New wave of M&A has profit potential for spread betters

IT HAS been a veritable whirlwind of good old-fashioned company matchmaking of late and especially so here in Britain, thanks to the sharp depreciation in sterling.

In May, UK manufacturer Chloride was snapped up by its American rival Emerson. More recently, International Power revived merger talks with French energy firm GDF Suez, household goods group Reckitt Benckiser made a successful £2.5bn takeover offer for SSL and United Biscuits’ owners put their company up for sale.

While August is unlikely to see another flurry of mergers and acquisitions (M&A) activity because of the summer holidays, spread betters should be preparing themselves for further matchmaking come the autumn, and not just in the UK either. Only last month, Pimco’s Charles Lahr said: “Provided we avoid a double-dip recession scenario, we may be at the beginning of a substantial rise in the M&A cycle.”

Spotting prospective M&A targets can be a profitable spread betting strategy. For a start, interested parties will normally offer a bid that is at a premium to the target’s share price and traders will then move to price in this premium. Therefore, the share price tends to rise. A bidding war – as we saw last autumn for confectioner Cadbury – can cause the share price to move even higher as potential acquirers raise their offers. For example, the typical deal premium seen this year is around 29 per cent compared to 22 per cent in the 2004-2007 M&A cycle.

In both the US and the UK, recent deals have reawakened interest in M&A and raised hopes of a new cycle. Even in Europe, where activity has remained muted, the preconditions to an increase in transaction volumes are very much in place, say Graham Bishop and Ian Richards, analysts at RBS.

PERSISTENT UNDER-PRICING
“Corporate balance sheets and cash flow generation are strong. And valuations across the equity market reflect a persistent under-pricing of assets, in our view. Against this backdrop, we think there is a high chance that we see more trade buyers making strategic acquisitions, particularly if market and macro volatility continue to subside,” they say.

And not only has the corporate sector been generating cash-flow, the economic uncertainty has also meant that firms have become cautious, resulting in a high profit retention rate.

But which sectors should spread betters be looking at for M&A activity?

The RBS analysts say that the sectors with the highest returns – as measured by return on equity – should offer the greatest opportunities because “the balance sheet is a critical determinant of the ability to fund and pursue M&A”.

Their research shows that sectors such as utilities, construction, telecoms, industrials and media stocks are likely to see M&A activity over the next cycle.

For example, London-listed travel companies National Express and Go-Ahead are cited as potentially the most vulnerable to external interest.

RBS’s Iain Turner highlights the current activity between International Power and GDF Suez but also notes that the quoted water companies such as Pennon, Northumbrian, Severn Trent and United Utilities could also be potential targets.

Savvy spread betters should use the quieter summer weeks to research which firms look vulnerable and be ready to place their long trade come the autumn.