Takeover frenzy: the hit list

PORTFOLIO POINT: How can investors make money from the rash of takeovers sweeping the corporate world? Here’s a starting point.

A corporate shopping spree, the likes of which we haven’t seen for years, kicked off this week with deals worth billions of dollars unleashed on an unsuspecting public.

Overnight share raids on television networks. Private equity bids for fund managers. Chinese companies swooping on old Australian mining interests '¦

But if you really want to make money from the rash of takeovers sweeping the corporate world you really need to look beyond the macro factors that make Australia so attractive (see Australia in a sweet spot).

Over the years I’ve created six simple criteria that can help you pinpoint whether a stocks is likely to experience some kind of corporate activity.

• The presence of a strategic shareholding on its register.
• Industry consolidation taking place.
• Substantial changes to the legislative or regulatory environment.
• The occurrence of a previous (and unsuccessful) bid for the company in question.
• Monopolistic and/or duopolistic industry structures.
• Underutilised balance sheets and strong cash flows.

The first thing to note is that our definition of “corporate activity” does not necessarily mean a full takeover. We interpret it to include strategic shareholdings, blocking stakes and demergers – all of which contribute to outperformance over the index.

Want proof?

Look no further than the list of top 10 takeover targets I assembled last July (see Top 10 takeover targets), which have now outperformed the benchmark ASX 300 Accumulation index by a whopping 9.9 percentage points.

As you can see from the following table, the list I assembled last year returned 34.4% or 37% (depending whether it was equally weighted or adjusted for their index weights) compared with the benchmark ASX 300 Accumulation index, which returned 27.1%.

-Tom's Top 10 Takeover Target Analysis
Stock	Start price 14-Jul-09	Dividends paid (not incl. franking)	End price #REF!	% gain/ (loss)	Arithmetic weighting	Portfolio gain/ (loss)	Index weighting 14-Jul-09	Portfolio gain/ (loss)
FGL*	524	27.3	605	20.7%	9.1%	1.9%	1.1%	3.2%
CMJ*	266	22.5	342	37.0%	9.1%	3.4%	0.1%	0.7%
AWB*	102	0.0	148	45.1%	9.1%	4.1%	0.1%	0.3%
ESG	89	0.0	86	-3.4%	9.1%	-0.3%	0.1%	0.0%
ORG	1421	75.0	1611	18.6%	9.1%	1.7%	1.4%	3.6%
STO	1339	64.0	1284	0.7%	9.1%	0.1%	1.3%	0.1%
AIO	139	0.0	167	20.1%	9.1%	1.8%	0.2%	0.6%
AXA*	324	27.8	522	69.7%	9.1%	6.3%	0.4%	3.8%
SEK	393	16.6	723	88.2%	9.1%	8.0%	0.1%	1.3%
RIO	4910	100.8	8298	71.1%	9.1%	6.5%	2.4%	23.2%
CTX	1177	55.0	1245	10.5%	9.1%	1.0%	0.2%	0.3%
Total						34.4%		37.0%
XKOAI	26378		33539			27.1%		27.1%
Out/(Under)performance						7.2%		9.9%
* Subject to some form of corporate activity since 14 July 2009

From my list, four companies – Foster’s, Consolidated Media, AWB and AXA – experienced some form of corporate activity that contributed to returns. The strike rate compares quite favourably given the chances of the average stock receiving a takeover bid is less than 10%.

While it is tempting rest on one’s laurels, new takeovers means new opportunities and with that in mind I have assembled a new “hit list” of the stocks most likely to attract more attention in the months ahead.

Ten Network (TEN)

James Packer’s $260 million overnight share raid on Ten should keep the spotlight on the company in the months ahead, even if it doesn’t lead to a full bid. What we have seen over the past couple of years from our media moguls is acquisition by stealth: they acquire a stake, get a seat on the board, agitate for change and expand under the creep provisions that allow them to buy another 3% every six months without having to launch a full bid.

Ten has been through some hard times lately, but back in 2005 it was quite a success story because it had good cost control and captured an attractive demographic. The recently unveiled strategy that puts a renewed focus on news and current affairs hasn’t been received that favourably by the analyst community. Packer’s interest in the company is more likely to be sports-oriented. As the 50% owner of Consolidated Media Holdings (CMJ), he holds 25% of Foxtel and 50% of Premier Media, which produces sports broadcasts for Foxtel. If Ten and Foxtel were to team up and submit joint bids to broadcast certain events, it could produce enormous benefits for both parties.

