How to play the deal frenzy on the ASX

The global sharemarket is buzzing with the promise of artificial intelligence, with the ASX buzzing with takeover activity.

Unfortunately, sometimes the two themes overlap and a $9bn bid from a Japanese chip maker for local tech stock Altium means the end of another potential AI play for Australian investors.

The takeover frenzy of 2024 has been a long time coming — but it’s hit with a vengeance.

The dominoes keep falling. Industrial conglomerate CSR sold to the French this week, Alumina Limited is being sold to the Americans, Newcrest Gold was sold to the Canadians.

As investors, this is the price we pay for an open market. If you want our market leaders, such as CSL and Macquarie, to keep buying whatever they want around the world, then the doors must remain open on the ASX.

The problem, of course, is we are losing in the game. CSL and Macquarie are exceptions in their overseas ambitions.

Most of our leading stocks simply squeeze the lemon in the domestic market. It’s so much easier to keep adding to your local monopoly than taking on regulation risk by heading overseas.

CSR Managing Director and CEO Julie Coates. CSR was recently sold to a French company. Picture: Supplied

Not surprisingly with such an approach, when major companies finally do venture offshore they are often innocents abroad … and get fleeced through lack of experience.

Which is all grist to the mill, but the end result is the local market is literally shrinking, with a net reduction of more than 100 listed companies on the ASX over the past year.

Worst still, many of these takeovers represent companies which really matter. Altium sits within a tiny selection of stocks which can fit under the AI umbrella. Newcrest was the nation’s biggest gold miner, CSR was a key player in the building materials sector.

(Of course, sometimes a foreign takeover means a bullet dodged. The absurd price Jack Dorsey’s Block group paid for Afterpay comes to mind, the dumb money from Japan Post for Toll Holdings makes the cut as well.)

Why so much takeover activity, and why now? Because our stocks are cheap.

Yes, funnily enough, if you trail the rest of the world on price growth and valuations, at a certain point the rest of the world comes looking over the garden wall and cherrypicks the best companies in your market.

Identify the target

The upside to the takeover frenzy is if you are lucky enough to be holding a stock when it gets a takeover bid you will probably receive an instant 30 per cent lift on the value of your holding — often better.

The 33 per cent premium in the bid by Renesas of Japan for Altium is what we’ve come to expect from offshore bidders.

So, how do you pick a takeover target? Cut to the chase … despite all those “takeover target” lists, in ­reality it’s pot luck.

For years I dealt with a fund manager who ran a specialist takeover strategy fund. She regularly put out a list of takeover targets and over three years there was one correct call out of a rolling list of 20.

It’s not so much a random process as a very low-probability situation. Even if we had a takeover every week there are still more than 2000 stocks on the ASX.

Look a little more closely at takeover hedge funds and you will find they spend most of their time — and make most of their money — working on the probabilities around takeovers, where there is a first bid and then successive bids which get sweeter.

This is what happened at Newcrest Gold when Canada’s Newmont came knocking more than once before arriving at a “best and final price”.

But surely, you say, some companies are sitting ducks? Screaming takeover targets where it’s only a matter of when, not if, they will be the subject of a bid.

This is only partly true. For a start, there is more than one way to grab control of a company, since predators are allowed to creep up a register over a long period.

Besides, just because it logically makes sense does not mean it is going to happen. At least a decade ago I recall a broker’s report outlining how the locally listed Alumina would ultimately receive a takeover bid from its US big brother Alcoa. And it has come to pass … a decade later.

It would have been a long wait for anyone who bought the stock merely for its takeover potential, because the Alumina share price has been drifting for the past five years.

It’s also worth keeping in mind there are effective takeover blocks in place which are just as powerful as any legal restrictions.

Very highly priced stocks become effectively takeover proof because nobody in their right mind would pay the valuation the market is already accepting.

Alternatively, there can be Foreign Investment Review Board limits, though these restrictions are rarely enacted.

With some companies, the takeover gods simply smile upon them. In 2001, the government blocked Royal Dutch Shell from taking over Woodside, allowing the group to thrive and later buy BHP Petroleum.

More recently, Woodside has failed to merge with Santos. This might also be a blessing in disguise.

The big four banks are big because they took over everything else in local banking. Remember the regional banks Bankwest (now in CBA), St George and Advance (now in Westpac), and Suncorp bank (now about to join ANZ).

In this instance the takeover code works a treat for the large banks — at the same time the “four pillars” policy means none of the big four can take over the other.

Either way, the takeover boom is a boon for investors. A 30 per cent instant profit on a stock you own is a beautiful thing — the trick is to redeploy the money successfully.

What’s next?

There are too many strong established companies such as Altium and CSR going out the back door, and the tiny numbers coming through the front door are not making up the lost ground. It’s what’s called de-equitisation, and it’s a mounting problem.

A string of takeovers would be fine if there were an endless string of new sharemarket floats, but the initial public offerings scene is barely alive on the ASX.

We get endless tiny mining companies floating, but where are the market leaders? This last year Chemist Warehouse bypassed the IPO process, the much vaunted Redox chemicals IPO was a flop, so too the Judo Bank float. The next iteration of a Virgin Australia float is not going to happen anytime soon.

Perhaps the ideal stock is able to play both sides of the takeover game.

Circling back to AI and the lack of opportunity in the local market, the AI-themed data centre stock NextDC is both a regular predator — picking up what it wants on overseas markets — while commanding a permanent position as a takeover target.

Over the past 12 months, this stock is up 73 per cent and is currently trading at all-time high levels — a takeover bid which added another 30 per cent to returns would be hard to reject.

But, the secret is not to buy a stock just because it may get a takeover bid — they are almost impossible to pick in advance.