With 2012 drawing to a close, many investment bankers will be reflecting that instead of taking their families to Hawaii, they might have to settle for a final fling at their beach house in Palm Beach, before it goes under the hammer in 2013 due to a forced sale. They probably view themselves as lucky if they have a job.
There have been the same number of deals this year as last, but the average value of those deals has halved in 2012, compared to 2011, according to SP Capital IQ. That's right, all the activity is happening at the small cap end of the spectrum. In 2011 the deal value was $105.5 billion, whereas this year it has been just over $52 billion.
This columnist mustn't be alone in noticing the number of takeover rumours that swirl around stocks that are on low PEs that indicate they are in distress. Familiar names include Fairfax Media, Qantas, David Jones and Macmahon Holdings. There is also more than the usual (it seems) evidence of corporate predators pulling out of deals, such as happened when private equity giant TPG left Billabong high and dry.
Then there was the farcical, where David Jones took seriously a $1.52 billion bid by a Scottish punter living in a post office and an office next to a wig shop and noodle store in Newcastle, England.
What's going on?
The main thing affecting deal making is uncertainty, which is a global phenomenon. It is reflected in the lack of liquidity in the market – which is a fancy way of saying that people aren't trading much (volumes are down about 30 per cent on this time last year). Because the bid-offer spread is widening, it is very expensive to accumulate a significant stake in a company.
Another factor for Australian companies is the strength of the domestic currency. This makes it expensive for companies paying for Australian assets in euros or US dollars.
The small cap light
Wilson Asset Management founder Geoff Wilson spells out succinctly, why deal activities in small caps are reaching frenzied levels:
“There is always more corporate activity in smaller companies. Because of their size they are affordable to more companies, both here and offshore.”
Under the Radar is seeing many opportunities for minority investors to benefit from big (international and domestic) companies taking advantage of small caps going for cheap prices.
They'll do this because in a stagnant economic environment, it's the easiest way to achieve growth (and keep those highly paid executives in a job).
The fund managers Under the Radar spoke to say that the momentum of deal activity is only going up.
“There have been 22 [takeover] bids since June 30. Most of these have been in the resources sector,” says Ben Griffiths, who is a founder of the fund manager Eley Griffiths, which manages $1.2 billion.
He then rattles them all off, and tells Under the Radar that his fund is increasing its weighting towards small resources, and in particular the small gold stocks. He continues:
“Six months ago you didn't see the stirring of interest from corporates, especially at the smaller end. The animal spirits are improving. People are feeling slightly better about things.”
Low interest rate boon
The legacy of the famed economist John Maynard Keynes is alive and well in Sydney's CBD.
Geoff Wilson invokes more fiscal rigour, pointing out the low cost of financing means that Australia's strong exchange rate is irrelevant for international buyers, who are benefiting from interest rates that are basically zero.
“If your cost of borrowing is 0.3 per cent you can pay a PE of 80 and it will still be EPS [earnings per share positive,” he says.
If you crunch the numbers, you realise that even paying interest rates of 6 per cent to debt finance an acquisition means you could pay up to 24 times before it would no longer be EPS positive.
Radar is sure a lot of those investment bankers are saying just this to their clients, before they head off to Palm Beach for the last time.