|Summary: The next phase of the takeovers game will be mega takeovers, reflecting the recent pattern overseas. Here’s some targets to consider.|
|Key take-out: The conditions are right and big Australian companies are on the global M&A radar screen. They cover almost everything, from banks to miners, and beverage groups to telecommunications. Don’t be surprised if a mega bid is launched in the near future.|
|Key beneficiaries: General investors. Category: Mergers & acquisitions.|
Takeover fever. We told you it was going to happen, and now in June 2014 it has returned with a vengeance.
Today – Wednesday June 4 – the ASX announced two key takeover moves: The Frasers Group of Singapore announced a bid for property blue-chip Australand, while retailer Noni B also informed the market it was reviewing takeover offers.
The blitz of M&A (merger and acquisition activity) follows a remarkable run over the last four weeks, with the latest data showing May was the biggest month for mergers and acquisitions in three and a half years.
Australia’s listed companies proposed $18.73 billion worth of takeover deals last month, according to Bloomberg. The total volume was higher than the already impressive $18.19 billion reported in April (which had been a 642% increase on March) and was just shy of the $18.91 billion recorded in December 2010.
Despite the ramp-up in activity, however, Australia still lags the rest of the world.
Indeed what Australia has witnessed to date is regarded by many in the market as ‘phase 1’, where medium-sized companies are engaged in M&A activity.
Globally, M&A has moved ahead to the next phase of takeover fever … mega deals.
Mega-deals, such as the $US68.4 billion Time Warner-Comcast merger and Facebook’s $US18 billion purchase of WhatsApp, have rocked the US, while in Europe Pfizer almost bought out AstraZeneca for a whopping $US122.6 billion, with the bid failing (for now) on a disagreement on pricing. The AstraZeneca deal would have marked one of the biggest takeovers ever.
As confidence continues to improve in the market, it’s only a matter of time before Australian companies catch up and progress to the next phase of the corporate cycle amid slowing earnings and continued low financing costs. Indeed, as the graph below reveals, the Pacific region is trailing both the US and Europe in terms of activity.
The anticipation of large-scale corporate activity spells opportunity for discerning investors. At a time when investors are wary of an ageing bull market, companies which are the targets of takeovers offer a compelling step-up in returns.
In recent months Eureka Report’s takeover specialist, Tom Elliott, correctly predicted takeover targets Australand (ALZ), Envestra (ENV and Treasury Wine Estates (TWE) would receive bids. He also spotted dairy company Warrnambool Cheese and Butter (WCB) before it saw its share price more than double amid a three-way takeover battle.
Subscribers who had invested in each of Elliott’s latest takeover targets, published on April 9, would have already generated an 8% return without considering dividends, compared to just 0% from the S&P/ASX 200 index.
With the current environment in mind, Elliott has now turned his attention to Australia’s most prospective mega-deals (in descending order by their size).
Tom Elliott’s six potential mega deals
ANZ and Standard Chartered – $59.7 billion
Thanks to Australia’s ‘four pillars’ banking policy, there is no chance ANZ Bank could be taken over by any of its domestic competitors. And, as local earnings growth eventually slows (although Commonwealth Bank’s share price suggests this’ll never happen), chief executives like ANZ’s Mike Smith will start looking overseas for acquisitions.
If the ANZ board is smart, they’ll resist the siren-like call of offshore ventures. As NAB’s troubled UK operations demonstrate, the grass is not always greener on the other side of the fence. The aforementioned record share price of banking market leader CBA demonstrates that local fund managers love domestic franchises with solid cash flows and dividends. If ANZ tampers with this formula, it’ll be punished – much as NAB shareholders have been for quite some time.
Nonetheless, the rumours persist that ANZ has its eyes on Standard Chartered. Earlier this year Citigroup issued a note on the possibility of a tie-up between the London-headquartered ex-colonial bank franchise that has a substantial network across Asia and Melbourne-based ANZ.
Chevron and Woodside (WPL) – $34.5 billion
Last week Woodside decided to abandon pursuit of the Israel-based Leviathan project. Like Wesfarmers, this leaves the oil and gas producer with two choices:
If Woodside goes the ‘safe’ route of returning money to shareholders, it’ll almost certainly become a takeover target. The company’s North-West Shelf projects have created substantial value, yet a management group that stands still for too long eventually gets replaced by a more aggressive competitor.
Chevron or BHP Billiton (BHP) are potential buyers of Woodside, although they’d have to pay more than $50 per share to receive a recommendation from WPL’s board. To read more on Woodside’s current difficulties read David Walker today (click here).
Wesfarmers (WES) and Optus – around $27 billion
As Wesfarmers’ (WES) non-retail earnings fall relative to the size of its Coles acquisition back in 2007, the West Australian conglomerate must decide if it wants to remain just that – a conglomerate. Assuming the answer is yes (which I believe to be the case), then Wesfarmers must now be contemplating a few acquisitions.
