Investment bankers will predictably talk up 2013’s prospects for equity markets, capital raisings and mergers and acquisitions activity (M&A) in an inevitable rush of newspaper “forecast” stories over the next six weeks.
For once they might be right with bullish M&A predictions.
In a slow-growth world, more companies will find their best earnings boost is through acquisitions.
Aggregate corporate balance sheets are in good shape, sharemarket valuations are depressed, and global corporate bond yields are low. It will not take much to unleash hungry predators.
Macquarie Equities Research is especially bullish on M&A.
In a recent research note, it forecast a multi-year uptrend in M&A to start in 2013, once the United States government deals with its so-called “fiscal cliff”. It expects global M&A deals to rise to $US4.6 trillion by 2015, up more than 80 per cent on current levels.
That does not mean investors should scour the market for takeover targets, a strategy that often results in investment loss and is best left to speculators.
Nor should they chase serial acquirers that grow rapidly by buying other companies only to produce a return that is below their cost of capital and hurts their return on equity.
All too often, serial acquirers take on too much debt, issue too much stock, and crash.
Instead, seek mid-cap companies with a history of astutely buying and integrating rivals, and using acquisitions to deliver a higher return on shareholder funds rather than diminish it.
Such companies are rare: acquisitions tend to destroy rather than create shareholder value over long periods.
I have considered only industrial and financial companies for this analysis and broken the buyers into three categories: companies that successfully make game-changing acquisitions; those that deliver sustained growth through bolt-on acquisitions; and the steady acquirers that tick over with clever deals.
Companies in each category share a common theme: their ability to buy other businesses is a genuine competitive advantage and value-enhancing trait. Investors pay a higher valuation for these stocks because they back management’s ability to deliver sustained fast growth through a mix of acquisitions and organic growth. Such companies are ideally positioned to snap up weakened rivals in 2013.
Three companies stand out in the game-changing acquisitions category: Super Retail Group, McMillan Shakespeare Group and Flexigroup.
Super Retail’s $610 million acquisition of Rebel Group in 2011 looks better by the day. Rebel is delivering solid like-for-like sales growth and confounding the doubters who thought Super Retail paid too much in a weak retail climate. Super Retail tends to make a smart acquisition every few years, build it up and move on to the next one. It has mostly delivered strong shareholder value.
Salary packager McMillan Shakespeare has done well since buying Interleasing (Australia), a car-lease provider, for $208 million in 2010. It is remarkable how quickly Interleasing has delivered shareholder value and the acquisition gives confidence that management can maintain McMillan’s trajectory through organic growth and astute deals.
Point-of-sale finance provider Flexigroup has also captured the market’s attention with game-changing acquisitions. Its purchase of Certegy Australia, an interest-free lending business, for $31 million in 2010, has already paid off several times over and exceeded management and market expectations. A 2012 acquisition, the Lombard interest-free loans and credit-card business, shows early promise.
Telecommunications and technology providers dominate in the second category of companies that grow rapidly through bolt-on acquisitions. It is hard to fault the acquisition strategies of telcos TPG Telecom and M2 Telecommunications (iiNet and Big Air Group could just as easily join this group). Caution is needed at current share prices but watch this group of small and mid-cap telco stocks continue to grow strongly in 2013 as they snap up smaller rivals and take market share from bigger ones. In the tech space, UXC has shown it can deliver rapid gains through organic growth and acquisitions.
Do not underestimate the third category of acquirers that buy smaller rivals without much fanfare and have a conservative approach. Dental group 1300 Smiles stands out: several medical service and professional service groups have come unstuck over the years by acquiring too many businesses too fast. 1300 Smiles almost seems too conservative by comparison and due for a more aggressive acquisition strategy, yet it has delivered excellent shareholder value in the past few years.
Veterinary practice buyer Greencross Vets has shown it can boost shareholder value through acquisitions after a slow start upon listing in 2007. Funeral group Invocare has also delivered excellent shareholder value through well-timed acquisitions and organic growth.
Most stocks on this list look fully valued after big gains in the past 12 months. Yet each deserves a spot on portfolio watch lists in anticipation of improving value, either from an easing share price or stronger signs that growth is being boosted organically or through acquisitions.