Share prices are often boosted by takeover bids. If you’re holding shares in a targeted company, you could be quids in, even if the bid turns out to be unsuccessful. Euan Stuart explains how to take advantage.
The financial markets are in the grip of a merger & acquisitions (M&A) frenzy. Look over the business section of any Sunday paper for the last month and you will see the lead story is almost always to do with a big-name takeover. Indeed, such are the names being bandied around that would-be deals are even making it into news sections.
Whether it is Manchester United and the ‘will-they-won’t they’ saga of the Glazer family’s rising stake, the possibility of a bid for Sainsbury’s, or the very public spat between Philip Green and Stuart Rose over the former’s unsuccessful bid for Marks & Spencer (M&S), or even the failed Permira purchase of WH Smith, takeover fever is front-page news.
This is excellent for investors: bids tend to come in at significant premiums to market capitalisations, so if you’re holding shares in a takeover target that gets hit, you’ll be quids in. You’ll get an immediate uplift in the value of your shares and then, if you’re lucky, other bidders might come to the table and you could end up with even more.
Remember the Morrisons bid for Safeway? Pre-bid, the shares were trading at 210p. On the news of a bid, they soared to over 300p, making holders a profit of 43% in just a few days. More recently, there was Abbey National. Pre-bid, the shares were trading at 470p, but after Banco Santander announced its intentions, they soared to 580p, up 23%.
And these bids don’t even need to be successful to boost a share price. Look at Marks & Spencer and WH Smith. Early this year, shares in both were at long-term lows, but news of serious bids (from Philip Green and private-equity group Permira respectively) made them soar. Both bids ran into problems, but even so, the share prices have held up well since. Investors clearly believe that if one suitor is willing to offer this kind of money for ailing firms, another will soon be prepared to offer at least the same.
So why all this sudden interest in M&As? First, there are lots of firms about that seem to need help adapting to a changing world. M&S and WH Smith have become targets for a reason: both have fabulous brands and franchises, but neither seem able to use them properly. M&S’s management can’t figure out how to fight the rising power of supermarkets (namely Asda and Tesco) and neither can WH Smith’s. That means both firms trade on a discount to their rivals. There could be splendid rewards on offer to anyone who can turn their businesses around.
Second, interest rates are still hovering near historical lows and few expect them to rise much from here, given the uncertain state of the economy, so the cost of funding acquisitions remains low. Third, in today’s world, size really matters. Large firms have more scope to reduce costs, crush opposition and gain publicity. Some years ago, the trend was to create large firms through buying a string of possibly unrelated businesses, but today the emphasis is on building one huge core business and running it right.
And finally, don’t forget the role of investment banks. Deprived of some of the lucrative streams of income that poured in during the bubble years (trading commissions, for instance), they are only too happy to advise corporates to make deals and to take the fees on offer. A quick look at the volume of recent deals by just one house – Merrill Lynch – shows that they must be raking it in from all their current deals. These include Meggit at $400m, the RBS sale by Santander at $2.2bn, Admiral at $600m, F&C Isis at $300m, Diageo’s sale of its stake in General Mills at $2bn, Premier Foods’ sale of Hicks Muse Tate’s remaining 50% stake at $225m. The banks is also advising on Harmony, the SCH/Abbey deal, Manchester United (as a corporate broker) and InterContinental Hotels (as a corporate broker).
So the big question now has to be: how do you spot the next takeover target and get your share of the profits from the boom? There is no cut and dried answer to this, but the best basic plan is to follow the lead of the big US fund-management houses. These have been pouring into the UK and look for firms that have fallen on hard times and seen their share prices collapse despite still having reasonable, and salvageable, businesses. US fund-management group Brandes, which has a good record in spotting value, has, for example, taken – and hung on to – a major stake in M&S (the last published figure put it at 11.9%), as well as one in Sainsbury’s (I’ve followed them here, by the way – I hold Sainsbury’s shares in my personal portfolio). They’ll be expecting to make money in one of two ways: either these firms will sort themselves out, or they’ll be bought by someone who will do it for them.
Still, you don’t just want to be going out and buying any old suffering company. Brandes would have done a good deal of research before picking the likes of M&S. You need to as well: just losing a lot of money is not going to be enough to attract a bid. There are thousands of failing firms out there with no enduring assets and nothing to offer but poor performance and weak management – they will stay that way until they finally fold.
So what makes takeover targets different? First, says Nick Louth in the Investors Chronicle, look for firms operating in areas with high barriers to entry – ie, where planning arrangements, regulation and other bureaucratic hindrances make life harder for new entrants than incumbents, or where the cost of setting up an entirely new business would be prohibitive. Such barriers exist for supermarkets, banks, builders with big land holdings, airports and port operators. Imagine trying to start any of those business from scratch. That it is so hard – impossible even – to do so limits competition and increases the chances that an ailing firm can be turned around.
Next, it’s worth looking for companies trading at less than net asset value, says Louth. These make attractive targets: a firm that is worth less than the sum of its parts, net of debt, is, by definition, “not adding value” for shareholders. But for potential bidders, knowing that you can quickly off-load assets – property, for example – for more than you spent to buy the entire firm, is “highly attractive”. Sub-scale players can also be attractive. When economies of scale are vital, being the fifth or sixth-largest player is a problem: supermarket chains or pub chains that can’t quite make it into the big league fall into this category.
But there’s another important thing to bear in mind in all of this, which is that, in many cases, acquisitions and mergers are of no long-term benefit to shareholders, offering only a short-term boost in shareprice according to how much the buyer covets the target. That means the best time to sell may well be when the offer has just been announced and the shares have jumped. Do this and you don’t have to worry whether the offer is for cash or paper (you get shares in the buyer’s company in exchange for yours in the target company).
The problem with paper offers, as Nick Louth points out, is that the value of the bid changes with the movements in the bidder’s shares, so you never know quite what you are getting. Worse, a series of academic studies suggest most takeovers fail to benefit the acquirer over the long run, making holding their shares very unattractive. The record of the largest mergers is “particularly poor”, says Louth. Consider the case of AOL, which bought Time Warner in 2000 at the height of the internet boom in an all-share deal worth $85bn. Today, the AOL shares accepted by Time Warner’s shareholders are worth barely 15% of their peak value.
Cash bids make more sense for retail investors. They are simpler to evaluate, and do not tie you in to the combined entity. But even if someone comes up with a cash offer for your share, do you really want to wait for the cheque? Many a bid has failed, or hit a last-minute hitch, leaving investors with shares worth less than they thought. My advice? Look for likely bid targets and buy them. But when an offer comes, sell your shares. Don’t wait for the bid to fail, or for the management to make a mess of the integration process. A bird in the hand is worth two in the bush.