Citi Research released an investment report yesterday titled “Screening for Potential Small Cap Takeouts”. Analysts Deane M. Dray and colleagues believe the current market is ripe for small cap M&A activity and developed a screening mechanism to identify 438 potential small cap takeover targets in 16 sectors. “Following a year when M&A was largely sidetracked due to an unfavorable pricing environment, we expect bolt-on acquisitions of smaller-sized companies to be high on the capital allocation priority list for the Multi-Industry sector in 2014.”

Stock screening methodology

The Citi analysts stock screening methodology to identify takeout candidates involved filtering for (1) a market cap less than $4 billion; (2) the bottom 80% of companies in each end market in terms of  EV/EBITDA; and (3) positive operating margins (to eliminate “turnaround stories”). This screening system resulted in the identification of 438 potential M&A targets. The analysts also suggest considering other filters that could be used to further reduce the number of companies on the list.

“Heat map” for attractive M&A sectors

The Citi report also highlight several sectors as likely to see a significant amount of M&A activity this year. “We continue to expect plenty of activity in the always intriguing “Holy Trinity” of industrial M&A, namely healthcare, security, and water. We also focused on hot end markets like software-as-a-service (SaaS), test & measurement, and energy, particularly in oil & gas.”

small caps M&A

Companies likely to make major acquisitions in 2014

Dray et al. also note that M&A deal flow was slow in 2013, so most companies have “ample firepower” to make deals this year. They highlight a few companies who they believe are likely to pull the trigger on a major deal in 2014:

“Danaher is pushing into overtime with its expected use of the +$8 billion of M&A capacity, but is staying disciplined in an environment of extended valuations. It has recently been relying on more below-the-radar bolt-on deals that collectively totaled $1 billion in 2013. But investors are still looking for the synergistic $1 billion+ deals that could drive estimates meaningfully higher. Based on our screening of acquisition firepower with an expressed willingness to do deals, the other companies with a potential M&A catalyst include 3M Co (NYSE:MMM), Roper Industries, Inc. (NYSE:ROP), and AMETEK, Inc. (NYSE:AME).”