George Godber, manager of the CF Miton UK Value Opportunities fund, says that Vodafone selling its stake in Verizon Wireless seems to have kick-started more activity in the UK and across Europe.
"It’s very clear M&A confidence is building, although we were at multi-year lows in the UK and the US really until the end of August," he said.
Stuart Widdowson (pictured), manager of the Strategic Equity Capital fund, says that there is plenty of evidence of a pick-up in the small cap space which he invests in, which is to be expected as the economy hits this stage of a recovery.
"What you tend to find at this point of the cycle is UK businesses with good operations being bought by US trade buyers," he said.
Neither manager specifically sets out to buy companies they think will be taken over, but both are led to the same stocks.
Widdowson looks for companies that pass muster on the valuation techniques used by private equity buyers and he says there are plenty of examples in the UK market. "You’re looking for good individual companies that are trading at a discount compared with their peers overseas," he said.
Here are five stocks the managers highlight as potential takeover targets in the coming months.
Colt
Godber says that although analysts have been predicting an uptick in M&A activity for some time, there is no surprise it has taken longer to come to fruition than was predicted.
"Boards of directors don’t tend to do things suddenly. It was only last August Draghi said 'we will do whatever it takes', which had such a positive effect on markets."
"The real world moved to a different rhythm to the stock market." He says that the telecoms industry is likely to see consolidation in the near future.
"It’s very clear there’s a sea-change in the telecoms industry in Europe," Godber (pictured) said.
He points to Vodafone’s purchase of Kabel Deutschland as a sign of growing M&A activity in the sector.
There are also suggestions that Spanish telecoms giant Telefonica is considering buying out Telecom Italia, with which it currently runs some joint ventures.
Godber says that Colt could look attractive to potential bidders at the moment.
Colt stands for City of London Technology. It is an IT company that is in possession of a large number of fibre-optic cables that run between European cities.
Godber says this makes it an extremely appealing acquisition for a company that wants to use these cables to provide services. Super-fast broadband is extremely popular with consumers, adding to the attraction of Colt’s infrastructure.
"They have spent £6bn building up that network and now it’s capitalised at £1bn, so if you want fibre, that’s a decent stock to look at," he said.
Colt is headquartered in Luxembourg but trades on the FTSE 250. Shares have been more or less flat over the past year, while UK mid caps have grown by 31.99 per cent.
Performance of stock vs index over 1yr
Source: FE Analytics
Shire
Widdowson says that he and his colleagues are convinced that Shire will end up being bought in the next two to three years.
The company is the right size to be taken over and has an enviable pipeline of drugs – exactly what the big players in the sector are lacking.
"Companies are awash with cash and struggling for ideas and Shire is one of the few decent companies out there to show growth," he said.
The big pharmaceutical companies are looking to take over companies with products that are proven and ready for market, and Shire fits the bill, Widdowson explained.
The company has seen strong share price growth over the past year, outpacing the sector in a good year and returning 33.88 per cent, well ahead of the 18.35 per cent made by the FTSE All Share.
Performance of stock vs indices over 1yr
Source: FE Analytics
Aer Lingus
Godber also thinks that the airline market could be a good bet for corporate activity.
"I think there will be further consolidation in the airline industry: the market is becoming more rational and you will probably see further rationalisation happen there. In many stocks, there really is a lot of opportunity," he said.
Aer Lingus is the stock that the manger thinks looks most likely to be picked up, although its current ownership is complicated.
Ryanair has built up a 29 per cent stake in the hope of being able to launch a takeover bid, but this was blocked by the competition commission, which ordered the company to sell down its stake to less than 5 per cent.
Godber says that the fleet is valued at roughly €750m on the airline’s books, and if someone were to buy them new it would take six years to get delivery, such is the backlog of orders in the industry.
The main attraction, though, is the 23 slots at Heathrow that the company owns, and Godber says this was likely the main draw for Ryanair.
"Heathrow is at capacity, so if you want Heathrow you have to buy it," he said.
Allocate
"Another natural hunting ground tends to be software and there aren’t that many UK-listed businesses in the software sector with sales above £100m a year, because they tend to get taken over," Widdowson said.
He points to the takeover of ascribe by Emi last week as an example of what is possible in the sector. Ascribe runs the pharmacy systems in A&E departments and mental health trusts.
He says that Allocate is a company with a very similar profile to Ascribe but which is trading on a massive discount to the valuation paid for the latter.
Shares rose sharply over the summer, according to data from FE Analytics.
Performance of stock vs indices over 1yr
Source: FE Analytics
Cobham, e2v and Ultra Electronics
Widdowson says that the defence industry is likely to see corporate activity in the coming months.
"There was a wave of consolidation in the US in the 1990s and we would expect to see more of that," he said.
"UK companies that could benefit are e2v, Cobham and Ultra Electronics."
Widdowson says none of these companies are firing on all cylinders, but for different reasons. He adds they could be targets for larger companies looking to consolidate as they chase reduced levels of government spending.