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Stocks to Watch In a Rising M&A Tide

Tickers in this article: AEO ANF BRK.A BRK.B FSYS GCI MDRX SKS TTWO TW VC WSM

NEW YORK ( TheStreet) -- The recent deals for Dell(DELL) , Heinz(HNZ) , American Airlines (AMRPQ) and Virgin Media (VMED) may indicate to some a return of the mega-deal, after years of post-crisis C-Suite caution.

It certainly is a fun exercise to speculate where Warren Buffett might aim Berkshire Hathaway's (BRK.A) M&A elephant gun , after the 'Oracle of Omaha' said in March that his failure to make a large acquisition was among his biggest 2012 disappointments .

But given a trend toward smaller mergers and buyouts by corporations and private equity firms, investors may do well to continue to focus their M&A speculation on small and mid-cap companies.

Rising valuations for corporations across the Russell 2000 Index (RUT) and the Russell Midcap Index (RMCC) , a stabilizing economic outlook, an imperative for revenue growth and attractive financing, may continue to drive small and mid-cap deals in 2013, according to a March 4 screening of M&A targets by Citigroup analyst Scott Chronert.

Last year, M&A removed about 5% of the Russell 2000's total equity value -- $58 billion -- and helped drive the 14.6% return for the index, with a similar amount being acquired from the Russell Midcap index, according to Chonert's calculations.

"We continue constructive on the outlook for small and midcap M&A activity during 2013," Chronert wrote.

"Typically, small cap will be characterized by more deals, but with smaller size. Conversely, deal count in mid cap is typically lower, but with offsetting higher deal values," the analyst added, while noting Buffett and 3G Capital's $23 billion deal for Heinz has driven mid-cap M&A this year.

Using a screen for positive free cash flow and low debt companies, and another one for underperforming stocks and fundamentals relative to peer groups, Citigroup highlighted actuarial firm Towers Watson (TW) , media conglomerate Gannett(CGI) , payments specialist Total System Services (TSS) , home retailer Williams-Sonoma(WSM) , American Eagle Outfitters (AEO) and Packaging Corporation of America (PKG) , as possible private equity buyout targets with market caps in excess of $4 billion.

The team of Citigroup analysts also see underachieving companies such as Abercrombie & Fitch (ANF) , car parts supplier Visteon(VC) , Allscripts Healthcare Solutions (MDRX) , retailer Saks(SKS) , Fuel Systems Solutions (FSYS) and gaming software maker Take-Two Interactive Software (TTWO) , as notable small and mid-cap deal targets in 2013.

Those firms may be the target of a strategic or private equity suitor because of low valuation multiples, higher than free cash flow yields and debt levels below peer trends, according to the Citigroup analysts, who have "buy" ratings on each of the firms mentioned.

Citigroup's forecast for a steady flow of small and mid-sized deals would reflect a continued trend for private equity firms to target in the $1 billion to $5 billion range, and for corporations to look at tuck-in acquisitions rather than transformative mergers.