likely to remain so for some time. In this environment, companies aspiring to grow often need to take the initiative and do something transformational – like acquiring to add a complementary operation and extract synergies or entering a new market or geography.(e.g. Southern Cross & ARN Media) 

2. Interest rates appear to have peaked and have stabilised. This has given boards and management teams with a solid corporate balance sheet the confidence to borrow and commit to M&A. 

3. Valuations remain attractive – particularly in the small industrials sector of the market. Despite the rally we saw towards the end of last year, many small caps trade at discounts to their large capitalisation peers. (e.g. Pact Group being taken private by its largest shareholder) 

4. Some companies are managed poorly, often leading to mispriced assets. This creates the opportunity for quick wins by experienced operators who can use their expertise and execution capability (e.g. the Paragon Care merger with Clifford Hallam Health, and the KKR takeover of United Malt) 

5. Balance sheet efficiency opportunity– on some occasions, hidden tax losses or dividend imputation credits may be valuable in the hands of an acquirer (e.g. Cyan’s takeover of MRM will allow quicker utilisation of Singaporean tax losses) 

6. Adding new capability – in some cases, a company may be interested in adding a new business line in an adjacent market or a new technology or capability that enhances its business (Genex bid for renewables assets by J-Power) 

7. PE arbitrage – sometimes, stocks trading on higher multiples may elect to use their higher-valued script to acquire within or in overseas markets (e.g. Steadfast Group’s progressive expansion via acquisition in the US) 

For international acquirers, additional factors may also include. 

8. Low Australian dollar. The low Australian dollar (AUD vs USD) compared to its long-term history makes Australian companies more attractively priced for overseas acquirers, particularly if they have operations overseas. (e.g. CSR and Sant Gobain) 

9. Growing population. The Australian market remains attractive to many overseas companies given Australia’s high population growth compared to many other developed markets, where populations are declining or barely growing. 

Potential Beneficiaries from a lift in M&A 

First Samuel’s investment process is designed to anticipate the potential for value creation available to potential suitors. In many cases, we will directly consider the value of the assets when held by others directly. Such an approach was vital in the valuation of Boral and PushPay holdings. 

In other cases, we seek to assess the likelihood that a firm asset would be attractive as an addition to existing businesses. This was important in the assessment of  

Within the current crop of First Samuel portfolio stocks, we identify the following names, amongst others, as potential share price beneficiaries due to advances from suitors. 

• Cleanaway (CWY)—A business with real assets like Boral, we think Cleanaway would be of interest to Seven Group, whose financial and operational disciplines would enhance franchise and shareholder returns. 

• Bega (BGA) – Bega owns a range of food manufacturing assets, which are often globally traded. Bega itself purchased a range of its holdings from global players such as Mondelēz International ($92bn USD market cap), and the Canadian multinational Saputo ($8bn market cap). With a globally transparent market for these assets, the opportunity for companies with stronger currencies to exploit any mispricing in the Australia market is substantial. 

• Aurelia Metals (AMI) – Metals Acquisition Corp (MAC) is a better-capitalised mining company that operates assets around the Cobar region where Aurelia operates. The combination of processing capabilities would be valuable to a merged entity. 

• ARN Media (A1N) – While it is currently itself involved in a takeover for Southern Cross Media (SXL), partnering alongside Anchorage Capital, in time A1N may itself be acquired. Seven Group Holdings has already acquired a stake of just under 20%. This business would be a natural addition to Seven’s media interests, adding digital capability amongst its iHeart Podcast assets. 

• Earlypay (EPY)—EarlyPay is a natural acquisition target for its major shareholding, COG Group. The synergies available in the form of higher revenue and lower costs are material to both companies. 

There are, of course, many companies that may also benefit from a pick-up in corporate activity because of the nature of their business operations. These stocks may benefit from a theme-driven/cyclical shift towards them by investors. Examples in include Macquarie Group. 

Macquarie Group runs a significant investment bank that provides corporate advisory services and is also an asset owner, both as a principal investor and via its Asset Management business. In Macquarie Group’s 3Q trading update, it noted that M&A activity had been at a 10-year low, which provides us comfort that there is significant leverage across its business. 

We see the growth in M&A as supportive of both the markets as a whole and our portfolio positions. With M&A unlikely to help the already expensive, most extensive stocks in the markets (e.g. BHP and the Big 4 Banks), any support from M&A is likely to help facilitate the transition of this market from a period of smaller company underperformance towards smaller company outperformance. 

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The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.