Four potential takeover targets

In the past six weeks, Crestchic (LOAD:398p), a manufacturer of load banks that is riding the boom in data centres, received a recommended 401p-a-share cash offer from Aggreko, a global supplier of mobile and modular power, temperature control equipment and energy services. The offer is pitched well above the 350p target price I outlined in my last analysis at 272p (‘Riding a strong upgrade cycle’, IC, 29 September 2022), and realises a 220 per cent gain on my entry point ('Alpha Research: A high-growth play on the battery storage boom’, 7 September 2021). It seems a fair price, equating to just shy of 15 times 2023 analysts’ earnings estimates. The bid explains why shares in small-cap closed end fund Rockwood Strategic (RKW:1,785p) have surged 24 per cent since my last buy call (‘On the hunt for small cap value plays’, 23 November 2022); the company’s holding in Crestchic is now worth £13.6mn of its net asset value of £46mn (1,810p), a healthy sum to recycle into new investment opportunities.

In addition, K3 Capital (K3C:343p), a professional services group that is benefiting from an uptick in its corporate retructuring and tax advisory activities and one with a bumper pipeline of M&A transactions for SME business owners, has attracted a 350p-a-share cash offer from private equity firm Sun European Partners. Pitched on an exit multiple of 16.8 times 2023 earnings estimates and well above my 325p target price, I recommend banking the quick-fire 38 per cent paper profit, having only initiated coverage last autumn (Alpha Research: ‘Making the most of the UK restructuring challenge’, 27 October 2022).

I also note that Stephen Blyth, founder and former chief executive of Braintree-based international freight management services group Xpediator (XPD:39p) is part of a consortium that is considering making a cash offer of 42p a share for the company. Blyth holds a 26.7 per cent stake through his investment vehicle, Cogels, and the consortium has non-binding letters of support from Xpediator’s two largest independent shareholders, who hold 27.1 per cent of the shares. Admittedly, I bailed out last autumn (‘Solving a logistical underperformance’, 29 September 2022), perturbed by boardroom changes, higher debt levels, a potential risk to earnings from deteriorating macroeconomic conditions and the axing of the dividend. If an offer is forthcomning, it would equate to an exit multiple of 14 times 2022 earnings estimates and is worth taking.

The key drivers of likely UK M&A activity this year

Looking ahead, Michael Nicholson, head of mergers and acquisitions at corporate broker Peel Hunt, offers a valuable insight into the key drivers of likely UK M&A activity this year, noting that greater stability in the outlook over the cost and availability of acquisition financing will be critical for both financial and strategic buyers who have already accepted that the cost of capital will be structurally higher for the foreseeable future. Both UK corporate and government bond markets have stabilised since former chancellor Kwasi Kwarteng's ill-judged fiscal announcement caused a spike in bond yields last autumn.

Nicholson also points out that the continuing ratings discount of the UK public equity markets compared with overseas markets, combined with currency tailwinds – sterling has declined 11 per cent against the US dollar in the past 12 months even after bouncing back 17 per cent from October’s all-time low – is likely to fuel demand from international corporates. Expect UK consolidation to continue given the combination of “higher operating costs, greater cost of capital and an evolving trend for institutional investors in UK equities to be increasingly selective about the companies they back.” The upshot being that the threshold for listed companies is set to rise further, meaning that “small and micro-cap listed companies are increasingly re-assessing whether the listed market is the right venue to pursue their stratregies.” In this enviroment, Nicholson notes that “larger, stronger bidders will continue to identify opportunities to extract material and immediate synergies from acquiring smaller, weaker peers.”

Nicholson also highlights that boardroom confidence is a lead indicator of future M&A activity. That’s because uncertain times drive introspection, but UK corporates entered the current environment with stronger balance sheets, thus providing a “platform for strategic combinations to be driven by more defensive rationales to achieve economies of scale or security of supply through vertical integration.”

Interestingly, private equity firms are often the first movers as the economic climate and business sentiment reach an inflexion point. Peel Hunt expects the future to be no different this time as investment teams scour the UK public markets for opportunities and, with no lack of equity capital, the “reopening of the debt markets will surely trigger take-private activity.” The broker sees the primary focus being on those companies with high quality earnings and stable cash flows, especially where the public market rating stands at a discount to where equivalent assets trade in the private market. It’s no coincidence that both Crestchic and K3 Capital boast high cash conversion rates, bumper profit margins and have a moat around their businesses that acts as a barrier to entry from rivals.

My active watchlist

In terms of my active watchlist, I feel that two of my 2022 Bargain Shares Portfolio constituents will either re-rate further or attract interest from predators: lowly rated commodity play Sylvania Platinum (SLP:108p); and Barnsley-based Billington (BILN:300p), one of the UK's leading structural steel and construction safety solutions specialists. Sylvania is trading on a miserly 2.7 times forecast net profit to enterprise valuation based on Liberum Capital’s estimates for the 12 months to 30 June 2023, while Billington is rated on a prospective price/earnings (PE) ratio of six after house broker FinnCap pushed through a 55 per cent earnings upgrade last month.

Something has to give at Anexo (ANX:107p), a provider of a litigation claims process focused on the recovery of credit hire and repair costs for the impecunious non-fault motorist involved in a road traffic accident. The £121mn market capitalisation company is rated on less than four times Panmure Gordon’s 2023 cash profit estimate to enterprise valuation even though it could earn a bumper pre-tax profit of £20mn-£25mn (after litigation funding and marketing costs) on its emissions scandal action against VW (on behalf of 13,000 claimants). A few months ago, chairman and 17 per cent shareholder Alan Sellers was a buyer at 127p a share.

Cyber security group Kape Technologies (KAPE: 271p) fits the bill, too. Shore Capital estimate that Kape’s shares are priced on a forecast free cash flow yield of 12 per cent for 2023, a forward PE ratio of 8.5 and prospective cash profit multiple of 7.7 to enterprise valuation, the latter being a 45 per cent discount to the average rating over the past five years. Last year, rival Avast was acquired by NortonLifeLock on 19 times cash profit to enterprise valuation, and an exit PE ratio of 24, highlighting the value on offer.

■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com at £16.95 each plus £3.95 postage and packaging. Details of the content can be viewed on www.ypdbooks.com.

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