Beyond Toll: More takeover targets to watch

After today’s unexpected $6.5 billion takeover bid for Toll Group, we look at other potential targets.

This week's stunning and audacious $6.5 billion bid by Japan Post for Toll Holdings is a key takeover deal. It is one of the biggest in the world this year and the largest local deal since the SAB Miller takeover of Fosters back in 2011.

Moreover, the Toll deal has ignited interest in takeover activity because Japan Post have offered a whopping 50% premium to the trading value of Toll stock which had been tracking on the local market as a relatively unexciting industrial play in recent times.

In recent months Eureka Report has engaged Tom Elliott whose funds management group Beulah Capital has run a specialist takeover fund to nominate his outstanding takeover picks. On the basis that Toll is very likely to trigger further merger and acquisition activity ... here's a recap of Tom's recent selection of top takeover targets. 

- Managing Editor James Kirby

Summary: Logistics business Toll Group has backed a $6.5 billion takeover offer from Japan Post, valuing the company at a 53% premium to the three-month trading average of Toll shares. With the local share market rising strongly, it’s a good time to consider other potential takeover targets. Activity is likely in the resources, financial services, agribusiness, utilities and telecommunications sectors.

Key take-out: Although commodity prices remain weak, the only resources company I’d consider a key target is Rio Tinto.

Key beneficiaries: General investors. Category: Shares.

Challenger (CGF)

This company runs both a life insurance business specialising in annuities and a funds management arm. It is leveraged to both the growth in superannuation assets (almost guaranteed by Australia’s rising super levy), and the increasing number of baby boomers looking to fund retirement using their accumulated savings.

Recently CGF’s share price fell after one of its annuity products was adversely affected by a Department of Social Services ruling. In the longer term this hiccup shouldn’t affect Challenger’s core business. In addition it’s highly likely the David Murray-chaired Financial System Inquiry will encourage greater reliance on retirement income products – especially in the aforementioned era of ultra-low interest rates.

Mortgage Choice (MOC)

Since I wrote about this company in Eureka Report last year (see Three hot takeover buys, January 29, 2014), MOC’s share price has risen, fallen and risen again. I still think this stock remains a takeover target for one of the major banks looking to grow in the super-competitive mortgage space. Although customers prefer their mortgage brokers to be independent of the banks whose loans they sell, MOC’s major competitor (Aussie Home Loans) manages to prosper as a wholly-owned subsidiary of a Big Four bank.

At present MOC has on its register the Commonwealth Bank (CBA also controls Aussie Home Loans with an 80% interest). Eventually CBA will look to increase this ownership, which under Australian takeover rules can only occur with a bid for all the outstanding shares.

Nufarm (NUF), Graincorp (GNC) and Bega Cheese (BGA)

Agricultural stocks are a good place to be right now. Weather patterns generally have been favourable in key Australian farming regions and Asian demand for Western foodstuffs (e.g. wheat, beef and dairy) continues to grow.

The three listed companies I like in this sector are Nufarm (agricultural chemicals), Graincorp (grain handling) and Bega Cheese (a dairy business based in, er, Bega NSW). NUF is the pick-and-shovel seller to the sector. Japan’s Sumitomo owns a large minority stake in the company, and will eventually look to take it over completely.

Twelve months ago newly-installed treasurer Joe Hockey declared a generous bid by US predator Archer Daniels Midland (ADM) for GNC contravened Australia’s national interest. Since then ADM has maintained its 20% stake in GNC, and thanks to a bone thrown by Mr Hockey has permission to increase this shareholding to 25%.

Eventually I think ADM will present the treasurer with a restructured bid for GNC.

While the original GNC bid was being fought, Warrnambool Cheese and Butter shareholders enjoyed a competitive takeover ultimately won by Canadian dairy giant Saputo. Since then Bega Cheese shares have traded in a tight range of $4.80 to $5.40 as investors speculate on a similar bid. BGA closed at $5.05 on February 18.

