2011 has been a volatile period in global markets as Eurozone worries, international concerns and local complications all converged to heighten risk premiums. I have lost count of the number of times the world has ended this year, but it is fair to say that at least it has been an interesting year.

But, 2011 is almost done... So what can we expect in 2012?

Well, I think there will be two major trends in the coming year: merger and acquisition (M&A) activity increasing in key sectors and real inflationary pressures. There will also be the continuation of the 2010/2011 minor trend of shareholder-funded bailouts (i.e. rights issues).

While the M&A ramp up is a trend that has been growing since 2009/10, the inflationary pressures are partly due to the weakening ZAR that brings imported inflation and partly due to the rising (soft) commodity prices driven by overseas sovereign bailouts via basically Governments printing money.

On the M&A front, those companies with well-capitalized balance sheets will increasingly be taking advantage of their under-capitalized competitors, peers and parallel-industry peers. Not only that, but some larger groups are in tough spots and will look to make strategic acquisitions as a means to dig themselves out of their holes.

Here are a couple thoughts on potential 2012 deals in the small caps space:

- Telkom (TKG) makes a bid for EOH (EOH): With Telkom's continuing run of miserable results, the telecos Group has explicitly stated that it is looking to make acquisitions and enter the "ICT services space". Now a number of years ago Telkom made a failed bid for Business Connexion (BCX). Not only has the ICT landscape changed since then, but BCX has also had a series of subsequently disappointing results. By far the shining jewel in the JSE-listed technology space is EOH and, in recent months, EOH's market cap of R2,4bn has just pipped BCX's of R2,2bn. EOH is a service-orientated diversified ICT group that not only fits perfectly into what it sounds Telkom is looking for, but it is also of an appropriate size for Telkom to swallow and still have an effect on future profits. Will EOH management accept the bid? More than likely not, thus I think in the event of a Telkom bid for EOH it will more than likely turn hostile.

- JSE-listed technology sector continues aggressive M&A: The JSE-listed technology sector is very much in consolidation phase. BCX's acquisition of UCS's services cluster, the eventual delisting of UCS, the ADCorp bid for Paracon (not quite tech, but PCN places ICT staff), EOH's acquisition of TSS Managed Services, and BCX's further acquisition of the Canoa Group all are just tips of the iceberg. 2012 will see much more of this (beyond even my above mentioned Telkom-led bid for EOH), as various small caps in the tech space make lots of bolt-on acquisitions. Look for acquisitions by most of the tech majors (Datatec, Gijima, EOH, BCX, Datacentrix etc) and some of the tech minors (like Silverbridge, AdaptIT and, perhaps even, ISA).

- Spur actually buys something...or gets bought: Spur (SUR) has historically lagged behind its largest rival (see BCX, SUR & RLF: Cautionaries or Lack Thereof), Famous Brands (FBR). Taste (TAS) has also recently jumped into the spotlight with an amazing +217% run on its share price. More recently, Spur has withdrawn the cautionary announcement that has been hanging over its share for quite a while. The cautionary was more than likely to do with an acquisition, but negotiations obviously fell apart. This is not a first for Spur. All of this puts further pressure on Spur to do, well, something! I think that this pressure will push Spur to make an extra effort in 2012 to close a deal. Any deal. And, as forced hands are often weak ones, it is more than likely that this deal will not actually work out well for patient SUR shareholders. Either that or Famous Brands could quite easily make a bid for Spur (FBR is c.3x SUR's market cap and rated at a much higher PE ratio). With Nandos, MacDonalds etc all playing in the South African fast food space, I doubt that the Competition Commission would mind if FBR swallowed SUR. This last point may well not happen in 2012, but if Spur continues to stagnate, it is more than likely to be an eventuality.

- Chemical and agri-sectors froth: Further consolidation of unlisted chemical and agri-businesses will continue with Rolfes (RLF) and Ububele (UBU) leading the small cap charge. Both companies are building up respective mass in each of these sectors and one can expect them to continue to plough their free cash flow into bolt-on acquisitions in these spaces. Zeder (ZED) is also likely to play in the agri-space here, but this is not so much a forecast as a fact given that Zeder was established by the smart guys at PSG in order to make acquisitions and investments in the unlisted agri-sector.

- Sasfin spins critical mass into IQuad: On its own, I think IQuad would have drifted sideways through 2012. But, Sasfin (see Sasfin Buys Into IQuad & Contrarian Value Play: Sasfin) has just bought what will likely become a controlling stake in the Group and intends to use it to "...broaden and expand the Group's commercial services and consolidate these activities in a unified structure and leverage off its enlarged client base." The last part implies that Sasfin will probably use IQuad as a vehicle to list further businesses from inside its vast stable. I would expect this to begin during 2012 and will see IQuad rapidly grow in size and scale. Whether these deals will be the benefit of IQuad shareholders or Sasfin's, I am unsure... Personally, I have decided to play this trade from Sasfin's side as SFN not only appears significantly undervalued, but also because most holding companies tend to look after themselves before their subsidiaries.

- Gold juniors continue marginal mine consolidation: The current consolidation in the junior gold sector space will continue unabated. This is not just supported by the fact that my other major trend is inflation and this will support the Rand gold price, but also due to the personalities involved (read: Swanepoel and Froneman). Village and GoldOne will carry on aggressively buying up junk, uhm, I mean "marginal gold mines" while DRD will probably enter the fray towards the latter part of 2012 in order to support its continued existence (DRD's LoM of its processing is arguably only around 5 years). PAN will be the exception to the rule as it spins off its Manica project.

