Unfettered and undeterred. These two words typify the very mood of Indian corporations. The way corporations across sectors are striking deals (read acquisitions) with utmost ease and efficiency, demonstrates that keen observation of value investments always win over the prevailing situation in the markets. Albeit the plummeting of markets and recurring bad news, the strength, appetite, and agility for investment opportunities is yet to wane. And in such developments, investors are set to gain considering the pace, acquisition-size, and potential involved in the acquisitions.
Acquisitions like the HDFC Bank’s of Centurion Bank of Punjab, and ICICI Bank with Sangli Bank, and the still unconfirmed Orchid Chemicals-Solrex, and the likes, would see amalgamation of advantages and talents of the acquirer and the acquired entity and their resultant impact on the performance of these companies. However, in these developments, there were investors, who lost opportunities of picking up these companies in their portfolio, while others milked these acquisitions.
Hence, monitoring and being invested in companies, which have delivered fair performance and are relatively smaller in their respective sectors, could help you know about the possibilities of a bigger player acquiring these stars, which would have the ability to become the sun.
FE Investor, in a study of fundamentally strong companies across the sector, finds out the very potential targets, which you as an investor, can keep a tab of, and, if not invested, can invest in these companies. There are two things at which you need to have a closer look. First: the companies chosen (see the table) have a proven track record and are fundamentally strong and hold ‘a possibility’ of an acquisition by a stronger player and even if the acquisition didn’t materialise in the short-term, these companies can add value to your portfolio. Companies, which scored well on the return on capital employed (RoCE), return on net worth (RoNW), sales, and PAT parameters, were chosen and sifted through. Second: there are certain characteristics, which a potential acquisition target company has, and in understanding such characteristics, you could identify a company, which could be a potential acquisition target for a bigger player in its sector. Here is an elucidation of these characteristics, which could help you pick these companies and enhance your possibility of deriving lucrative gains.
Understand the big brother?s needs
Once you know what the big companies are looking for, you would be able to determine which companies are the chief candidates for acquisitions. A big company has the ability to develop or acquire a gamut of varying services and products. However, if it can buy a company at a reasonable price that has a unique niche in a particular industry, either in terms of a product or service, it would most likely take a plunge and acquire it. Says Krishna Kumar, fund manager, BNP Paribas Mutual Fund, “Companies, which have promoters holding less than 25-30% would be on the acquisition radar, provided the business of the company is good.”
The companies, which are circumspective, wait until the smaller company has a niche carved out. And in terms of both money and time, it is often cheaper for larger companies to acquire a given product or a service than to build it out from scratch. This allows them to avoid much of the risk associated with a startup procedure.
a) Reach, strength and history
Companies, which have a smaller base often don’t have the ability to market their items nationally, much less internationally. Larger firms with deeper pockets have this ability. Therefore, look for not only a company with a viable product line, but one that, with the proper financing, could have the potential for large-scale growth. The potential acquisition target must have a clean operating history, consistent revenue streams, and steady businesses. Also, you must note whether the potential target company has been proactive in telling its story to the investment community? Has it transacted with striking regularity?
Almost every company at some point in time will be engaged in some sort of litigation. However, a potential acquisition target would not be saddled down with lawsuits. Also, these companies usually develop economies of scale. In other words, its revenues grow, but its overhead – its rent, interest payments, and maybe even its labour costs – stays the same, or increases at a much lower rate than revenue. Bigger players aim at such companies that have their cost structure in line, and that have a viable plan to grow revenue.
b) Cash and cashing in on
Companies with cash on their books look attractive to private equity groups and bigger fish, because that cash may be used to help finance the leverages buyout in the fist place. Also, no debt factor works in such companies favour. What good is a leveraged buyout to an acquirer if purchasing the company is going to make the buyer even more over-extended?
For privately-owned companies, a growth-through-acquisition strategy can be a cost-effective and relatively quick approach for achieving key goals and objectives.
Although many owners and executives first consider this strategy only when they learn a local competitor may be up for sale, other acquisition targets may exist that are actually a better fit. However, you should never buy a company solely because it is, or may become, an acquisition target.
