Here’s why I think ASX-listed Appen could be a potential takeover target

Why I think Appen could find itself in the crosshairs of private capital…

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Once upon a time, Appen Ltd (ASX: APX) was an ASX market darling sitting alongside four other constituents of the WAAAX group.

For many years, the AI training data company was a crown jewel among a bucket of ASX tech shares. From 2017 to 2019, revenue growth accelerated at a tremendous rate — with Appen posting growth of 33%, 62%, and 97% in each successive year.

However, the company’s growth became derailed during the COVID-19 pandemic. In 2020, revenue growth slowed to 47% before reducing to a limp last year at a pace of 10%. Consequently, the Appen share price has been obliterated from its all-time high in 2020 — falling 83%.

So, why would anyone consider acquiring Appen now?

Primed for higher interest rates

Distressed valuations over the past couple of years have created an ideal merger and acquisition (M&A) environment. In fact, last year was a record high for M&As, topping $5 trillion in deal volume. Not to be left out, the ASX had its fair share of the action with aggregate transaction value hitting $130.5 billion.

While strong activity has continued into this year, private capital is now searching for deals in a rising rate environment. As such, dealmakers might show a greater interest in companies with minimal debt and a decent amount of cash.

Additionally, a solid track record of profitability is a must. We have already seen the ramifications on ASX shares that are loss-making in this macroeconomic climate. And most important, the company needs to display signs of being fundamentally ‘undervalued’ by the market.

When it comes to Appen on the ASX, in my view, the unloved tech company ticks these boxes.

How ASX-listed Appen shapes up

For all of its listed life, Appen has been profitable on a trailing 12-month basis. And while the company’s earnings have been in decline since mid-2020, this has coincided with several acquisitions and top-line growth across new markets.

Possibly the key to any potential Appen appeal is its immaculate balance sheet. At the end of December 2021, debt was zilch while cash and cash equivalents sat at US$47.9 million. For reference, automotive industry software company Infomedia Limited (ASX: IFM) received a takeover approach this morning, sporting a similar-looking balance sheet.

The final reason why I think ASX-listed Appen could be a potential takeover target is the valuation. Slowing growth and downgraded guidances have sapped investors of their confidence in the Appen share price.

As a result, the company trades on a price-to-earnings (P/E) ratio of 19 times — compared to the industry average of 30 times. Similarly, Appen’s price-to-book (P/B) ratio is the lowest it has been as a listed company at 1.4 times.

These factors don’t take into consideration how future performance could adjust the company’s valuation. However, I think private capital could be tempted to take a chance if Appen can continue to run at profit, pay a dividend, and trade at a relatively cheap valuation.

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

Before you consider Appen, you'll want to hear this.

Motley Fool Investing expert Scott Phillips just revealed what he believes are the 5 best stocks for investors to buy right now... and Appen wasn't one of them.

The online investing service he’s run for over a decade, Motley Fool Share Advisor, has provided thousands of paying members with stock picks that have doubled, tripled or even more.* And right now, Scott thinks there are 5 stocks that are better buys.

*Returns as of January 13th 2022

Motley Fool contributor Mitchell Lawler has positions in Appen Ltd. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Appen Ltd and Infomedia. The Motley Fool Australia has recommended Infomedia. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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