My top three takeover targets

The environment for takeovers looks ideal, due to a combination of weak share prices, cheap debt and stagnant earnings, even though equity markets have been volatile recently.

Most CEOs are rewarded for improving corporate profits. At the same time, sluggish economic growth means that organic earnings growth is hard to achieve at the moment. As a result, “buying” extra profits – via the takeover of a competitor – makes a great deal of sense right now.

A number of deals have been announced in recent days. The key changes are in the telco space with deal activity at M2 Group and Vocus, as well as UXC. 

UXC

Just yesterday, locally listed IT consultancy firm UXC Limited (ASX: UXC) received a quasi-friendly $1.28 per share cash offer from New York Stock Exchange-listed Computer Sciences Corporation (NYSE: CSC). The bid consists of a capital amount of $1.26 per share plus a fully franked dividend of $0.02 per share in the event the merger proceeds.

UXC's board has granted CSC a five week due diligence period during which both parties will attempt to strike a firm deal. With the Australian dollar weak, UXC is a steal for CSC which, as a multi-billion dollar listed American company can afford to pay a little more here. UXC is currently trading just below the bid value of $A1.28 per share; there exists a good chance of an increase from this price.

M2 Group 

Just months ago, mid-tier telco Vocus Communications Ltd (ASX: VOC) merged with erstwhile competitor Amcom Telecommunications Ltd. 

As I've written previously (see Telco merger mania lifts a gear, May 6), broadband providers like these have a huge incentive to merge ahead of the completion of the National Broadband Network (NBN). Once the NBN is online across Australia, all telco retailers will essentially offer the same service to their customers. As a result, it makes sense now to become as big as possible. Because of this, larger player TPG Telecom Ltd (ASX: TPM) has also taken over WA-based iiNet.

This consolidation process continued last week when VOC unveiled a friendly scrip merger for fellow player M2 Group Ltd (ASX: MTU).

Subject to due diligence and regulatory approval, MTU shareholders will receive 1.625 VOC shares for each MTU share, a deal I expect will proceed unhindered.

Veda

This credit reporting business recently received a $2.4 billion cash takeover priced at $2.70 per share from New York Stock Exchange-listed Equifax (NYSE: EFX). Thanks to some hard-nosed negotiations by Veda's (ASX: VED) board, Equifax has just increased its offer by 4.6 per cent to $2.825 per VED share. 

Interestingly, the local share market is pricing VED shares at a near 5 per cent discount to the takeover price, suggesting fears the deal might yet fall over. Such fears are misplaced.

Bidders do not raise their price and receive a friendly recommendation from a target company's board only to then walk away. And Foreign Investment Review Board (FIRB) approval is unlikely to be an issue given the existence of the Australia-United States Free Trade Agreement. Around $2.69-$2.70 VED shares offer an attractive return to deal completion, which should occur during the first quarter of 2016.

Where to now?

This second-tier telco frenzy continued days ago when TPG (having just digested iiNet) announced a $1bn alliance with Vodafone Australia, a subsidiary of Hutchison Telecommunications (Australia) Ltd (ASX: HTA).

Eventually I expect Hutchison and TPG to merge.  At the same time, Vocus will not stand still in its efforts to obtain maximum market share ahead of the NBN's completion. And Optus Australia (owned by Singapore Telecom) will be concerned at losing its place in the telco hierarchy to these aggressive competitors. 

Either or both TPG and Vocus remain targets post this latest bout of telco consolidation. The rewards for mass-market broadband players after the NBN's completion remain huge as Australians discover more and more things to do online. 

Oil Search 

Recently Woodside Petroleum (ASX: WPL) made a 1-for-4 scrip bid for Oil Search (ASX: OSH). This approach was met with indifference from OSH's board, although WPL remains interested. Although global prices for fossil fuels are low due to fracking technology in the USA combined with a move among Western governments towards alternative energy, large populations in expanding economies like China and India will demand gas for power generation for some time to come. 

And as every good contrarian trader knows, the cheapest time to purchase a summer straw hat is in the middle of winter. WPL's chief executive Peter Coleman has declared his company's bid for OSH is “full price”. Notwithstanding this, WPL is widely rumoured to be testing financial markets for a $2bn-$3bn debt raising which, if it comes off, might be used to sweeten the OSH bid. 

Under Australian takeover law, a bid cannot be increased once the acquirer declares it “final”. Until that time, the offer in question may be described as either “full” or “fair” without hindering the chance of an increase. 

WPL is trying to purchase OSH on the cheap. There's every chance it'll sweeten its offer – possibly with some cash – before this contest is over. 

My three outstanding targets: Fairfax (Domain), Mortgage Choice and Transurban 

There are a number of other ASX-listed companies which might receive some form of corporate activity in the next six to twelve months.

1.  Media business Fairfax Ltd (ASX: FXJ) continues to look interesting despite its suite of old school assets.

Having demerged its AM radio assets (including Melbourne's 3AW – for which I also work) to Macquarie Radio Network (ASX: MRN) just months ago, FXJ will soon look to spin off its real estate classifieds business Domain. 

I expect this demerger to occur in calendar 2016 and Domain could definitely become a target once Fairfax demerges it. Assuming Domain trades at a profit multiple similar to competitor Realestate.com.au (ASX: REA), FXJ shareholders could be in for a much need uplift in company value.

By contrast, News Corp (publisher of Eureka Report) owns the majority of Realestate.com.au, so it would be the only real buyer of the classifieds website – unless it decided to sell, which is unlikely. The majority owner might decide to take the company private, however.

2. Home loan broker Mortgage Choice (ASX: MOC) is a stock I'm persevering with despite its less-than-stellar share price performance in recent times.

The big four banks (NAB, ANZ, Westpac and Commonwealth Bank) require new avenues of growth in an otherwise sluggish loan market – and in-house mortgage brokers remain a good way to expand margins on home loans.

Moreover, MOC has on its register a 20.1 per cent holding by CBA.

3.  The long-term cash-generating toll roads owned by Transurban Group (ASX: TCL) continue to provide value.

Right now TCL is negotiating with the Victorian Government to build a new freeway link in Melbourne's west called the Western Distributor. Because the state government in question wants to avoid taking on too much debt, TCL has submitted a financing proposal for the Western Distributor which involves the commitment of very little Victorian taxpayers' funds in return for an ownership extension on the company's other Melbourne asset Citylink. Should Premier Daniel Andrews cave in on this demand, TCL shareholders will reap the benefits.

And large sovereign wealth funds like Canada Pension Plan and Ontario Teachers' Pension Plan – both of which have previously shown interest in TCL – might be tempted to have another look at one of Australia's largest toll road operators.

One last thing: As for the question of whether Woolworths could become a takeover target – there is some speculation across the market that such a move is not out of the question … my answer is: maybe.

Woolworths, the company, does need some remedial work. One of the large British chains such as Sainsbury's or Tesco would be best placed to do this.