The approach for Cadbury (CBRY) by Kraft has seen bid speculation return to the UK market. The recession has left companies looking for growth by other means than organic expansion, so enthusiasm for growth by acquisition or merger is returning.
Of course, financing is still tight but deals are still possible by mixing cash and new shares. Indeed a number of companies have been raising cash via rights issues with the specific purpose of taking advantage of low stock valuations and companies in trouble.
Cadbury’s wasn’t actually one of those companies in trouble and was in improved shape following the demerger of its beverages business. In fact Cadburys saw itself more as an acquirer rather than a target, and the Kraft bid looks opportunistic.
Our current view is that the first bid from Kraft is not a knock out blow and there is further upside to go for in the shares - although if a higher bid fails to materialise there would be some downside.
Whilst it is near impossible to pick the next takeover target, it is much easier to look for areas of the market which are ripe for consolidation. A sector which we like due to good expected organic growth on the back of a recovery in commodity prices, but which could also benefit from consolidation, is mining.
A proposed merger between Rio Tinto (RIO) and BHP Billiton (BLT) broke down last year but a joint venture between the two is set to deliver benefits.
Elsewhere in the sector the smaller players are also involved in an interesting bid situation. Xstrata (XTA) has bid for Anglo American and been turned down, but may again look at some of its rivals. However there is also the possibility that Xstrata will itself receive an approach from the Brazilian company Vale.
Stepping away from mining, one of the stocks which we like that has a potential buyer waiting in the wings is Inmarsat (ISAT), in the telecommunication sector. Harbinger is a major private equity shareholder in Inmarsat, and is looking to consolidate the satellite telephony industry.
Harbinger has previously made an approach for full control of Inmarsat which was unsuccessful, and are now waiting to compete another deal before again looking at future consolidation opportunities in the industry. In the meantime Inmarsat continues to deliver decent organic growth.
Placing bets on individual stocks on takeover speculation alone is a risky strategy, but we believe the rumored and actual targets mentioned above have the additional benefit of good organic growth which should see their share prices advance in the future.
BHP Billiton (BLT) Buy
While the group’s already clean balance sheet (Net debt/EBITDA of 0.3x) and low cost operations give it less gearing to higher commodity prices, we continue to see it as one of the best in class, in terms of asset operations, capital structure and growth opportunities. Although BHP offers one of the highest yields among diversified miners, its distribution policy remains undemanding considering its very low gearing, which means it is very well positioned to participate in opportunistic M&A. Our new fair value of 1,900p is based on a 2010 PE of 12.5x. Market cap: £38,887m,Yield: 2.7% m, 52-week range: High 1768p; Low 731p Price: 1762p Fair value:1900p
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Cadbury (CRY) Accumulate
Though we have assumed that the probability of a counterbid from Nestle-Hershey is reasonably low, we believe that Kraft could raise its £10.2m offer. Based on our analysis of the potential value of Cadbury to Kraft, we have upgraded our fair value to 881p. If a bid fails to materialise, our analysis suggests a fair value of 660p for the stock as a stand alone company. We believe that the bid makes good sense for Kraft, with the two companies having complimentary emerging market footprints and distribution channels. Market cap: £10,771m,Yield: 2.1% m, 52-week range: High 808p; Low 445p Price: 787p Fair value: 881p
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Inmarsat (ISAT) Buy
Inmarsat continues to grow in its four main segments: aero, marine, land and leasing. We feel this justifies its current high valuation multiples, with the potential for earnings to surprise on the upside. The group has solid financials compared to its peers and has good free cashflow generation, helped by the completion of its current capex cycle. In our opinion, the Skywave deal makes perfect sense, whilst the S-band spectrum award is a huge opportunity for the group, despite the uncertainties as to how Inmarsat best monetises this prospect. Market Cap: £2,564m,Yield: 3.8% ,52-Week Range:High 614p; Low 300p, Price: 558p ,Fair Value: 627p
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Rio Tinto (RIO) Buy
Rio Tinto’s turnaround story should continue to unfold. The $15bn rights issue has provided some relief to the balance sheet, and the recently-announced disposal of the majority of the Alcan packaging business and higher-than expected volumes sold in H1 are signs of Rio’s ongoing improvements. The recovery in commodities markets, further asset sales and future growth in capital expenditure should underpin profits growth and balance sheet stability. Our fair value of 3,400p is based on a 2010 P/E of 12.0x. Market cap: £28,729m,Yield: 41.7%,52-week range:High 1398p; Low 288p,Price: 980p,Fair value: 1150p
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Xstrata (XTA) Buy
With a relatively high cost base compared to some other diversified miners, Xstrata offers a higher operational leverage to rising commodities. M&A is also likely to be an important part of Xstrata’s growth strategy. The proposed merger of equals with Anglo American would generate significant synergies in our view, but should it fail to go through, other value-creating acquisitions could be on the cards. Investment should be helped by Xstrata’s improving balance sheet. Our fair value of 1,150p is based on a 2010 PE of 13.0x.
Market cap: £28,729m,Yield: 41.7%,52-week range:High 1398p; Low 288p,Price: 980p,Fair value: 1150p
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