With a market cap of $770m, Bega is only a fraction of Warrnambool’s size. Listed dairy companies are, however, few in number, making BGA a definite target for another foreign bidder.

Transurban (TCL) and Spark Infrastructure (SKI)

Just six months ago it seemed the next move in Australian interest rates might be up. Since then, however, the European Central Bank has embarked on a program of money printing, China has slowed and the Australian economy is weaker.

As a result of these factors interest rates are steady and may even fall further. In this environment shares with predictable cash yields are highly sought. Telstra (TLS) has been a prime recipient of this “hunt for yield” with its share price hitting multi-year highs recently.

While I doubt TLS will be taken over, other yield stocks such as Transurban and Spark Infrastructure are real targets.

TCL has received bids in the past, primarily from infrastructure-loving Canadian pension funds. Fortunately for TCL shareholders, the company’s board rejected such overtures and its shares have continued to rise. At a cash yield of 4.1% (plus some franking), Transurban isn’t cheap – but any debt used to finance its potential purchase is far cheaper.

Spark is a regulated energy utility with highly predictable cashflows. Its yield hovers around 5.2% unfranked (the latter due to its trust structure), with gradual payout increases forecast for years ahead.

The same longer term pension funds looking at Transurban may eventually cast their eyes over Spark. Around the developed world the aforementioned bulge of retiring baby boomers need stable incomes to support them in their twilight years. Thus providers of annuities (CGF) and generators of cashflow (TCL and SKI) are attractive businesses.

Oil, gas and iron ore

The recent collapse of prices for these commodities has been well covered in Eureka Report. From a takeover perspective, is it time to catch the falling knife and buy quality producers at bombed-out prices? Well, right now the only significant resources company I’d consider a key target is Rio Tinto.

Oil and gas producers have been hard hit by the war for market dominance between Saudi Arabia and the North American “frackers” i.e. the American fracking specialists which have greatly boosted US oil capacity. 

Because Saudi is a state and not a company, it’s capable of pumping excess oil for years to destroy the competition. For this reason it’s too early to expect takeover action at the likes of Santos or Woodside whose share prices have already suffered.

Iron ore prices have slid because of output increases from the likes of BHP, Brazil’s Vale, Gina Rinehart’s Hope Mining and Rio Tinto. Casualties of this production war include Atlas Mining and Fortescue Metals, neither of which are making any money with ore below $US70 per tonne.

Last year Rio received a merger proposal from Swiss-based Glencore. While this was never put to shareholders, Glencore will be watching Rio’s reaction to the iron ore price slump with great interest. Should these two companies merge, around $4bn in synergies could be extracted from the deal.

In the meantime, Rio’s low cost of production means it remains healthily cashflow positive at a time when smaller producers are struggling. Eventually rationality will re-emerge amongst the big iron ore miners, and Rio will be one of the survivors. Therefore it remains a target.

Automotive Holdings Group (AHE)

This company is a Perth-based automotive group that manages the largest number of car dealerships in Australia. It also runs a refrigerated logistics division. On AHE’s register with a 19.9% holding is fellow car dealer AP Eagers (APE) – based in Queensland, and the second-largest such business in this country. 

Both companies have market caps around $1 billion and record solid profits when Australian auto sales top one million vehicles per annum.

The widely fragmented car selling industry is ripe for consolidation. In my view it is only a matter of when – not if – APE approaches AHE with a merger proposal.

Combined, the two companies would account for over 10% of total new cars sold here every year. In the meantime AHE trades on a price-earnings ratio of around 11.5 times and has a cash yield of over 6%, both of which are comforting metrics.

Ten Network Holdings (TEN)  

For several years now Ten Network (TEN) has been a plaything of sorts for James Packer, Lachlan Murdoch and Gina Rinehart. Separately, it’s also been a key investment for television tycoon Bruce Gordon who appears to be the least willing to sell.

Despite the collective abilities of this group, they have all dusted hundreds of millions since buying into Ten. Now potential suitors such as Discovery Communications, Time Warner, Paramount and private equity specialist Hellman & Friedman are running the ruler over Australia’s smallest commercial free-to-air network.

