What to Look for in a Takeover Target

Takeover targets are often acquired for a sizeable premium over the company’s closing price. Find out what makes a target like Agrium Inc. (TSX:AGU)(NYSE:AGU) desirable to potential suitors.

| More on:
The Motley Fool

Companies that are acquired or merge with larger companies are attractive prospects for investors. That’s because when an acquisition is announced, the price paid for the takeover target is often at a premium, typically 20-30% of the share price at the time the deal is announced.

Instantaneous one-day gains like that are hard to come by and very difficult to pass up.

One of the more famous acquisitions in recent memory, as far as the Canadian market is concerned, was Burger King’s acquisition of Tim Hortons in 2014 to form Restaurant Brands International Inc. (TSX:QSR)(NYSE:QSR).

The deal created the third-largest quick-service restaurant company in North America, and Tim Hortons shareholders saw the value of their investment in the coffee and donuts chain jump 30% on the news.

One of the appealing aspects of Tim Hortons, as far as Burger King was concerned, was the company’s ability to generate generous amounts of excess cash flow.

While many investors pay close attention to dividends, large businesses that are looking to acquire smaller businesses will tend to favour free cash flow metrics over the size the company’s dividends.

That’s because free cash flow will tell you how much the company could actually pay out to owners versus what the company is actually paying out.

The new owners, if they wanted to, could raise the company’s dividend following the acquisition, could redirect that cash flow to reinvest that money in growth initiatives, or even use that cash flow to acquire additional companies.

A recent example of the dynamic between free cash flow versus dividends playing out is with Calpine Corporation (NYSE:CPN), which was acquired earlier this year by a private equity firm Energy Capital Partners and a consortium of investors for $5.6 billion — a nearly 50% premium to the value of the company in May, when rumours started to circulate that Calpine’s business was looking to be sold.

While Calpine didn’t pay a dividend, which is unusual for a utility company, it was the free cash flow that private equity investors were after, knowing they could redirect that cash flow in whatever manner their hearts desired.

Another factor to watch out for when looking for a potential takeover target is the synergistic value of the business to a strategic acquirer. A good example of this is Maxar Technologies Ltd. (TSX:MAXR)(NYSE:MAXR), which acquired DigitalGlobe earlier this year.

DigitalGlobe offered unique value to Maxar, as the company had an established footprint in the U.S. defence market — a market which Maxar is aggressively pursuing.

Another recent example would be the currently pending merger between Potash Corporation of Saskatchewan Inc. (TSX:POT)(NYSE:POT) and Agrium Inc. (TSX:AGU)(NYSE:AGU). If approved, it would create the world’s largest crop nutrient company.

Facing lower prices for potash and nitrogen, the newly created company, to be named Nutrien, will jointly be in an improved position to take advantage of economies of scale and manage supply chain issues.

Bottom line

Ultimately, it’s the same element — free cash flow — that makes for a winning trade and which will also help you locate attractive takeover targets.

After all, companies such as Restaurant Brands, Maxar Technologies, or even private equity firms are looking to do the same thing as every other investor, which is to buy undervalued businesses.

Those hunting for takeover opportunities will be best advised to look for synergistic opportunities and businesses generating strong cash flow that would present value for a potential suitor.

Currently rumoured to be on the shopping block is DHX MEDIA LTD CLASS B (TSX:DHX.B)(NASDAQ:DHXM), which has struggled to meet analyst expectations recently but may offer strategic value to media companies looking to round out their children’s programming offering.

Stay Hungry. Stay Smart. Stay Foolish.

Should you invest $1,000 in Enbridge right now?

Before you buy stock in Enbridge, consider this:

The Motley Fool Stock Advisor Canada analyst team just identified what they believe are the Top Stocks for 2025 and Beyond for investors to buy now… and Enbridge wasn’t one of them. The Top Stocks that made the cut could potentially produce monster returns in the coming years.

Consider MercadoLibre, which we first recommended on January 8, 2014 ... if you invested $1,000 in the “eBay of Latin America” at the time of our recommendation, you’d have $21,345.77!*

Stock Advisor Canada provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month – one from Canada and one from the U.S. The Stock Advisor Canada service has outperformed the return of S&P/TSX Composite Index by 24 percentage points since 2013*.

See the Top Stocks * Returns as of 4/21/25

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Jason Phillips has no position in the companies mentioned. The Motley Fool owns shares of RESTAURANT BRANDS INTERNATIONAL INC. Agrium and Maxar Technologies are recommendations of Stock Advisor Canada.

More on Dividend Stocks

a sign flashes global stock data
Dividend Stocks

Where I’d Invest $8,000 In the TSX Today

There's no shortage of great stocks on the TSX today. Here's a look at three options to consider adding to…

Read more »

Two seniors float in a pool.
Dividend Stocks

How I’d Turn $7,000 Into a Growing Income Stream for Retirement

Investors looking for a growing income stream for retirement will find these stocks must-buy options right now.

Read more »

Tractor spraying a field of wheat
Dividend Stocks

Top 2 Canadian Stocks to Buy for Long-Term Gains

Sometimes investors worry too much about the near term, which is what makes these two top value options.

Read more »

ETF stands for Exchange Traded Fund
Dividend Stocks

How I’d Build a Monthly Dividend Portfolio With $7,000

Investors can start building a monthly dividend portfolio through dividend ETFs that pay out monthly.

Read more »

a person watches a downward arrow crash through the floor
Dividend Stocks

Is This Correction Your Chance? Buy Up These 4 Dividend Stocks on Sale

These four dividend stocks aren't only top choices for yield, but for safety as well.

Read more »

ways to boost income
Dividend Stocks

1 Dividend Stock Down 34% From 52-Week Highs to Buy for Lifetime Income

This dividend stock is likely to just do even better, especially amidst copper prices.

Read more »

Man data analyze
Dividend Stocks

1 Magnificent Consumer Stock Down 17% to Buy and Hold Forever

Alimentation Couche-Tard (TSX:ATD) stock might be one of the best bargains available on the stock market for long-term investors right…

Read more »

data analyze research
Dividend Stocks

This 6% Dividend Stock Hasn’t Missed a Payment in 3 Decades

This TSX stock has a solid track record of dividend payments and growth. Moreover, it offers a sustainable yield of…

Read more »