Five potential takeover targets

It is a truism of the stock market that once a business is listed on the exchange, it is up for sale, all day, every day. And with the stock market down by 30%, all of the listed businesses are effectively in a bargain sale, priced to clear.

The caveat, of course, is whether the individual companies have a business that will still exist on the other side of the Covid-19 crash, and can rebuild revenue and earnings. If so, there are bargains not only for individual investors, but for companies and private-equity funds that have the cash to take advantage of opportunities they might have liked for some time, but which are now suddenly significantly cheaper.

Here are 5 potential takeover candidates in the carnage of the COVID-19 crash.

1. Treasury Wine Estates (TWE:ASX)

Market capitalisation: 6.8 Billion

Global wine group Treasury Wine Estates was already considered by many market watchers to be a takeover target, having underwhelmed in its half-year result and lowered its full-year guidance even before the coronavirus hit – and then downgrading for the second time in a month, this time incorporating the impact of the outbreak. From $16.24 at the start of the year, TWE has subsided to $9.46, a drop of 42%.

Treasury has been hurt by a wine glut in North America, in the wake of a larger-than-expected Californian grape harvest in 2019, cheap private-label wine subsequently flooding the market, and the effects of the trade war with China. The company has estimated that the over-supply will take about two years to clear. Treasury Wine was known to be reviewing its business before the coronavirus hit; the potential impact of the disease on demand for its wine in China – it is the biggest-selling winemaker in China, which is the company’s most profitable market – was reason enough for the shares to be sold-off.

The internal review was canvassing whether to separate the prestige brands such as Penfolds, Wynns and Seppelt from the lower-priced commercial brands, such as Lindemans and Blossom Hill. The basic problem was that the two arms of the business had become incompatible: Bank of America told Treasury earlier this year that the value of the flagship Penfolds business alone was well above the share price at the time – and that Treasury could be worth about $20 per share if the company were to be broken up. The higher-end brands earn a return on investment between two and four times more than the commercial portfolio.

OK – so you might not get $20 now. But tell me that value extraction isn’t still attractive, especially if the North American wine glut is going to be around for a couple of years? If Treasury doesn’t want to do this, someone else might think the value of the prestige brands worth extracting in the current environment, given that they are getting access to those brands at bargain share-price levels.

2. Afterpay (APT:ASX)

Market capitalisation: $5 Billion

Everybody has an opinion on the “buy now, pay later” fintech leader Afterpay, which has almost become a verb in that space – in the same way that people (particularly young people) will “Uber” somewhere, they will “Afterpay” for stuff, in four instalments. It’s actually more a “buy now, receive now, pay later” model, with the credit assessed and funded by Afterpay.

The company has always been highly polarising in the investment community, and that is especially so in the current environment: some say that because it does not conduct credit checks on its customers and has never had to try to recover debts, Afterpay will face problems from low-income customers losing their jobs. Others believe that the service is used by higher-income repeat customers as a budgeting tool, that it helps retailers, and is not a debt trap, given that a single overdue payment sees a user locked out.

The company does not yet make a profit, but this has not greatly concerned Afterpay fans, who have focused on the huge opportunity in the US market, and progress in that expansion. Afterpay launched in the US in 2018, and its customer base in the market has already exceeded its base of 3.1 million customers in Australia. If Afterpay can replicate the trust, loyalty and repeat business that it appears to have built with its Australian consumers in the US – and its other main expansion targets, the UK and Canada – it can reasonably expect increased volume and eventual profitability. Covid-19 has put a spanner in the works, as it has with most businesses, at least temporarily, but Afterpay is confident that its model could even be “enhanced with changing market conditions.”

Starting the year at $29.28, APT soared to $40.50 by 19 February, only to be dragged back to $8.90 by the Covid-19 Correction – a gut-wrenching fall of 78%. Since then, Afterpay has rebounded to $19.10, a rise of 107%. But the stock is still down 37% for 2020 to date.

One thing is for certain, other companies in the payments area would have noticed that Afterpay is a lot cheaper now. Think Mastercard, or Pay Pal, or possibly even Swedish payments solution provider Klarna.

