The local stocks looming large in a target-rich M&A environment

In the first two instalments of this series, we’ve taken a birds-eye view of local M&A activity and seen why it’s likely to be red-hot for some time. In this third and final article, we ask our fundies to dig into some of the ongoing deals and spotlight potential target companies.

Which companies have a bullseye painted on them right now? Which deals that are already underway are likely to close far higher than their starting point?

As exciting as M&A can be, investors should also bear in mind a few home truths. Warren Buffett himself warns against investment activity that draws the most applause, “the great moves are usually greeted by yawns.” And as Shaw and Partners’ James Gerrish suggests below, trying to pick winners purely on the basis of a potential takeover is unwise.

But especially if you hold some of these firms in your portfolio, it's helpful to be aware of the bidding activity out there right now. In the following wire, I’ve asked our fund manager contributors to identify a few of the hottest bidding wars underway and to reveal some of the local companies ripe for takeover.

What makes a good target for PE?

James Gerrish, Shaw and Partners

There’s certainly no point owning a stock purely on the proviso it’s going to be taken over. You’ve got to own a stock for its underlying merits and your view on the future of that stock.

But if someone else with deep pockets in the PE space or another trade buyer has the same view as you and they take it out, then great. Bingo (ASX: BIN) was an example of that.

It’s a good lesson in what PE looks for – Bingo was on a really high earnings multiple for the next one to two years, because in the outer years the assets that it acquired would start to accumulate earnings. This is an example of a PE company bidding at a big earnings multiple for strategic assets. The lesson is that you can’t simply screen for undervalued stocks now - it’s all about the asset base and what they can generate in the future.

That was also the case with Vocus (ASX: VOC) (which will be acquired for $3.5 billion by a partnership of Macquarie Infrastructure and Real Assets and Aware Super fund).

Another example would be National Storage (ASX: NSR). The stock price is now at $2.05. It had two bidders pre-COVID, who each lobbed $2.20 bids and a third came in, a large US self-storage company, with a $2.40 bid. And we’ve then had the third domestic player in the space, Abacus (ASX: ABP), having raised its stake. When you’ve had three parties offering somewhere between $2.20 and $2.40, to me NSR looks like an obvious takeover target.

Local software firm could be on the block

Alex Shevelev, Forager Funds

The team at mining software business RPM Global (ASX: RUL) has been hard at work for years building new products for miners around the world. The industry-leading products were selling fast before the pandemic, with recurring software revenue rising 26% last year.

While it was tough to sign new deals when COVID ran rampant in many important mining geographies, the business roared back early this year as miners got back to work. In the quarter to March 2021, RPM signed deals worth almost double those inked in the first six months of the financial year. This was the company’s biggest quarter ever.

CEO Richard Matthews has form running and selling software businesses: first Mincom and then eServeGlobal (which remains listed but sold a big division). The growing recurring revenue will be attractive to a range of large suitors. With a high corporate overhead, any sale will allow the acquirer to reduce costs dramatically. Owning 3.5% of the company, all acquired on-market, Matthews has a big incentive to maximise value if any bidder shows interest.

Bidding wars rage on

Luke Cummings, Harvest Lane Asset Management

Deterra (ASX: DRR), which is the iron ore royalty spinout that came from Iluka Resources (ASX: ILU). The iron ore boom at present isn’t a surprise to anyone, but that particular block at BHP has some expansion coming down the pipe. I think we can get a number significantly higher than where the stock trades now – that deal seems to make good strategic sense.

Web Central Group (ASX: WCG) is another. It’s predominantly owned by 5G Networks (ASX: 5GN), which bid for WCG last year. That’s a bit of a turnaround story, and I‘d be amazed if 5GN didn’t try and take out the balance of that at some stage. There are other examples of that happening in recent years, such as Asaleo Care (ASX: AHY), which is getting bids from a major shareholder, Essity.

And in terms of other bidding that’s currently underway, we have a position in Vitalharvest (ASX: VTH). MIRA started out at a pretty low-ball $1 bid, then bumped this up to $1.025. Then (Sydney PE firm) ROC Partners came out of left-field with a $1.08 bid, and has kept “duking it out” with MIRA, which is currently the front-runner with a bid of $1.265.

But with ROC now having super fund Cbus behind them in terms of funding, I’d be amazed if there’s not one or two higher legs to go there, just because of how spirited the bidding has been.

And finally, financial services firm Mainstream Group (ASX: MAI). From an initial bid of $1.20, it’s now up to $2.25. And having just delivered a really strong trading update recently, we can absolutely make the case there for a higher price there, just because of the strategic nature of the asset.

In conclusion

What we've covered here is just the tip of the iceberg. Many more discussions are no doubt happening behind closed doors, as COVID casualties weigh their options and the winners assess the landscape for prey. 

One thing that will be interesting to see in the months ahead is whether other super funds hitch their wagon to M&A deals, as we've already seen a few times in the last 18 months at AustralianSuper, Cbus and others. We'll keep an eye on the situation as it unfolds and bring you further insights when possible.

Stay up to date with this series

Make sure you "FOLLOW" my profile to be notified of the upcoming entries in this series. In part one, we determined whether there is indeed an M&A boom and what this means for investors. And in part two, our three fund managers explain what they believe is driving this boom.