Potential M&A Targets In The Small Cap Sector

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).”