Klarna, which has a banking licence in Europe, has partnered with Commonwealth Bank of Australia. It has installed the Klarna product in its banking application and has also invested $US300 million ($500 million) in Klarna.

3. Altium (ALU:ASX)

Market capitalisation: $3.4 Billion

Electronic printed circuit board (PCB) design software company Altium is one of the ASX’s genuine global technology stars, but that has not stopped the Covid-19 Crash from slicing 37% off its value, to $3.4 billion. Any company looking for leading companies in an expanding global market that are still growing their market share would have to have circled and underlined Altium on their list.

Despite its valuation haircut, Altium could actually be well-placed to weather the coronavirus storm, because its electronic design work is not linked to manufacturing volumes. And Altium’s products are deeply embedded in the profound technological shifts we are experiencing, in the rise of forces such as cloud computing, big data, artificial intelligence (AI) and 5G – structural shifts that should not be derailed by Covid-19. The PCB is at the heart of the burgeoning use of “smart” connected devices in everyday life – Altium says it is “committed to achieve market leadership to the point of being the dominant provider of PCB design software by 2025.” Like most businesses, earnings are susceptible in the short term, but Altium has the buffer of a net cash position on the balance sheet.

 4. Webjet Limited (WEB:ASX)

Market capitalisation: $510 Million

It has been an awful quarter for online travel agent Webjet: the shares started the year at $13.02, and cruised to $14.44 within three weeks – but the world is a different place now. Webjet went into a trading halt on 18 March and has been trying to raise $250 million of capital at a reported $1.80, to shore-up its near-term future, given that cashflow has collapsed in the face of a virtual shutdown of the domestic and global tourism industries.

Webjet has been smashed, and it looks like it has come down to super-cheap levels – priced at 6.9 times expected FY21 earnings. But the big ‘IF,’ of course, is IF those earnings expectations are achievable; which would require a recovery of aviation and tourism. Like many companies in the tourism/airline business, Webjet would be a screaming buy if we knew whether this was the bottom, or whether things could get worse.

Webjet’s problem is not over-indebtedness in tough times: it had borrowings of $191.7 million at December 31, while net debt accounted for only 0.35 times its EBITDA (earnings before interest, tax, depreciation and amortisation).

With its proposed equity issue to raise money apparently not going to fly (pun intended), Webjet - which is still in trading halt - is reported to be considering a convertible funding arrangement with private equity group KKR, or a similar fund. If it is KKR, that is the group that was reported to be poised to make a takeover bid for Webjet before the coronavirus hit. Might KKR be even more interested at a price suddenly 70% cheaper?

5. Virgin Australia (VAH:ASX)

Market capitalisation: $658 Million

At these share-price levels, Virgin Australia doesn’t really have shareholders in the normal sense – it has punters betting on the struggling airline being taken out by one of its big shareholders. After seven straight years of losses, Virgin Australia does not have the cash reserves to survive a prolonged air-travel slump; but the paradox is that the Australian government needs it to keep flying, and to be able to resume its schedule once Covid-19 permits. The government cannot afford a repetition of the Ansett collapse in 2001. As Australian Competition and Consumer Commission (ACCC) chairman Rod Sims put it earlier this month: “we went into this crisis with two full-service airlines and we need to come out of this crisis with two full-service airlines.”

Virgin Australia has suspended all international flights until mid-June and cut domestic capacity by about 50%.

The Australian government is not going to nationalise Virgin Australia, so all eyes turn to its share register, which is 90%-owned by the government-controlled Singapore Airlines and Etihad Airways, Chinese groups Hainan Airlines (HNA) and Nanshan, and Richard Branson’s Virgin Group. All of these have their own financial issues, but at least Singapore Airlines has cashed itself up, raising $US10.5 billion ($17.5 billion), backed by Singapore government funds. Of all Virgin’s shareholders, Singapore Airlines is considered to have the most to gain from a takeover of the Australian airline, and that is about all that is keeping the minority shareholders in the stock. The downside? Investment bank Credit Suisse has a target price on VAH of 1 cent.