After rumours of bidding interest filtered out, Ten’s shares rallied from 18c to 27.5c. At this level the indebted and unprofitable broadcaster looks expensive. Over the longer term, free-to-air TV will eventually succumb to the internet. The best companies like Ten can hope for are to generate as much cash as possible while older people still watch television. Ten closed at 21c on February 18 and in a contested bidding war, Ten’s price may get to 35-40c – but if the potential acquirers walk away it’ll be back at 18c before you know it. Not one for the faint-hearted.

Treasury Wine Estates (TWE)

As one of the last great independent collections of wine brands, TWE was always going to attract merger interest – it controls Penfolds, Rosemount and Wolfblass to name just three.

Early last year a group of funds led by buyout specialists Kohlberg Kravis Roberts (KKR) lobbed a $5.20 per share bid on the table.

After several months of deliberation the TWE board claimed that 50% of the company’s shareholders felt the offer was inadequate and the bid was rejected.

TWE’s shares then hovered around the $4.50-$4.60 mark, rising to close at $5.16 on February 18. When a takeover falls apart I like to see the erstwhile target’s share price decline at least 20% before buying in. Right now TWE is in no man’s land with its shares just slightly down from KKR’s offer.

While the lower Australian dollar is positive for TWE’s large but unprofitable US business, KKR et al won’t be back until the TWE share price declines further. I’d expect action again once this stock slips to around $4.20.

iiNet Ltd (IIN)  

Although I’ve written about this second-tier telco a number of times before, industry momentum still suggests a round of consolidation amongst the medium-sized players. Right now locally-listed Vocus Communications (VOC) is moving to take over Perth-based Amcom Telecommunications (AMM). Combining their respective east and west coast-based fibre optic networks makes a great deal of sense.

Unfortunately, fellow mid-cap telco TPG (ASX code TPM) refuses to hand victory to VOC on a plate and has recently purchased 6.7% of AMM.

To date TPG has described this stake as merely a “strategic investment”. Clearly this is nonsense. TPG will either demand a higher price for its shares (from which all other AMM shareholders would benefit) or make a bid of its own. Either outcome is good for AMM.

This land grab for customers will not cease any time soon. Assuming the NBN is eventually built, all telcos big and small will be able to offer broadband customers largely the same speed and service. Profitability will be determined by size, with the larger companies outperforming the smaller.

iiNet and TPG are the next cabs off the rank here. A merger between the two is quite possible. Alternatively, the combined VOC/AMM might have a crack at either or both. In the meantime broadband spend is a bright spot in an otherwise tepid Australian economy.

DUET Group (DUE)

Notwithstanding threats by US Federal Reserve chair Janet Yellen to lift American interest rates sometime soon, cash yields remain at multi-generational lows. This keeps investors hungry for strong and stable dividends, and local utilities have proved adept at supplying these.

Right now we hold toll road operator Transurban Group (TCL), electricity carrier Spark Infrastructure Group (SKI) and pipeline operator Duet Group (DUE). These stocks’ respective cash yields range from 4.2% to 6.6%, and all enjoy the relative freedom from competition that makes good utility companies great.

TCL has been the subject of takeover interest before from various Canadian pension funds. Its attractiveness hasn’t declined in the intervening period, and I expect it’ll be bid for again at some stage.

Just months ago Cheung Kong Group successfully acquired Envestra (ENV), trumping a rival bid from pipeline operator APA Group (APA). Because super profitable utilities are a game of scale, DUE might eventually catch APA’s attention also.

SKI enjoys similar regulated returns, and should therefore prove attractive to predators in the medium term. Due primarily to their strong and defendable dividend yields, all these businesses are ones I’d be happy to hold in the absence of any bids. Any further merger proposals in the infrastructure space would be icing on an already attractive cake.


Tom Elliott is a director of Beulah Capital and MM&E Capital.