Tips To Finding M&A Deals

Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Last week I wrote about the transaction that Warren Buffett and 3G Capital are intending to complete: taking Heinz private. In the Heinz post I tried to explain why, to my understanding, that company was a clear M&A target: strong global brands, solid (and stable) free cash flow generation, and low leverage. In this post I will try to make a short but useful analysis of what to look for when looking for M&A candidates, and will try to provide a few companies as examples.

This should be a good year for M&A, and here's why:

  1. Low leverage levels: 12% of US companies have net cash and a Free Cash Flow Yield above 5%. Uncertainty and a very low deal flow (both related to each other) drove cash levels above historical averages.

  2. Uncertainties about global macro outlook have diminished after the European Central Bank intervened in the markets last year. Besides, the US economy is now growing again hand in hand with the US housing recovery.

  3. Interest rates still trade at historically low levels, making it possible to finance deals cheaply.

  4. M&A activity typically follows the performance of the stock market with a lag of 12 months, and corporate confidence with a lag of 18 months. Both drivers suggest M&A activity should rebound.

What To Look For

1) Industries prone to M&A: Companies operating in FCF-rich sectors with strong barriers to entry are always attractive targets. The consumer goods sector is always a key environment to watch for deals. Beer companies such as Compania Cervecerias Unidas (NYSE: CCU), which dominates the beer market in Chile (with a market share of 90%), are always attractive. Also, smaller companies that have developed strong brands, such as Boston Beer (NYSE: SAM), – owner of the brand Samuel Adams - are prone to be acquired by bigger companies shopping for growth. In the US, home of an energy revolution thanks to shale oil and gas, companies related to this sector are also prone to be taken over. A company like Parker Drilling Company (NYSE: PKD), a provider of contract drilling and drilling-related services, could also be an M&A target. The energy sector will keep its consolidation process in the years to come. Small companies with an increasing pipeline of projects are clear targets for Private Equity (PE) shops or bigger companies within the sector.

2) Relatively Low Valuations: You should also for fairly valued companies. Some companies like Compania Cervecerias will never be cheap, but another cash-rich and smart synergy exploiter company like AB InBev (NYSE: BUD) could acquire it even at seemingly fair multiples. CCU trades at 2013 x18 P/E and x11 EV/EBITDA. You can compare that with Boston Beer's 2013 x32 P/E and 15x EV/EBITDA which, operating in the same industry, seems expensive even for a US-based beer company. Meanwhile, Parker Drilling company seems inexpensive trading at 2013 x4.5 EV/EBITDA.

3) Manageable market cap size: Companies trading between $500 million and $2 billion are, statistically, the most probable targets. There are many Private Equity funds that can manage deals that size and most blue chip companies tend to buy niche small competitors that usually sell for that size. Boston Beer and Parker Drilling fall within that sweet spot, selling for $2 billion and $575 million, respectively. With a market capitalization of $5 billion, CCU is a big company but small next to AB InBev's $15.5 billion EBITDA.

Deal activity has picked up year to date (deal value is up by 14% Year over Year), but, despite cash rich corporate balance sheets, it's still 36% and 64% below the 10 year average in the US and Europe, respectively. If the US keeps its growth up and the Eurozone finds a way to get through its structural problems I am sure we shall have many deals coming down the line. Use my tips to find targets. I have found them useful (and profitable) in the past.

martinzaldua has no position in any stocks mentioned. The Motley Fool recommends Boston Beer, Compania Cervecerias Unidas S.A. (ADR), and H.J. Heinz Company. The Motley Fool owns shares of Boston Beer. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus