High-flying hedge funds are increasing their bets there will be more corporate takeovers in Australia – but they insist retail investors need to do a lot more homework than simply following suit in a frothy market.
With the benchmark index S&P/ASX 200 up 9.2 per cent for the year to date and flirting with the 6000-point mark – coupled with a healthier corporate landscape – investment experts believe the market is ripe for takeover activity and the lists of candidates is building.
Treasury Wine Estates, DUET Group, Challenger, Syrah Resources, Sirius Resources, Qube Holdings are among those being eyeballed by some of the country's top-performing hedge fund managers.Shares in all of these companies have soared since the start of the year.
At the same time, lower interest rates and the search for higher income-producing stocks such as the banks and Telstra are creating bubble-like conditions in the local sharemarket.
Julian Babarczy, head of Australian equities at one of the country's top-performing hedge funds, Regal Funds Management, believes the low interest rate environment is likely to benefit takeover targets.
"We believe 2015 could be a year of above-average takeover activity in the Australian market, driven by strong equity markets, good-quality corporate balance sheets, extremely low interest rates globally, and an environment of generally sluggish top-line growth."
Companies could use mergers and acquisitions in this context to boost their sales and use resulting cost savings to underpin earnings growth, Mr Babarczy said, predicting this could also boost share prices of companies after acquisitions.
But the experts warn investors need to look at the fundamentals of a company before simply investing based on takeover speculation.
"Obviously, investors need to make their own judgement on the merits of any investment, and potential for takeover should be only one of many factors they weigh when determining whether to buy a company's shares," Mr Babarczy said.
Clime Asset Management chief investment officer John Abernethy told Livewire Markets – a social media platform for investors – that the "problem is now with interest rates, where they are set in Australia and overseas, the temptation is to overpay for stocks. You can justify it based on bond yields but, from a valuation perspective, things look very stretched. And every time you go up a hill you have to come down the other side at some point."
PM Capital portfolio manager Uday Cheruvu added that buying a potential takeover target could go one of two ways.
"If they buy a business that they believe is undervalued from a fundamental perspective, a takeover offer speeds up the process of the stock price reflecting its correct valuation. If an investor buys a stock purely expecting a takeover offer to emerge, they are putting their return in the hands of external which may or may not eventuate.
"So, we would prefer to buy businesses which are currently being undervalued from a fundamental perspective. If a takeover happens, it's cream on top, but if nothing eventuates we are happy to take the return from the business performing to its fundamentals and thus the stock price outperforming," said Mr Cheruvu.
Mr Babarczy and Mr Cheruvu analyse the merits of the takeover candidates listed in this article:
Treasury Wine Estates (TWE), up 11 per cent this year.
Babarczy: "TWE is a known takeover candidate that could easily attract a fresh/revised bid from private equity."
Cheruvu: "A lot of interest from private equity but management/shareholders are holding out for a higher price. They are also restructuring the business with a potential sale and lease-back of their winery infrastructure. This has potential to unlock value but also may make the company less attractive to private equity as the balance sheet will have a lower amount of tangible assets. So, investors looking to buy the stock because there could be another takeover offer may be disappointed."
Challenger (CGF), up 5.6 per cent.
Babarczy: "With banks trading at high price-to-earnings (PE) multiples and lacking growth, Challenger is a small, easy bolt-on [acquisition target]."
Cheruvu: "Hard to see them being acquired by any of the major banks in the near term. The major banks are dealing with higher capital requirements and are looking to get to higher capital levels. In addition, there is uncertainty around conglomerate capital rules which is a tough environment to acquire a capital intensive business such as CGF."
DUET Group (DUE), up 5 per cent this year.
Babarczy: "DUET is attractive to both Spark Infrastructure (SKI) and APA Group. SKI have a 15 per cent stake (partly through derivatives), and APA are always looking to acquire bolt-on assets."
Cheruvu:" Any action in relation to this is likely to be a larger play. Investors are going to wait 'till post NSW election and if Liberals remain in power and have a mandate to start the sale of distribution and transmission assets, DUE will become part of a larger sector M&A thematic. APA is another potential buyer, but Spark currently has a blocking stake. Likely that Spark will participate in NSW privatisation at which time they may use their stake in DUE as funding source. So the process of how and when all this will play out is very uncertain."
Qube Holdings (QUB), up 20 per cent this year.
Babarczy: "Qube has an increasingly strategic suite of logistics assets that would be coveted by a number of off-shore logistics companies."
Cheruvu: "Given the Toll Holdings (TOL) transaction, it is natural that QUB will come on the radar, but I think QUB is likely to be an acquirer of assets rather than being a takeover target. QUB trades at a premium to the sector based on the long-term potential of assets such as Moorebank. We think Asciano (AIO) is an easier target for an acquirer looking for assets that are already earning a reasonable return in the Australian market. So we expect that if anything more happens in the near term, it is likely be centred around Asciano rather than QUB."
Syrah Resources (SYR), up 42.6 per cent this year.
Babarczy: "Syrah owns the highest quality and largest-size graphite project globally, which is highly strategic given it will be fundamental to the graphite supply chain used in batteries for electric vehicles."
Cheruvu: No view on this stock.
Sirius Resources (SIR), up 6.6 per cent this year.
Babarczy: "Sirius has high-grade sulphide-based Nickel concentrate that has large strategic value to global smelters. Also, material exploration upside which could see the Nova-Bollinger Nickel project expanded under a new owner."
Cheruvu: No view on this stock.
