We pick the next Small Cap takeover candidate

Richard Hemming

The reporting season is in full swing and in the middle of all this for the fourth time in eight weeks two more of Under the Radar Report's Small Cap Stock Best Buys received takeover offers, leading to 50% share price gains on the day. That’s one every two weeks! Find out one of the company’s Under the Radar Small Cap Stock tips to be the next on the chopping block.


It’s not just Under the Radar’s analysts that have been running the numbers on ASX Small Caps this reporting season; so has Gina Rinehart, and so have the kind folk from the US listed company Casa Systems, as well as management of the Canadian crop giant Nutrien; not to mention thousands of bean counters employed by private equity firms around the world.

An image of a bullseye

It’s been anticipated for a number of months now, but the trickle of takeovers of companies at the small cap end of the ASX has turned into a deluge. In the past two weeks there have been three all-cash takeover bids: Casa Systems made an offer for the data communications product developer Small Cap NetComm Wireless (NTC), Nutrien is gunning for the diversified rural services group Small Cap Ruralco (RHL) and Gina Rinehart’s Hancock Corp launched a bid for coking coal developer Riversdale Resources. NTC and RHL both spiked some 50% on the day of the announcement. Let’s see how Under the Radar Report does it.


The interest in ASX Small Caps is the combination of market weakness (the S&P/ASX Small Ordinaries fell almost 20% between late August and late December last year) a weaker Aussie dollar (down over 7% against the US dollar over the course of 2018), low interest rates and the weakening of global growth.

There have been four takeovers for Under the Radar Report Small Cap stocks in the past eight weeks, which also includes the bid for small cap retailer The Reject Shop (TRS) and the small cap paper and printing specialist Spicers (SRS), which was previously known as PaperlinX. Sure, some of these bids have been opportunistic (Raphael Geminder’s corporate vehicle making a bid for TRS) but the vast majority have been from offshore companies, and pretty big operators at that. Spicers is being sold to the Japan based global paper giant Kokusai Pulp & Paper (KPP).


Australia might have a small population, but it’s got a heavy weight economy. Australia’s GDP is over A$1.7 trillion (US$1.2tn) which some argue is bigger than the higher profile Russian economy. Plus, it’s got a stable government (system) with clear separation of power between the legislature, the executive and the judiciary. Moreover, it’s hard for offshore companies to build an Australian presence slowly; it’s often better to acquire something that has many of the attributes that you need. For these firms, taking over a company makes more economic sense than ever. They can borrow at 3% and the potential earnings increase from the acquired company ought to be a lot more than that. They get the double whammy. On the one hand the acquirer gets the extra revenue growth; and then they get (in theory) that extra earnings growth by cutting costs such as management, accounting and administration.


And as any buyer knows, the cheaper you buy something, the easier it is to generate a return. Under the Radar’s analysts first noticed small cap stock NetComm in early October. Its shares had halved between then and the end of August when it presented its full year results. What stood out was that it had no debt and $27 million in cash; and crucially had digital data know how giving it outstanding growth prospects through its internet connectivity division and the ongoing rollout of broadband technology. The company has major customers in the form of gorillas: Australia’s NBN Corp and AT&T, for whom it is rolling out fixed wireless in the US. All this and it was cheap to boot. Casa Systems obviously could see this too. NetComm is a good fit for Casa, which operates in the same space.


People talk about “economic cycles being important” but these don’t matter. Ultimately to be taken over you do you have to be a company that is strong enough to stand on its own but also be attractive to an acquirer such as helping consolidating its market positioning. It needs to generate an increase in market share and reduce the percentage of operating costs to sales of the entire group.

Admittedly these qualities cover just about every company we cover. Remember, as investors we’re looking for the same qualities as the corporate executives, which revolve around value.

But takeovers are more likely to happen in a fragmented market; and if you add into that equation industry turmoil, you see that magic “C” word rearing its head: “consolidation”. It also doesn’t hurt if the company is in distress. Remember earlier we mentioned Raphael Geminder? He happens to be executive chairman of packaging group Pact Group (PGH) whose market cap is just over $1 billion. He has almost 40% of this company, while his private company Bennamon Pty Ltd has been creeping up the register of Pro-Pac Packaging (PPG) and now controls almost 48%. PPG’s profits have been hit by the drought and its shares are a third of their price only 12 months ago, giving the company a market cap of just under $122 million.



About the Author

Richard Hemming

Richard Hemming (r.hemming@undertheradarreport.com.au) is an independent analyst who edits www.undertheradarreport.com.au, which provides investment opportunities in Small Caps that you won’t get anywhere else.

Under the Radar Report is licensed to give general financial advice only (AFSL: 409518). The author does not own shares in any of the stocks mentioned.

Under the Radar Report is licensed to give general financial advice only (ASFL: 409518). The author does not own shares in any of the stocks mentioned.

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