A move into the telco space makes a lot of sense. Via Coles, Wesfarmers now has a massive presence in the retail space. Having already offered supermarket customers some insurance products, why not branch out into mobile phones and broadband?
For Wesfarmers to expand in the telco industry, two paths present themselves:
Because it seems unlikely Singapore Telecommunications is a seller at the moment, iiNet seems Wesfarmers’ most likely target. Having said that, any asset or company is always for sale at the right price, and WES currently has plenty of financial firepower. (To read more, read Wesfarmers: Just not worth it.
Santos (STO) and Origin Energy (ORG) – $15.9 billion
The recent mega gas supply deal between Russia and China should sound a few warning bells for all the coal seam gas to liquefied natural gas (CSG-to-LNG) projects currently being developed around the Queensland port of Gladstone. The three largest companies involved in the Gladstone region are Santos, Origin and British Gas.
Right now these three operators are competing with each other for workers, expertise, financing and gas customers, with the latter now getting harder to find. Eventually they’ll work out that cooperation rather than competition is in their collective best interests. While I doubt there’ll be a takeover at the top level between Santos and Origin, shareholders stand a very good chance of being rewarded by some sort of merger at some stage between their respective CSG-to-LNG projects.
Origin may also have gained more attraction after it surprised the market in snapping up a 40% stake for the Poseidon permits in the Browse Basin offshore north-western Australia earlier this week.
Transurban(TCL) and Canadian pension funds – $14.2 billion
Having recently raised a considerable amount of money to fund its acquisition of the Queensland Motorways group, Transurban is now the premier toll road stock in Australia.
In the past it has received, and knocked back, takeover offers from a consortium of Canadian sovereign wealth funds (including the Ontario Teachers’ Pension Plan).
Due to Transurban’s growing cash flows and long-term asset franchises, I believe these offshore pension funds will eventually bid again for what is a unique Australian-based company with very secure long-term contracts and highly-attractive potential income streams.
To read more on Transurban see Robert Gottliebsen’s Tapping Transurban’s toll stream (May 2).
San Miguel (or Kirin) and Coca-Cola Amatil (CCL) – $7.2 billion
Back in 2008, then locally owned brewer Lion Nathan made a takeover bid for Coca-Cola Amatil (CCL). This ultimately foundered because Lion couldn’t agree terms with CCL’s shareholder with a 30% stake, the Coca-Cola Corporation of Atlanta, and Lion was soon after snapped up by Japanese brewer Kirin.
In more recent times CCL has changed chief executives from long-time incumbent Terry Davis to Alison Watkins. It has also issued a couple of profit warnings, and its share price has been hit hard.
Its core soft drink franchise remains an attractive asset, however, and potential bidders for the company include both San Miguel of the Philippines and the aforementioned Kirin of Japan.
The recent activity around Treasury Wine Estates (TWE) is instructive here, as it has received a $4.70 per share bid from private equity firm KKR just months after the winemaker issued its own set of profit warnings.
Reviewing your equity strategy
The prospect for these six mega deals is rapidly changing the global market’s perspective on the ASX.
Just days ago, one of the world’s biggest players, Bank of America Merrill Lynch, in its equity strategy update for Australia, said shorting the Australian market has become a dangerous exercise as it has reversed sizeable underperformance for some stocks.
Merrill Lynch identified 24 Australian companies with financial metrics that fit the mould of companies which had been involved in recent M&A transactions.
As well as enterprise value to EBITDA (earnings before interest, tax, depreciation and amortisation) of below eight times, the investment firm looked at low financial leverage (net debt to EBITDA of less than two times) and a free cash flow yield of greater than 6.5% in 2015, exemplifying good free cash flow.
The companies on its list are dominated by miners, including Mount Gibson Iron and Fortescue Metals Group, consumer stocks Myer, Seven West Media and Wotif.com, and mining services stocks WorleyParsons, Downer EDI, Monadelphous, and Mineral Resources.
iiNet and STW Communications (which also features in the edition today) also make the list.
In conclusion, takeover fever is now a reality, with the dollar value of mergers and acquisitions escalating each month. The next phase will be the ‘mega deal’ phase. Don’t be surprised if you wake up one morning to find one of these deals we’ve imagined becomes a reality too.
Tom Elliott, a director of Beulah Capital and MM&E Capital, may have interests in any of the stocks mentioned. The comments published are not financial product recommendations and may not represent the views of Eureka Report. To the extent that it contains general advice it has been prepared without taking into account your objectives, financial situation or needs. Before acting on it you should consider its appropriateness, having regard to your objectives, financial situation and needs.