- Adcock spends it money: Jumping into the medical space, Adcock Ingram has net cash on its balance sheet that is burning a hole in its pocket. A year or so ago the Group made a botched bid for Cipla Medpro SA (CMP), but in 2012 the Group is more than likely to look further into Africa for other acquisitions. This is both an efficient use of cash (in the absence of returning it to shareholders) and an extension of AIP's recent acquisitive moves.

- Glencore and Shaduka buy more into SA Inc.: Finally, Glencore's humongous cash pile and its bid for Optimum Coal (OPT) indicate its willingness and ability to buy into primary commodity sources in South Africa. I think that both Glencore and its South African partner, the well-connected Shanduka, will together go on a bit of a buying spree in South Africa that may see one or two listed commodity stocks (other than Optimum Coal) touched. Perhaps Keaton Energy (KEH)? Perhaps Metmar (MML)? Perhaps not... The key is that Glencore is a commodity trader, hence it is looking for both a mine offtake of a tradable commodity and a route to get it out of South Africa. Hence, look carefully at the coal sector and those players that own RBCT export allocation.

The next trend I expect in 2012 is really a global trend, but one that our 2010/2011 strong ZAR has temporarily protected us from: inflation. The ZAR has weakened dramatically in recent months and, while I am no forex expert, I feel that this trend will continue and that means that inflation will start to become a real concern in 2012.

High inflation implies interest rate hikes, but with South Africa's low growth rate, fragile economy and high unemployment rate, the SARB is in a 'catch 22' position. Thus, I think it is more than likely that the SARB will just keep interest rates flat for the whole of 2012. Perhaps a hike in the last part of 2012...?

Either way, inflationary pressures will start to become a concern and should have a couple of interesting effects on the JSE.

- The JSE should actually perform quite well in nominal terms in 2012 as a result of simply keeping up with inflation. Bonds and cash are really at risk in 2012, in this scenario.

- Interest-rate sensitive stocks will begin to lag as the market positions itself for an interest rate hike. In other words, banks, property companies and micro-lenders (like Capitec, Abil, Blue Financial Services and AfDawn) may all under-perform the ALSI. Expect rising bad debts as inflation acts as a sponge absorbing disposable income and pushing marginal credit risk into default territory. Imagine how bad this scenario could get if you add a late-2012 interest rate hike to the scenario? Watch out for this, particularly in the micro-lenders space. Blue Financial Services, though, may be partly protected against this, as it earns a major portion of its interest income from outside of South Africa.

- Inflation-hedge stocks will begin to outperform the ALSI. The best example of these, in my mind, is the primary food groups who sell branded, non-discretionary, inelastic primary foods and have the power to pass on input cost inflation. This includes stocks like Clover (CLR - see Clover: Defensive Small Cap Value Play), Pioneer (PFG), AVI (AVI), Tiger Brands (TBS) and, perhaps even, some of the poultry stocks like Astral (ARL), Rainbow (RBW), Country Bird Holdings (CBH) and Sovereign Foods (SOV). Personally, I like Clover for both this fact and because it is very undervalued at its current share price.

- Rand-hedge stocks will perform well in this environment, as local inflation tends to weaken the local currency due to 'purchasing power parity' pressures. So, stocks like BHP Billiton (BIL) and Anglo American (AGL) might make good bets, but they are quite dependent on the global economy continuing to grow too... In the small cap space, stocks like ISA (prices in U$D's), Rolfes (exports), Ellies (exports), Poyntings (exports) and coal, gold and other commodity juniors will benefit (e.g. PAN, GDO, KEH, EXX, PAM etc). A large portion of IQuad's (IQG) client base are export businesses, thus perhaps even IQuad could be considered partially a Rand-hedge in this circumstance.

- Strong Rand stocks will suffer with the most obvious example being 1Time Airlines (1TM). The airlines industry is extremely exposed to the oil price. With a weak ZAR, 1Time's Rand-fuel price will quite high, thus its margins will come under pressure. This at the same junction when consumer disposable incomes are under strain putting airline volumes under further pressure and new competitors (e.g. Velvet Air) are entering the market.

When I look around, I see some very strained balance sheets out there with some companies financing themselves out of overdraft. This is simply unsustainable and, particularly when a company is reporting loss after loss, will eventually lead to bankruptcy (all things held as a constant).

That is, unless shareholders bail the company out. In general, that takes the form of a highly dilutive rights issue and isn't even always a guarantee of success.

One such company that comes to mind is Ideco (IDE) and I expect the company to either turn a profit in 2012 or require a rights issue. And I suspect that it will not be turning a profit any time soon...

Then, a final note where I go out on a limb here, but I think that towards the latter half of 2012 the small cap construction companies will begin what will be a trend going into 2013: they will outperform their bigger listed competitors.

Not only has there been a trend of the small cap construction companies stealing employees and management from the big construction groups (seriously, read through SAN, ESR, SSK etc SENS over 2011 and you will see this trend as clear as day), but they also have smaller order books to full and greater operational flexibility to adapt to where the work appears.

At Thebe Stockbroking, we see Afrimat (AFT) and Stefanutti Stocks (SSK) as the best quality small cap construction stocks and, thus, they are likely to lead this radical reversal of power in late-2012.

In conclusion, 2012 is looking to be another interesting year!

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