Is UGL a takeover target?

Former stockmarket darling UGL (ASX: UGL) has a new chief executive and a new vision. The company might soon have a new owner too.

Ross Taylor, the new chief executive of engineering services company UGL (ASX: UGL), yesterday released a market update outlining his vision for a ‘New UGL’. Presumably he wants to put some distance between himself and the old UGL, which has made more than a few stuff-ups (including selling DTZ, its best business, for a song).

The market approved of the announcement, sending the stock up 10% on the day. No doubt the reaction had something to do with Taylor’s intention to double operating margins to 4% by 2017. It’s an ambitious target during a resources downturn, although at that level margins will still be shy of the 5% achieved during the boom.

Whether Taylor will still be chief executive in two years is debateable. If there really are margin gains to be had, UGL might become a takeover target for an engineering rival. Particularly so now that projects and contracts are harder to come by.

There was a time UGL looked more predator than prey. Indeed, UGL was once rumoured to be interested in taking over Transfield Services (ASX: TSE), another listed engineering company.

That’s unlikely now. Intelligent Investor Share Advisor compared the two companies in Cage match: UGL vs Transfield back in 2010 when UGL was capitalised at $2.5bn and Transfield at $1.5bn. Our Avoid recommendations at the time were based on a view that earnings were inflated by the boom (correct, as it turns out).

These days Transfield is capitalised at about $850m, more than double the size of UGL. And there’s a good reason why Transfield might turn its attentions to UGL sooner rather than later. Why?

Because companies that have thwarted takeovers – Transfield itself rejected a $2.00 bid from Spanish company Ferrovial in December – often launch takeovers themselves. Transfield management will be feeling the pressure to justify its rejection of Ferrovial, something that can inspire the urge to ‘do something’.

Of course, issuing stock to acquire UGL wouldn’t be the most shareholder-friendly behaviour. If Transfield stock is really worth more than $2.00 a share – as the board has explicitly stated – then using it as an acquisition currency around $1.70 should raise eyebrows.

There’s no guarantee Transfield will bid for UGL. And betting on takeovers is rarely a sound investment strategy, particularly if the target’s business is inherently risky.

With many mining contractors looking like rabbits in the headlights, merger mania has been slow to infect the sector. But UGL could be one of the first to fall if it does. 

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