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:
- 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.
- 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.
- Interest rates still trade at historically low levels, making it possible to finance deals cheaply.
- 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 S.A. (ADR) (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 Co Inc (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.