Tabcorp (TAH)

This gaming company has reportedly been considering demerging for a number of years and the loss of its Victorian gaming licence from 2013 would have sealed it. Project D, as it was known in-house, would see the casino and wagering operations of the business separated. Tabcorp is doing what Foster’s and CSR have done before it: making itself more attractive by dividing the business in two.

Once again, the casino division would be very attractive to Packer, who recently spent $201 million increasing his stake in Crown (CWN) from 40% to 43% and would recoup vast synergies from a collection of casinos in the Asia-Pacific region. In the absence of a bid, the demerger is still likely to release value, thus meeting our definition of corporate activity.

Coca-Cola Amatil (CCL)

This beverages company attracted a bid from Lion Nathan a few years ago, although the board wasn’t able to get the deal past head office in Atlanta, Georgia. Lion Nathan is now owned by the Japanese brewer Kirin and I don’t believe that its thirst for exposure to the Australian drinks market has been slaked as yet.

From a thematic standpoint, food and beverages companies are undergoing consolidation around the globe, with Kraft snatching Cadbury from Hershey in a $US20 billion deal earlier this year and, of course, Foster’s decision to separate its beer and wine divisions.

ConnectEast (CEU)

Value investors have a hard time coming to grips with this one but it’s hard to argue with the attractiveness of its toll road assets to rival Transurban (TCL), itself a the recipient of multiple bids from Canadian pension funds. These kinds of assets are sought-after because of their long life span and inflation-linked returns.

Carsales.com (CRZ)

There are a handful of good businesses in this space, including REA Group, Wotif.com and Seek, but this is the one that really ticks all our boxes. This company has all the advantages you would expect from a first mover in the space with significant market share and strong competitive advantage. This type of company is very attractive to “old world” media companies such as Fairfax and News Limited, which have been ceding ground ever since the online operators arrived on the scene.

Suncorp-Metway (SUN)

In the financial sector there are again, a number of options including Bank of Queensland and Bendigo & Adelaide Bank, but it’s Suncorp-Metway that is the standout for me. While neither of the banks listed would be prevented from being bought out, it is Suncorp-Metway that would be the most attractive in a scenario where the acquirer would break up the banking and insurance arms.

JB Hi-Fi (JBH)

The electronics retailer has been a star performer since it was listed in 2003. In this particular case I am attracted to two aspects of the company. It is easily the best performer in the sector and while that doesn’t immediately warrant inclusion in our list, there was considerable speculation that it was approached by Woolworths. This was never confirmed, but I believe there was a great deal of truth to this story and as such we will be watching very carefully.

CSR (CSR)

Building materials companies are often looked at by value investors because of their low multiples and place in the cycle. That doesn’t concern me so much. I’ve been following CSR very closely since it set about pursuing the dual track demerger, which led to the sale of the sugar division to Wilmar International for $1.75 billion. There are estimates that have CSR returning anywhere between 30¢ and 80¢ to shareholders as a result of this deal, and we feel confident in predicting further outperformance on the basis of the corporate activity to date.

IAG (IAG)

Most investors would be compelled to walk away from IAG because of its disappointing track record, but having followed takeovers for many years we know that the first approach is rarely the last. If you cast your mind back to 2008 you’ll remember that QBE launched an $8 billion bid for the rival insurer but eventually walked away. Companies rarely put this much effort into making an acquisition only to forget about, unless they are compelled to by the regulator.

Macmahon Holdings (MAH)

This is a bit of a tricky proposition following its earnings downgrade, in which it slashed forecasts from $36–40 million to $20 million and the subsequent sell off that saw it shed more than 25% of its value. There are a selection of different companies such as Nufarm and DownerEDI which, like Macmahon, are higher risk propositions but where corporate activity appears imminent. However, there’s the question of catching a falling knife. The main reason for its inclusion on this list is Leighton’s presence on the register with a 19% holding.

Tom Elliott, the managing director of MM&E Capital, may have interests in any of the stocks mentioned.