Understanding the rise in mergers and acquisitions

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When the share-market does not see value or investment merit in a particular stock the stock’s share price will recede. This could be because the company’s earnings (i.e. profit) outlook is poor (e.g. Bega Cheese Ltd) or perhaps the industry in the which the company operates is struggling (e.g. ARN Media Limited).

But often someone or a company will see value where the share-market does not. The logical outcome of this is one of the more interesting aspects of investment: the merger or the acquisition. Or, in jargon: M&A.

Merger & Acquisition activity types

There are four sources of M&A activity:

Strategic

This is where a company buys or merges with another company to make their combination better or more “strategic”. Such activity might be in response the target company having, for example good assets and weak management or the share price has fallen for emotive reasons and a critical strategic opportunity had been overlooked.

The takeover of Costa Group (the horticultural company) by a consortium of North American food-based investors in February is an example.

Private Equity (PE)

PE (i.e. investment in unlisted companies) 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.

A recent Australian example was the takeover of Virgin Australia by Bain Capital.

‘SPAC’ (Special Purpose Acquisition Company)

SPACs were very active in US markets in the 2020-2021 period, when very low interest rates encouraged investors to provide capital to a management team. A SPAC is simply a small listed ‘cash box’ company with the sole aim of taking a private company public. Listing via a SPAC can be easier than the traditional IPO route.

The listing of Trump Media by a SPAC last month is an example.

Venture Capital (VC)

VC is a form of private equity and a type of financing for startup companies and small businesses with long-term growth potential. Venture capitalists often purchase a company 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.

Global Mergers & Acquisition activity

M&A activity across the globe has declined after a post-covid bloom.

Graph that shows the global mergers and acquisitions per year based on the M&A activity type.

In Australia, 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 this year a merger involving Paragon Care, and a bid for MMA Offshore.

Reasons for a resurgence in Australia?

There are several reasons why M&A activity 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 increase in M&A are:

Low growth environment. The recent profit 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).

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.

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).

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).

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)

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)

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:
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)
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 an increase in Mergers & Acquisitions

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 our holdings in Boral and PushPay.

In other cases, we seek to assess the likelihood that a firm asset would be attractive as an addition to existing businesses.

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 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.

Read last month’s Wealth Intelligence, ‘is superannuation still your most efficient wealth creator?’

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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.