* Restructuring plays outpace market over last five yrs-Exane BNP
* KPN, Abengoa, Pandora among stocks with potential for gains
By Tricia Wright
LONDON, June 16 (Reuters) - A weaker-than-expected economic recovery in Europe, a bleak outlook for corporate profits and the resurgence of hostile merger activity are pushing investors to bet on troubled firms with restructuring potential.
Dutch telecom operator KPN, Spanish renewable energy firm Abengoa and Danish jewellery company Pandora are just a few examples of stocks seen offering upside as they turn themselves around and - in some cases - attract potential acquirers, fund managers say.
"We're at the beginning... of the corporate activity cycle, and that means that the kind of businesses that are ripe for consolidation or takeover or improvement are probably the better quality, long-duration franchises," Paras Anand, head of pan-European equities at Fidelity Worldwide Investment, said.
When flushing out restructuring opportunities, investors are comforted by the knowledge that many badly managed businesses have already collapsed, with shareholders having made a call on which firms they would continue to back.
UK electrical goods retailer Dixons, for example, benefited from problems at music retailer HMV when store groups across Europe were struggling in the face of reduced consumers' disposable incomes as governments imposed austerity. Dixons is now merging with Carphone Warehouse.
So how to screen for good bets in corporate Europe? For Exane BNP Paribas' analysts, one metric worth watching is how much a company devotes to capital expenditure and research and development relative to its market value. The higher that ratio gets, the more likely it is that the firm's spending has been inefficient - potentially signalling a radical shake-up is in the pipeline.
"(Firms may have) their strategy wrong, or market conditions change, or competitors are extremely aggressive and there has to be a strategic and structural response from those companies... (restructuring) is definitely something to look at," said Ian Richards, global head of equities at Exane BNP Paribas.
Their basket of Europe's top 25 apparent lame ducks, which as of February 2014 included Peugeot, Austrian oil and gas group OMV and Franco-Italian chipmaker STMicroelectronics, has outperformed the broader Euro STOXX 50 in four of the last five years.
It has also paid to focus on companies that need to improve their balance sheets on the basis that a low interest rate environment has proved advantageous for firms with debt.
This investment strategy should prove more fruitful for firms based in Europe than in the UK, fund managers say. While the European Central Bank recently cut interest rates to record lows, the Bank of England stunned the markets by saying rates could rise sooner than expected.
Britain's Thomas Cook, a holiday operator, and Trinity Mirror, a newspaper publisher, are examples of firms that have been striving to turn themselves around.
Even well-known restructuring stories like French retail giant Carrefour can still offer upside as broader market sentiment fails to adequately price the full extent of restructuring potential.
Its move to sell off some of its overseas businesses after an aggressive expansion into Asia and Latin America meant it took its eye off the ball nearer to home has turned it into a serious investment proposition once again.
Carrefour is one of the biggest holdings in the Investec Global Special Situations Fund.
Finland's Nokia, which sold its once dominant handset business to Microsoft after tough pressure from U.S. rival Apple, is another such widely known play.
Stan Pearson, head of European equities at Standard Life Investments, holds Nokia along with telecoms stocks KPN, Hellenic Telecom, Tele2, Telecom Italia , and Deutsche Telekom.
"Effectively we're making a judgment that the market might be pricing that they can do a certain amount of improvement, but it's not willing to give them the full benefit in terms of the scale of the improvement they can make," he said. (Graphic by Vincent Flasseur, editing by Lionel Laurent)