M&A Is Back. 4 Stocks That Could Be Targets.
Mergers are back—and that means opportunity for small-cap investors.
Small-caps don’t have a lot going for them. The Russell 2000 index has gained 0.2% this year, lagging the S&P 500’s 15% return. But they do have one thing in their favor: This year, there has been $847 billion of merger and acquisition activity in the Americas, up 43% over the same period last year, according to LSEG Group. That puts activity on pace to hit just over $1.87 trillion for the entire year, only a few hundred billion dollars below the 2021 peak. And small-cap companies are usually the target.
The return of M&A has been helped along by a number of factors, including a stabilization in interest rates. With the Federal Reserve done hiking—and, instead, considering cuts— interest rate volatility has declined and Treasury yields across the yield curve remain below their peaks. Yields on corporate bonds have dropped, too, reflecting market optimism over the ability of companies to repay their debt. Lower rates make it more attractive for companies to borrow money to make acquisitions. “We have stability on rates,” says Glenn Mincey, head of private equity at KPMG. “M&A activity will continue to increase for the rest of the year.”
Where should investors look for possible deals? Healthcare looks like a good place to start. Pharmaceutical giants such as Bristol Myers-Squibb and Amgen have drugs that will be coming off patent, leaving them exposed to potential competition. They’ll be looking to refresh their pipelines of drug candidates, and with billions of dollars in annual free cash flow, they have the capacity to buy smaller biotech players.
Opportunities are plentiful. The SPDR S&P Biotech exchange-traded fund has 131 stocks with an average market value of $14 billion and dozens of companies valued between $1 billion and $2 billion. Possibilities include the $5.9 billion Ionis Pharmaceuticals, which develops human therapeutic drugs, the $14 billion Incyte, which focuses on oncology and hematology, and the $2.2 billion Iovance Biotherapeutics, which makes cell therapies and novel cancer immunotherapy products. All three appeared on a Wolfe Research screen of small-cap stocks that have underperformed the biotech fund this year and have seen CEO changes in the past 12 years.
Larger software companies— Microsoft, Salesforce, and Adobe, to name a few—could be looking to bolster their artificial-intelligence capabilities and could find plenty of opportunity in smaller, AI-centric names. And there’s opportunity as well, with the Invesco S&P SmallCap Information Tech ETF down about 10% from its 2021 high.
One possibility: The $3.6 billion C3.ai. The company, which provides a platform for businesses to develop new AI applications, appeared on Wolfe’s screen of small-cap buyout candidates that have net debt less than three times expected profits, have Buy ratings from less than half of analysts covering them, and operate in consolidating industries. C3.ai’s revenue is mostly subscription-based, its sales are expected to hit $1 billion by the end of the decade, and it has no debt. It would look good nicely tucked into a larger software firm.