Why these two sectors (and single stock) are magnets for takeover talk

With the collapse of Silicon Valley Bank and Signature Bank compounding a weakening earnings picture, many investors are rightly asking how healthy companies actually are. Last year, M&A activity in the Australian market slowed down year-on-year but not greatly despite rising economic and geopolitical uncertainties. 

In the IPO market, the decline is more pronounced. Only 89 companies debuted on the public bourse last year, way down from 202 in 2021. And of those, even fewer are now trading above their listing price.

So, what does the future look like for Australian corporate M&A? In this wire, we'll take a closer look at the key factors that could drive takeover and merger activity in 2023. We'll also get a view on which companies and sectors stand to benefit from Ted Richards at WILSONS Advisory.

The five key trends of M&A in 2023

PWC research argues a subdued IPO market along with a higher quality bidding field has created a different M&A landscape. Rising interest rates, a tight labour market, and great investor scrutiny are all hindering the ability to make transformational transactions.

Higher quality M&A also requires creativity, and PWC believes creative, well-thought bidding will stand the test of time. To achieve this, the team believes five key trends are in store for the M&A landscape this year. These include:

1. A desire for "defensive investments": Sectors like healthcare, education, defence, energy transition, and infrastructure are all seen as beneficiaries of this year's M&A landscape. Or put it another way "assets with high barriers to entry such as intellectual property patents, strong market pricing power and/or the ability to pass on costs."
2. Value alignment increasingly important: Buyers are wary of pricing assets on an uptick as there’s no saying when earnings will make a comeback. Earnings consistency could prove to be a big differentiator in this market.
3. Bespoke solutions for bespoke times: Those making the offers need to become more flexible and agile. For instance, private equity funds are innovating by creating different financing structures for different deals.
4. Demerge and merge: Both demergers and mergers are applicable in this environment. Demergers will continue to prove popular as a way to unlock a multiple re-rating. On the flip side, mergers will offer economies of scale and support margin resilience (or better yet, margin accretion) in an inflationary environment.
5. The privatisation trend: More companies are choosing to stay private or are going private (looking at you, Sydney Airport and Oz Minerals). PWC believes investors can expect even greater activity in the public-to-private space next year as investors capitalise on the value available in the public market.

But... macro doesn't always hold deals back

While the big picture is full of headwinds, a bad macro picture does not always stop companies from making offers. As Richards explains, some companies aren't waiting around for inflation to peak or market sentiment to roar back if they are cashed up now.

"Quality companies or private capital will be looking to do M&A when they see opportunities, irrespective of where we are in the cycle. Macquarie Group (ASX: MQG), for example, takes advantage of challenging market conditions by making accretive acquisitions at attractive valuations," Richards tells me.

In the PWC list, the researchers noted five sectors that could be ripe for M&A activity when sentiment returns. But Richards actually nominates a sixth and seventh sectors where some dealmaking could occur: information technology and the resources space.

"After the carnage of the last 12 months for small and mid-cap tech stocks, it appears that value has started emerge for ‘patient capital’ that can look through the short-term headwinds facing the sector, which has been evidenced by recent bids for Readytech (ASX: RDY), Tyro Payments (ASX: TYR), Nitro Software (ASX: NTO), and Elmo Software (ASX: ELO) to name a few," he notes."

"Further consolidation in the resources sector is also likely, following a flurry of recent activity, including the recently rejected Newcrest Mining (ASX: NCM) takeover bid from Newmont, the completed BHP (ASX: BHP) takeover of OZ Minerals last year, and Mineral Resources’ (ASX: MIN) recent off-market takeover bid for Norwest Energy (ASX: NWE)," he adds.

And there are individual stocks in the pipeline too...

There's also plenty of action at the individual stock level. In particular, one company in the industrials space is attracting Richards' eye due to its infrastructure-like qualities and stable cash flows. Defensive, defensive, defensive.

"We think Cleanaway Waste Management (ASX: CWY) is a prime takeover target," he says. "The majority of Cleanaway’s revenue is recurring in nature underpinned by long-term contacts and the business passes on a lot of its costs like fuel and wages via rise and fall clauses in contracts. And let’s face it, waste management is an essential service required by local municipalities Australia-wide."

If an opportunistic buyer were to emerge for Cleanaway, it would also not be the first waste management company to get a bite at its cherry. Macquarie Group's Infrastructure and Real Assets arm bought out Bingo Industries for $2.3 billion on a forward EV/EBITDA multiple of 15x. Cleanaway, at time of publishing, has an EV/EBITDA multiple of 13 (per Guru Focus).

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I'll be in charge of asking the questions to Australia's best strategists, economists, and fixed income fund managers. If you have questions of your own, flick us an email: content@livewiremarkets.com