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Recent Merger & Acquisition activity suggests market confidence is returning – Fat Prophets

One indicator that market conditions are returning to normal is an increased level of merger and acquisition activity. Corporate deal making is indicative of increased confidence within companies that are looking to expand their industry footprint. Such developments also buoy wider market confidence as investors anticipate gains among other potential target companies.

American food and beverage company Kraft’s recently revealed bid for UK chocolate giant Cadbury certainly highlights the benefits of being on the right side of a takeover. Cadbury has so far knocked back Kraft’s advances, deeming them as materially undervaluing the company. Nevertheless, Cadbury’s current shareholders had the pleasant surprise of an immediate 38% gain in the company’s stock price following the news.

As is often the case with such offers, Kraft’s initial bid is unlikely to be their last. The Illinios based company may also face the prospect of fending off third party bids from the likes of Hershey and Nestle.

Although Cadbury understandably took the headlines, rumours also abound that resource heavyweight Xstrata may be on the cusp of launching a bid for Platinum producer Lonmin. Xstrata abandoned a previous attempt for the 75% of Lonmin that it doesn’t already own when the full force of the credit crisis hit last year. The deal’s potential revival would therefore be a further indictment that the worst has passed.

One factor that may discourage Xstrata from taking control of Lonmin is that such a move would all but rule out an Xstrata/Anglo American merger. The three companies account for more than half of the world’s platinum production. The regulatory authorities would therefore be unable to allow the three to merge from a competition perspective.

Either way, the resources sector is likely to be among the more active areas of corporate activity in the months ahead. Canada’s Eldorado Gold got the ball rolling last month with their friendly bid for Australia’s Sino Gold. As Members of our Australian report may be aware, Sino represents a reasonably unique opportunity in the sector given its access to Chinese gold deposits and proven development expertise.

Rather than foreign companies seeking access to China’s resources, however, corporate activity in the sector is more likely to be in the other direction. China may have missed out on their play for a larger chunk of Rio Tinto. Nevertheless, the country has not been without success elsewhere. This year alone, Chinese backed companies have feasted on Australia’s OZ Minerals and Felix Resources, in addition to Teck Resources in Canada. A massive deal with Fortescue has also given Chinese interests access to iron ore assets after being foiled in their Rio attempt.

China’s interest in the resources sector specifically is two-fold. On the one hand, resource assets are of great strategic importance to the country as it continues its industrialisation process. Buying significant stakes in producers, or even outright control, affords Beijing with a greater degree of security when it comes to both future supply and pricing.

The other issue for China is of course their largely US dollar denominated currency reserves, which currently stand at more than US$2 trillion. China has openly expressed concern for their exposure to the Greenback, which they see as under grave threat from America’s policy response to the GFC. The Fed has had little choice but to accept the risk of longer-term inflation and with it a devaluation of the dollar, as the cost of avoiding the deflationary scenario.

China meanwhile has its hands tied. Beijing would relish an opportunity to slash its US dollar exposure. China is however handicapped by the size of its current holdings. Any significant move out of dollars would have immediate and negative effect on their remaining holdings. They must instead seek to diversify steadily over time. Other paper currencies such as the euro will benefit from this, but hard assets are also a target, such as the various resource companies recently snared by Beijing.

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