Analysis: M&A spurt, cyclical mix to fuel Europe small caps

By Tricia Wright and David Brett

LONDON (BestGrowthStock) – Shares of small European companies are set to perform better than their larger brethren, fueled by a pick-up in takeover activity and their more cyclical mix.

After years of belt-tightening cuts in dividends, inventory and staff to deal with the credit crisis, bigger firms are armed with strong balance sheets and looking to expand in the face of limp growth.

Analysts said these arsenals of cash are highly likely to be unloaded into attractive small-cap takeover targets.

“There is money to spend and businesses are doing that via M&A. As confidence is increasing they are thinking ‘we have to do it now before we get further in the upcycle and things become more expensive’,” said Edwin van Oosten, fund manager of the 150 million euro ($200.6 million) ING Invest European Small Cap Fund, said.

According to Thomson Reuters StarMine data, 60 percent of companies globally beat or met expectations in the third quarter.

Van Oosten said the long list of potential small- and mid-cap takeover targets includes German crane maker Demag Cranes (D9CGn.DE: ), reportedly being stalked by U.S. peer Terex (TEX.N: ), and French online property ad company SeLoger.com (SLGC.PA: ), being hunted by German publisher Axel Springer (SPRGn.DE: ).

“Every time you start to see the equity market recover post a recession, you tend to see a pick-up in M&A, only this time that should be in spades, because companies need to find ways to grow given the anemic recovery, and balance sheets are strong,” Eduardo Lecubarri, head of small/mid-cap strategy at JPMorgan, said. Lecubarri said that M&A alone could add 8.4 percent upside to Pan-European SMid-Cap valuations if only the last M&A cycle repeated itself — 2004-2008 saw $705 million in SMid deals (34.6 percent of today’s combined SMid market capitalization) with an average premium of 24.4 percent.

Dean Turner, an investment strategist at Barclays Wealth, pointed out that in Europe the top sectors in terms of M&A takeover activity have been the electricity sector, telecommunications, banks and transportation.

CYCLICAL BOOST

Enhancing small caps’ appeal as takeover targets is their comparatively large weighting toward cyclical sectors.

Materials, industrials, consumer discretionary and technology account for 55 percent and 56 percent of companies in the Stoxx pan-European small and mid-cap indices, Thomson Reuters Datastream data shows. These more economically sensitive sectors make up only 29 percent of large caps.

“If the view is that the recovery is going to continue to be supported by the central banks… I think risk trade is something that will continue… and that does help your smaller companies,” Mike Lenhoff, chief strategist at Brewin Dolphin Securities, said.

UK small caps (.FTSC: ) have risen 8.8 percent this year versus a 5.3-percent gain from the blue chips (.FTSE: ).

Analysts said this outperformance has boosted the price-to-earnings ratio of smaller companies, with the one-year forward P/E ratio for UK small caps at 13.3 times, against 12.8 times for the FTSE 100.

German small caps (.SDAXI: ) have advanced 34 percent against a 15.5-percent rise in the blue chips (.GDAXI: ); and French small caps (.MS190: ) have climbed 11.8 percent versus a 4.5-percent decline in the CAC 40 (.FCHI: ).

(Editing by Andrew Callus)

Analysis: M&A spurt, cyclical mix to fuel Europe small caps