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Takeover potential

Created:
20 June 2008
Written by:
Dominic Picarda

It's easy money when a company in which you hold shares gets taken over for 50 per cent more than you paid just two months ago. So much so that spotting takeover candidates is a legitimate game for investors. Don't forget, of course, that far more companies are touted as targets than are swallowed. Even so, follow a few guidelines and your chances of making this so-called easy money get better.

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First, look for the corporate imperative. This is when company bosses get the urge to make bids simply because their counterparts are doing it. This has been the case in the UK housebuilding industry in recent years. How some of those bosses must regret their actions now.

Then consider the type of business that is more easily merged with another. For example, simple manufacturing companies can be targets because their operations can feasibly be transferred to another plant creating lots of extra profit. Ditto for services businesses, where operations can be centralised, and retailers, where chains can be rationalised and costly distribution systems merged. Beware, however, companies that lack economies of scale – ironically enough, one example is those housebuilding companies, where it was hardly feasible to shut down a building site and transfer it to another location.

Also, beware companies high in intellectual property - essentially because it can walk out of the door - and those where matters of public interest may scupper a takeover. Then, last, beware those companies where their sheer size makes a takeover unlikely.

Aero Inventory

Given its enviable niche in the aerospace trade and modest share-price valuation, it is surprising that there is no apparent takeover interest in the group. This may be because it has yet to prove that it can generate cash. So far, this has been held back by the number of large contracts it has assumed, which require it to buy its new customers' existing inventories. With excellent timing for this week's competition, Aero revealed it had received a takeover approach on 16 June. While management stressed the bid was "highly preliminary", the surge in the shares showed that investors are clearly excited by the prospect.

BG Group

BG Group is a prime takeover target. The company's production growth prospects are leagues ahead of practically any big rival. Its liquefied natural gas (LNG) business has a uniquely global presence. Also, it has a stake in possibly the most exciting oil discoveries for decades, off the shores of Brazil. Shell is the most obvious potential UK buyer, as BG would bolster its notably poor production growth prospects and complement its existing LNG business. But if Shell did bid, BP or a global rival might be sparked into making a rival offer. Only BG’s rich valuation has deterred potential buyers to date.

BHP Billiton

BHP is predator rather than prey, as it seeks to buy rival giant Rio Tinto. The possible price tag runs to hundreds of billions of dollars, so it would take deep pockets to acquire BHP Billiton itself. Competition watchdogs are concerned that a BHP-Rio tie-up would lead to excessive concentration of market power in iron ore, so any miner attempting to buy BHP would face similar obstacles. Asian sovereign wealth funds might have the wherewithal to bid for BHP, but the Australian authorities might object to such a buyer.

Capita

A premium valuation leaves little scope for any would-be buyer to create value from a takeover of Capita. And, as it's efficiently run already, there is limited potential for savings. The company itself is a keen acquirer of businesses, with 3 per cent of its revenue growth in 2007 coming from takeovers. Overall growth was 19 per cent. Scouring for potential targets is a serious job for Capita. It assessed 100 candidates last year, and spent £114m on 12 purchases. The group's strong cash flows support the bid activity, which is a useful element in propping up its exceptional growth record.

SIG

Weakness in the housing industry has taken its toll on SIG's shares. But, as Europe's leading provider of insulation, interiors and roofing products, SIG's exposure to new housing is estimated to be less than 16 per cent of sales. Of course, the shares' weakness could make SIG a more attractive takeover target. It is enjoying solid organic growth and is itself busily buying out smaller rivals. Net debt at the end of last year is estimated to be around £400m, or gearing of 71 per cent. And this could deter any potential bidder, especially given the current economic climate. However, for the bidder with deep pockets, SIG has to be an attractive proposition.

VOTE NOW!

You can vote on the Share Champions microsite, where you'll also find our experts' views on how are remaining candidates shape up.

Voting for this test closes on Tuesday evening, and we'll announce the next company to be ejected on the website on Wednesday. Details of the next test will appear next week.

The result of the last test - management quality - was that BAE Systems was voted off.

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by Dominic Picarda