The top 10 takeover targets for 2012

PORTFOLIO POINT: I’m expecting M&A action will gather pace in 2012. Here is my list of the 10 stocks most likely.

Takeovers have been somewhat thin on the ground during 2011 (due primarily to the ongoing eurozone crisis), but there is every chance that merger and acquisition (M&A) activity will pick up in 2012. My reason for saying this is that by any number of measures equities are looking very cheap at the moment – and below-average share prices often lead to predatory behaviour.

In July 2009 I selected my then Top 10 takeover targets for Eureka Report subscribers. Of the 10 stocks selected, four – Foster's Group (FGL), AWB (AWB), Eastern Star Gas (ESG) and AXA-Asia Pacific (AXA) – subsequently received bids. This suggests that my six criteria for takeover target selection work well at predicting corporate activity. They are:

• 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 cashflows.

So, what stocks should investors consider for the year ahead? Here, in no particular order, are my Top 10 for 2012:

Coca-Cola Amatil (CCL)

Since mid-2009, first Lion Nathan and now Foster's have been picked off by offshore buyers. This leaves CCL as the last large and locally listed beverages company in which Australians can invest. With its strong portfolio of brands and exposure to growth markets in parts of Asia, CCL would be a natural target for a firm like the Philippines' San Miguel. Remember also that CCL's parent, The Coca-Cola Corporation of Atlanta, has a strategic 30% stake in the company, which it has indicated in the past it would sell under the right circumstances.

Carsales.com (CRZ)

Over the past decade, internet companies such as CRZ, Realestate.com.au (REA) and Seek (SEK) have taken on and beaten the old print classifieds businesses of groups like Fairfax Media (FXJ). While I think that each of the above three internet stocks listed could receive a takeover, I particularly like CRZ because it truly dominates its sector – new and second-hand car listings. This is one to buy on a weak day due to its hefty price/earnings multiple: approximately 18 times historical earnings.

Echo Entertainment (EGP)

Formed out of the demerger of Tabcorp Holdings (TAH), EGP is a bit of a no-brainer when it comes to takeover potential. The company's two main assets are its casinos in Sydney and the Gold Coast, and these are of obvious interest to Australia's other gambling mogul, James Packer. At present Packer owns 4.9% of EGP and has made it clear that he'd like EGP's ownership cap of 10% lifted. Australian casinos are excellent monopolistic businesses in their respective markets, and Packer, via Crown (CWN), would like to add to his portfolio.

Gloucester Coal (GCL)

As evidenced by the recent battle for Macarthur (MCC) and merger of Whitehaven (WHC) with Aston Resources (AZT), Australian coal companies are in great demand right now. Given this, it's probably only a matter of time before GCL's 64.5% shareholder, Hong Kong's Noble Group, launches a mop-up bid for the third of the company it doesn't already own.

GrainCorp (GNC)

As is the case with coal stocks, Australian agricultural businesses are also of interest to offshore buyers at the moment. Over the past 12–18 months, companies like AWB and ABB Grain (ABB) have disappeared from the local bourse, and I believe GrainCorp will be the next target on the list. Following the recent good rains in eastern Australia, the company's earnings in the short-to-medium term are effectively underwritten, and the board has approved high special dividends (on top of the ordinary dividend payments) to shareholders. Canada's Agrium is a potential buyer of GNC.

Insurance Australia Group (IAG)

Several years ago, rival insurance group QBE made a cash and scrip bid for IAG, worth $4.20 a share at the time. IAG has since struggled to get its share price back above this level, and the annus horribilis of the past 12 months – natural disasters combined with weak investment markets – has taken its toll. In the past fortnight, however, IAG's shares have revived on the back of rumours that WA conglomerate Wesfarmers (WES) is interested in making a bid. WES already owns a medium sized insurance business, and adding IAG would catapult it into the big league. Another stock to buy on weakness.

IOOF Holdings (IFL)

Now that the Big Four banks are prevented from expanding their lending footprints via acquisition, they are looking to other business areas to grow future profits. As evidenced by Commonwealth Bank's (CBA) recent purchase of Count Financial (COU), wealth management is a sector ripe for expansion. In the listed arena, the most obvious target for this is IOOF, which could well attract the attention of either CBA, Westpac (WBC) or National Australia Bank (NAB), with ANZ being more focused, perhaps, on its Asian subsidiaries.

Rio Tinto (RIO)

With Rio it's interesting to contemplate what the resources world would now look like if BHP's Marius Kloppers had gone ahead with his plan to merge the two companies at the height of the global financial crisis in 2008. As we now know, Rio remains an independent business, but Chinese metals producer Chinalco still owns 9% of the company, and may still look to leverage this holding into some sort of corporate play. It's hard to see BHP having another crack at Rio now, but you never know – and both stocks in my view are moving from the cyclical status they've always been lumbered with to more defensive investments.

Santos (STO)

Coal seam gas (CSG) has been in the press for all the wrong reasons in recent months, but the fact remains that three large CSG projects are in the process of being built at the port of Gladstone in Queensland. Three is at least one too many such projects, and I expect that Santos will end up merging its gas operations there with either Origin or BG (British Gas) at some stage soon.

Spotless Group (SPT)

Spotless is an unusual pick in this group of potential targets as it's currently the subject of a $2.68 a share bid (raised from an initial $2.63) from private equity group Pacific Equity Partners (PEP). While I doubt PEP will succeed at this price, the fact that Spotless has opened a data room to any other potential bidders suggests to me that the company is genuinely in play. In order to obtain a board recommendation from Spotless, a successful bidder will have to meet chairman Peter Smedley's expectation on price – and this number almost certainly begins with a “3”, not a “2”.

Conclusion

Predicting takeovers is an imprecise science at best, so the above list should not be viewed as exhaustive. Having said that, if I can repeat my 2009 strike rate of 40% (four out of 10), then a portfolio holding the above shares should perform well for investors.

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