Potential Acquisition Targets For 2H15

by: Ryan Wood, CFA


Low Borrowing Costs & Slowing Growth Should Drive M&A Activity.

Current Industry Consolidation Points To Likely Candidates.

Potential Targets: SMCI, MMS, MNST, FANG, ALGN.

In recent months, we have seen a plethora of M&A activity across multiple sectors. Everything from Avago(NASDAQ:AVGO)/Broadcom(BRCM) to Halliburton(NYSE:HAL)/Baker Hughes(BHI) and Heinz(HNZ)/Kraft(KFT) to Charter(NASDAQ:CHTR)/Time Warner Cable(TWC). Not to mention the never ending deal making in the health care space. The current low interest rate environment coupled with slowing growth among the larger players creates an ideal environment for further consolidation, particularly among the smaller faster growing players. And with rates expected to rise in the coming months, the pressure is mounting for larger players to "lock up" growth for the next several years. Below I have identified what I consider to be five potential acquisition targets across various sectors. While investing based solely on potential M&A activity is usually a losing game, it is worth considering as part of a broader due diligence process. All source material not otherwise linked is taken from company filings.

Super Micro Computer (NASDAQ:SMCI)

SMCI is a global leader in energy efficient computing and provides end-to-end solutions for the data center, cloud computing, and enterprise IT markets. The company is in the early years of a secular growth trend and represents a clear opportunity for a larger slower growth competitor like Hewlett-Packard (NYSE:HPQ) to buy a faster growth business for a bargain price. With HPQ pushing hard into the enterprise IT and cloud computing space, SMCI would be a logical fit and would likely be less expensive than developing a customer base organically. And with SMCI's superior high efficiency server designs, critical in a world of rapidly expanding internet traffic and digital content, the company is well positioned to take additional share in this growing industry. SMCI currently trades at roughly 14x forward earnings, well below the S&P 500 multiple of 18x, despite having a much stronger growth rate and margin profile. Even assuming a 30% takeover premium, an acquirer would still only be paying an average multiple for a business that performs well above average. Plus, the company's solid cash flow and strong balance sheet are icing on the cake.

Maximus (NYSE:MMS)

MMS provides business process and consulting services to state and federal government health agencies. The company operates government-sponsored organizations like entitlement programs, health insurance exchanges, and other health care reform initiatives across multiple countries. MMS has benefited from the Obamacare rollout in the U.S. as well as increased government focus on cost containment and entitlement reform abroad. Given the company's debt-free balance sheet and attractive growth and margin profile, MMS would make a good acquisition for a larger competitor like UnitedHealth Group (NYSE:UNH). And considering UNH's intent to move further into the faster growing and higher margin service space, MMS would be a nice complement to UNH's existing Optum service offerings. While MMS is not cheap, at roughly 22x forward earnings, the long-term growth and margin enhancement that UNH would receive would likely be worth the price.

Monster Beverage (NASDAQ:MNST)

MNST is a global non-alcoholic beverage company that primarily produces energy drinks, as well as various coffee, tea, juice, and soda drinks now owned by The Coca-Cola Company (NYSE:KO). Given that energy drinks are one of the highest margin and fastest growing categories in the beverage space, MNST has long been an attractive target for larger players in the industry. Until recently competitors like KO have been content to market their own energy brands, as opposed to buying those of MNST, with noticeably little success. But last summer KO took a roughly 17% equity stake in the company and transferred all of its energy portfolio to MNST, while taking on all of MNST's non-energy portfolio. In addition, KO expanded it's long-term distribution agreement with MNST to included additional European territories. Clearly KO stands to benefit the most from a combination with MNST and is likely setting the stage for a future acquisition. MNST is also not cheap, at roughly 33x forward earnings, but its impressive growth and minority ownership stake make it more valuable to KO than to any other competitor. As a result, investors should consider an eventual acquisition by KO.

Diamondback Energy (NASDAQ:FANG)

FANG is an onshore oil and gas E&P firm based in Midland, TX. The company focuses primarily on developing its extensive shale reserves in the Permian Basin. FANG is one of the lowest cost shale producers in the country, with some wells proving economical with oil as low as $45/barrel. And in the current $60/barrel environment, FANG is able to generate a healthy profit while other higher-cost producers continue to lose money. FANG recently raised its 2015 production guidance, which has already more than doubled year-over-year, making the company attractive to larger slower growing and lower margin integrated players like Exxon Mobil (NYSE:XOM). With strong cash flow and a AAA credit rating, XOM could easily and cheaply finance the acquisition, thereby boosting its production growth while also enhancing its profitability. While FANG is currently rather expensive, trading at roughly 45x forward earnings, when you consider the company's exponentially greater production growth and margin profile, along with its solid balance sheet, you have to consider it as a possible strategic acquisition target.

Align Technology (NASDAQ:ALGN)

ALGN is a medical device company serving the dentistry and orthodontics industries. The company offers clear dental aligner systems, intra-oral scanners, and computer-aided design services, as well as digital record keeping systems. ALGN continues to enjoy accelerating revenue growth and industry leading margins due to the increased digitization of dental offices in the U.S. along with significant international expansion. In addition, the company recently partnered with Sirona Dental (NASDAQ:SIRO) to offer its Invisalign system in conjunction with SIRO's digital intra-oral cameras, thereby eliminating the need for dentists to create and transport physical dental impressions. This partnership should further entrench ALGN with its customers. And while certain of its many Invisalign patents expire in 2017, potentially allowing competitors to enter the market, these patents cover only old and outdated versions of the product. ALGN's current product remains well protected making it a prime target for a competitor like SIRO, especially given the existing partnership between the two companies. While not cheap at 29x forward earnings, the accelerating growth rate, pristine balance sheet, and newly expanded share repurchase program make ALGN a hidden gem.

Disclosure: I am/we are long SMCI, FANG, ALGN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.