The likely surge of M&A activity following the Brexit vote is one of the top calls for L&G UK Special Situations fund manager Richard Penny.
The manager of the £220m fund says more deals among middle to mega-caps firms are on the rise especially given the weaker sterling.
Just two weeks after the UK voted to leave the European Union, microchip maker Arm Holdings was bought by Japanese buyer Softbank Group for £24.3bn, with the weakness in the pound making it a more affordable purchase.
Penny now lists stock such as broadcaster ITV, pharma giant AstraZeneca and hospital equipment firm Smith and Nephew as candidates for mega mergers.
Penny says: “In the mid and large-cap space M&A is something that would happen. The pound is undervalued and probably it’ll continue that way because of Brexit and quantitative easing.
“You have a weak currency so it is cheap for overseas buyers and you have a lack of obvious growth so people would put businesses together and take costs down.”
Penny says a large chuck of possible acquirers might come from Japan as well as the US, helped by their stronger currency, such as in the Arm deal.
However, Penny, who took over the fund in 2014, says mega-mergers still have their challenges despite the presence of “good candidates” as it can take several years before a deal can happen.
Penny’s fund, which is a concentration of 32 names and seeks opportunities in “undervalued and mispriced” stocks, covers 45 per cent in large caps, 45 per cent mid caps and the rest in small liquid small cap names.
He says the fund has already benefited from M&As in the last few years, including the mega merger of Shell and BG Group, while Shire, which makes up 4.6 per cent of the fund announced its $32bn takeover of drugmaker Baxalta in June.
According to Penny, the stock now looks set to deliver double-digit earnings growth, and plans the launch up to 20 products by 2020 with expected “healthy” volume demand.
Another key call is tech firm Microfocus, the fund’s top holding, which has an exposure of 5.1 per cent within the fund.
Penny says: “Microfocus is a technology company but it is old technology so it buys technology that people own for 20 to 30 years, it takes costs out. The firm did an acquisition last year when they’ve improved their earnings.
Another holding, GVC Holdings, a mid-cap name which operates sporting bets, acquired a stake in online gaming firm Bwin, which was “an underperforming operator”.
Penny says post Brexit the fund didn’t experience any outflows, but instead gathered more assets.
As a contrarian investor, he bought back some “out of fashion” stocks including housebuilders such as Bovills, as well as niche lenders such as Paragon Group. He also increased the exposure in financials such as St James Place and Aviva.
“Post Brexit, we’ll have uncertainty about the housing market, but consumers seem pretty resilient. The real worry is if we have it on a wide scale on employment, but we haven’t seen that yet.”