What you should do?
Past experience says that especially in India, acquisitions are done after continuous talks and consent of the target management and promoters. Open market transactions don’t result in anything except if it is for pure investment purpose. Because after investing huge money, if the deal doesn’t work out, then the acquiring company suffers. If one looks at the Tata-JLR deal, there could be lot of repercussions, which the company may not have know and it may have to infuse some more funds into the acquired company post-acquisition.
Now, when this type of acquisition happens for some investors, it may be a surprise or some may be happy, as they are already invested and were expecting the same anytime in the future. From this, it is understood that identifying potential targets is not easy and if it is identified then how much time frame should we take into account? There are some factors, which can be considered by investors in different situations and could pick the stocks that could be potential targets for acquisition and this can become a very good stock for long-term investment.
Can there be other cases like this in the same sector or other sectors? More banks could be potential targets considering the consolidation in the sector and the new Basel-II norms. There are eight banks with promoters holding nil, except two banks with a marginal promoters stake. From this, there could be seven potential targets of bigger banks in the country. And there is news that Yes Bank is eyeing potential acquisition targets.
In the case of banks, the major advantage in acquiring one bank maybe to acquire its branch network as Reserve Bank of India has been cautious in issuing licenses in particular areas for new branches. Points out Navendra Singh, a banking sector analyst, “One should note that acquisition becomes easier when banks are in losses and these banks come into the highly-watched entities of the RBI and it stresses on acquiring these entities.”
This rule has made bigger banks scout for smaller banks having a presence in smaller towns and villages. Also, greater penetration and healthy advances and deposits work in the favour of smaller banks. A case in point is the acquisition of Sangli Bank by ICICI Bank. Sangli Bank had a major presence in Maharashtra mainly in rural areas, where ICICI Bank wasn’t present. ICICI Bank cashed in on the opportunity to acquire Sangli Bank at a very attractive valuation. Also, there are certain medium and smaller banks with no promoters holding and have very healthy advances and deposits and a good branch network. City Union Bank is a case to point out. The bank is continuously expanding its branch network and has a very good net profit margin.
From a consolidation point of view, you could take exposure to capital goods and the infrastructure sector due to their healthy order book and these sectors being the biggest driver of the growing economy. Especially, in case of the capital goods sector, where a smaller company has a specialisation in some product, could be on the radar of bigger capital goods, which wants to enter that segment and sees very high growth irrespective of whether the target company is in losses or not. These dynamics also work for infrastructure, where there are a lot of smaller companies having a presence in a particular city or state. Someone wanting to have a pan-India presence can acquire such type of companies to get a larger market share. However, it may be difficult for any company to acquire due to higher promoter holding. And the difficulty is made more difficult when there is a creation of speculative news about a company.
a) Reading between the developments Orchid Chemicals and Pharmaceuticals, a small pharma company came into the limelight due to a 12.8% stake, reportedly, bought by Solrex pharmaceuticals from the open market. This kind of significant stake-buying takes place only when any entity desires to acquire that company. There may be various reasons for acquisitions; like very attractive valuations, strong products, higher presence, and synergy. However, you must note that if any entity buys more than a 15% stake, subsequently, it has to give an open offer to the shareholders to buy an additional 20% stake.
Hence, the reported deal of 12.8%, which is less than the 15% limit, indicates maybe Solrex wants to just be a financial investor. Hence, you need to read into developments of the acquired company carefully. Also, you must ask yourself questions such as what could be the objective behind open-market acquisition? Is there any speculation to generate a run-up in the stock? Or is it just for financial gains? More specifically, if you think there is a possibility of the potential acquisition of the company you are invested in, simply ask the question: ?What can it offer?? Also, in order to test the authenticity of news regarding a company you must consider two factors. First, how important is the news in terms of its impact. Second, is the news knowable from relevant and reliable sources? Because just keep in mind that there may be as much ‘off the books’ data to incorporate as there is within the company’s numbers.
