Aussie equities: Why it’s smart to take the long-term view on M&A deals

ASX investors have seen a flurry of corporate transactions and associated equity raisings in recent months. Here Pendal equities analyst ANTHONY MORAN explains the opportunities

• Negative reaction to M&A can uncover opportunities
• Orora and Treasury Wine recent examples.
• Find out about Pendal Focus Australian Share fund

NEWSPAPER headlines have been full of merger and acquisition activity and associated capital raisings in recent months.

Chemist Warehouse-Sigma Healthcare. Brookfield-Origin. Newcrest-Newmont. Allkem-Livent. Woodside-Santos.

The activity is likely to continue in 2024, especially in the resources space.

Investors haven’t always been impressed with recent deals – but that doesn’t mean there isn’t opportunity, says Anthony Moran, an analyst with Pendal’s Aussie equities team.

Negative reactions and sell-offs following M&A deals can provide opportunities for investors, says Moran.

“Any deal that is large enough to be raising equity tend to be shareholder destructive in the short term,” he says.

“The market tends to over-react to the downside and that’s understandable because the market doesn’t like diluting the positive investment case for a company.

“M&A introduces a whole new element of uncertainty. There are going to be risks around the businesses being bought, and investors have to learn about them,” he says.

“Also, Australia’s track record of large M&A is extremely weak. It’s just a safer bet that a deal won’t go too well, almost regardless of the details.”

Opportunities from negative reactions

The negative reaction to M&A can provide potential investment opportunities, Anthony explains.

“Market over-reactions around M&A are exacerbated at the moment with fears that the economic cycle is rolling over.”

Investors are concerned that companies are buying businesses that may have puffed up earnings or been trading on a cyclical peak, he says.

“They are worried that the acquiring company has not done enough due diligence and that gives them a reason to sell off the acquiring stock.

“But if you can do the work on the acquired businesses and start to get an understanding and more informed perspective on the probability of the success of a deal, then the sell-off could be quite an attractive investment opportunity.”

Take a long-term view of M&A

Amcor’s purchase of US-based flexible packaging company Bemis in 2019 worked well with significant cost synergies extracted and an improved top line.

But initially, after the deal was announced, Amcor was sold off.

Pendal Focus Australian Share Fund

Now rated at the highest level by Lonsec, Morningstar and Zenith

Read more

A similar example was Boral’s 2016 purchase of US-based fly ash producer Headwaters.

Following the announcement of the deal Boral was initially sold-off – then bid up as investors got excited by the potential growth prospects of the Headwaters business.

Ultimately there were few natural synergies between the businesses and as the underlying low quality of the Headwaters business became apparent, Boral underperformed over several years.

It recent months, two ASX-listed companies — both held in Pendal equities funds — have acquired businesses and are now trading on historically low multiples.

“Packaging group Orora (ASX: ORA) bought a France-based specialty premium glass manufacturer that supplies high-end glass bottles for luxury spirits and is a global leader,” Anthony says.

“But investors are worried that post COVID, the growth in luxury spirits, in particular, is rolling over.  

There are concerns Orora paid too much, the industry is going to become more competitive and the ESG burden of decarbonising returns will hurt returns,” he says.

Treasury Wine Estate (ASX: TWE) bought a US luxury wine company that has grown quickly in recent years.

Investors are concerned that the growth in earnings will not be sustainable, and that US consumer demand will wane.”

Anthony says that while it is much too early to tell whether the Orora and Treasury purchases are good deals, the kneejerk reaction from markets, selling off the companies, provides an opportunity for investors.

“Take the time to do the work on the underlying assets purchased. Talk to other industry participants and find out how these businesses are positioned, what’s sustaining their returns and what the outlook is.

“And bear in mind that doing the deals haven’t changed the underlying assets in the rest of the businesses.

“The de-rating has hit both the acquisition business and the legacy businesses. That means the legacy businesses have gotten cheaper.”

About Anthony Moran

Anthony Moran is an analyst with more than 15 years of experience covering a range of Australian and international sectors. His sector coverage has included Australian Industrials and Energy, Building Materials, Capital Goods, Engineering & Construction, Transport, Telcos, REITs, Utilities and Infrastructure.

He has previously worked as an equity analyst for AllianceBernstein and Macquarie Group, spending a further two years as a management consultant at Port Jackson Partners and two years as an institutional research sales executive with Deutsche Bank.

Anthony is a CFA Charterholder and holds bachelor’s degrees in Commerce and Law from the University of Sydney.

Find out more about Pendal Focus Australian Share Fund  

Contact a Pendal key account manager