Smaller Company M&A –
Buyers not just Targets
When we launched the Appian Smaller Company Opportunities Fund (ASCOF) just over two years ago, we highlighted M&A (mergers & acquisitions) as an investment theme that was potentially more positive for small and mid-cap companies than for larger corporates.
In the first instance we argued that the relatively attractive valuations of smaller companies means it is more likely that they will become acquisition targets for larger companies – particularly as larger companies, which are struggling to grow organically in the current economic environment, have strong balance sheets and access to low cost debt finance.
Our second point was that is easier for small companies to do transformational deals. If a small company acquires a €100m business it can be a very meaningful deal whereas it would be immaterial in the context of large multinational with existing sales in the tens of billions.
The acquisition target part of our thesis was proved correct quite quickly, with one of the fund’s holdings being acquired within three months of the launch of the fund. In total five companies in which the fund owned shares were acquired during the fund’s first two years. This is a meaningful number in the context of fund which aims to hold only 25-30 stocks, and it was an important contribution to the 45% gain returned by the ASCOF over its first two years.
More recently the fund has also benefited from companies it has invested in being acquirers, not targets. Two of the ASCOF’s holdings have just completed reverse takeovers – these are potentially transformational deals where a company buys another business which is as large, or larger, than its existing business. In both cases, the market reaction to these deals has been positive.
The first acquisition was by Micro Focus, a company that provides software products and services to customers who run mission critical systems on legacy languages such as Cobol and Corba. In mid-September it agreed to buy Attachmate a leading provider of enterprise infrastructure software (including SUSE Linux, NetIQ and Novell) for US$2.35bn. Attachmate’s revenues are twice that of the existing Micro Focus business and its earnings (EBITDA) are 50% higher, yet the price being paid is only two thirds of Micro Focus’ own market value.
Investors responded positively, as they liked the price being paid for the business and also the potential for Micro Focus management to enhance revenues and margins in the acquired business, which it has successfully done with previous acquisitions. As a result, Micro Focus’ share price is now 15% higher than pre-deal levels despite volatile stock markets over that period.
The second deal was by Powerflute, which runs a specialist packaging board business in Finland. At the end of September it announced the €81m acquisition of another Finnish based paper company, Corenso, which makes core board, a related product. Corenso’s revenues are higher than Powerflute’s but its earnings (EBITDA) of €20m are the same as it generates lower margins. However, there is potential for these to increase as Powerflute has identified efficiencies to be realised in the acquired business.
Corenso’s purchase price represents a very attractive multiple of 4 times EBITDA which compares to 6-7 times for other paper companies. With the scale and value which Powerflute is adding from this transaction, Powerflute itself can now command a valuation multiple similar to other paper stocks. As a result, its shares have performed strongly in response to the deal posting a gain of 40% since it was announced.
These deals further highlight how M&A is an avenue for smaller companies to deliver positive share price performances whether stock market conditions are positive or not – either by becoming takeover targets or by delivering positive acquisitions such as these two recent deals.