What an M&A boom would mean for investors

Global mergers and acquisition activity topped US$1.3 trillion in the first quarter of 2021, setting a new record for the strongest opening period ever and suggesting we could be in for a bumper year. This follows the ramping up of M&A activity in the last few months of 2020, all the more remarkable after the standstill of last March.

In the Australian market, some of Livewire readers’ most-tipped small-cap stocks are among those recently lobbed with bids – including home loan company Mortgage Choice (ASX: MOC) and lithium miner Galaxy Resources (ASX: GXY). But how should shareholders feel about M&A? It’s a complex area with many variables.

In this three-part series, these contributors reveal how they approach the topic of M&A, their outlook on activity for the rest of 2021 and for some potential targets they’re watching closely:

• Luke Cummings, CIO and managing director, Harvest Lane Asset Management
• Alex Shevelev, senior analyst, Forager Funds
• James Gerrish, portfolio manager, Shaw and Partners

In this first instalment, our trio of fundies explains why they believe we’re in the early stages of a boom and outline what this could mean for Australian equity investors.

Source: Shutterstock

“Very deep pipeline of potential deals”

Luke Cummings, Harvest Lane Asset Management

I do think we’re in the early stages of a boom, but it depends on how you define early. I think we’ve probably been in the midst of a boom since about June or July last year, and it seems that many of the deals remain under the radar. There are probably six or seven stocks for every high profile company that has transactions either underway or which have completed recently, such as Tabcorp Holdings (ASX: TAH), Crown Resorts (ASX: CWN) or Bingo Industries (ASX: BIN).

Conversations with investment bankers and lawyers indicate that many have very deep pipelines of potential deals - even to the point where some are trying to put the brakes on and slow some of the activity.

Is it positive for investors? Yes, I believe so. Buyers do M&A for various reasons, and sometimes it is because stocks are "bombed out" and are in turnaround mode. But generally, deals happen when the market and the economy are doing well, and particularly when potential buyers perceive this positivity will be sustained for a while. Having private equity firms and corporate buyers sniffing around these things is, I believe, broadly positive for any investor with a portfolio of stocks.

Low rates and a world “flush with cash”

James Gerrish, Shaw and Partners

The main things that you need for an M&A cycle are:

• access to capital
• capital available at cheap levels
• cashed-up private equity firms
• acquisition targets that represent value.

On the funding side, we have low rates and ample liquidity – the world’s flush with cash at the moment. And then on the target side, we've got pockets of the market that have been hit really hard by COVID. A lot have recovered, but some haven’t, so you’ve got businesses out there that are cheap. So yes, I think we’ll see a lot more M&A.

For investors, takeover activity is a sign of underlying confidence, so it’s positive in that regard. It’s obviously positive for share prices if you happen to hold a company that gets taken over. And if one company sees another as a viable takeover target in this sort of environment, other companies will have a similar view. This then creates a healthy "bidding war" scenario. Take Crown (ASX: CWN) for example, having first had one bid on the table from Blackstone, followed by another from Star Entertainment Group (ASX: SGR), and there’s no doubt others out there circling, too.

“Market prices are up, money is cheap”

Alex Shevelev, Forager Funds Management

While logic might suggest lots of takeovers when share prices are low, that hasn’t historically been the case. Most potential acquirers are dealing with their own problems in a wider market downturn. And not all shareholders are willing to sell at low prices to an acquirer just because a small number of other investors are running for the exits.

Purely speculating on takeovers is not an easy way to make money. And when the prospect of a takeover has become the last bastion of hope for value realisation, it is usually a sign that the investment has soured. Businesses that are growing and performing well or have already turned themselves around make for far more attractive targets.

So, yes, now is a great environment to see more deals. Market prices are up. The effects of COVID have made many industries ripe for takeovers. And money is cheap.

The last six months have seen bids for two of our portfolio companies: WPP AUNZ (ASX: WPP) and Mainstream (ASX: MAI). The latter is a strategic business with a recurring revenue stream long ignored by stock market investors. An initial bid of $1.20 per share has risen to $2.60 as large global competitors with deep pockets scrambled to seize control. I’m sure there will be more.

This can be great news for investors in strongly performing but often underappreciated listed businesses. As long as investors get a full price. You don’t want to look back in 12 months’ time and realise you gave your company away for a steal.

In conclusion

It seems almost certain more M&A activity lies ahead, given the confluence of factors supporting a boom. Follow the money, as Shaw and Partners’ Gerrish says, and that’s where it takes you. Cashed-up private equity firms in a time of historically low interest rates suggest a buyout frenzy ahead – especially given the swathes of battered businesses left reeling as the pandemic subsides and the vaccine-led recovery rolls ahead. So, that’s where we are now, but how sustainable is this boom, and what are some of the opportunities? We’ll find out in the next instalments of this series.

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 two, our three fund managers will explain what they believe is driving this M&A boom. And in the finale, they will discuss a few listed companies that are either already fielding offers or which are ripe for takeover in the months ahead.