Ian Forrest looks at some recent takeovers.
Takeovers? What does it all mean
February and March always provide plenty of information for investors to get their teeth into, thanks to the flurry of full-year reports published by companies. While it is interesting to see whether sales and profits meet expectations, the market is much more interested in comments from management about how they see trading progressing in the year ahead and what plans there are for growing or restructuring the business.
Brexit, will companies be affected?
Overshadowing all of that this year is, of course, the issue of Brexit and how companies might be affected. That will only be known for sure once the negotiations are much more advanced, which may take some considerable time. As a result speculation abounds and much of it will no doubt be proved wrong.
Another notable feature in recent months has been a number of takeover bids, some involving household names. There is evidence that takeovers often fail to generate the benefits that are optimistically forecast when first proposed and prove to be a rather expensive way to grow. Some companies actively avoid them. There is a famous story, possibly apocryphal, that the founder of JCB, Joseph Bamford, declined the opportunity to take over rivals as he felt they would naturally go out of business as JCB grew.
The early months of the year seem to be a popular time for takeover bids. In January last year supermarket giant Tesco announced its acquisition of wholesaler Booker, followed only a few weeks later by the failed bid for Unilever by US foods giant Kraft Heinz. January this year saw Melrose Industries’ hostile bid for engineering group GKN, followed more recently by International Paper’s rejected bid for another FTSE 100 constituent Smurfit Kappa.
How investors should react to a takeover bid depends on a number of factors. If they are a shareholder in the company that has received a bid they will want to consider whether the bid values the company fairly, both in terms of its current performance and future potential. They may also be keen to ensure that the bidder is a suitable owner and will treat their company in the right way. They will get some steer on that from the reaction by the directors, as we have seen in the case of GKN’s firm rejection of Melrose’s offer. Of course, shareholders need to be aware that some directors might be influenced by the fact that their own position might be at risk if the deal goes through.
A high offer, especially if it is all in cash and represents a significant premium to the closing market price just before the bid, can be very hard to resist. However, it is worth taking a close look at the target company’s response. Sometimes a bid can stimulate a big change in strategy and a major review of the company’s strategy. That was certainly the case at Unilever where the company launched a major initiative to boost its sales, reduce costs, increase returns to shareholders and sell its spreads business. The shares responded and we continue to recommend it as a buy for lower risk investors.
More recently GKN has responded to its takeover bid with plans to demerge its aerospace and automotive businesses and return up to £2.5bn to shareholders. The situation is also a good example of one where external factors, such as politics, can get involved. GKN supplies parts for RAF planes, which means that its ownership is a more sensitive issue than in other sectors, while there are some concerns that jobs will be lost as a result of the deal.
While we retain our buy recommendation on Melrose for medium risk investors, thanks partly to the improved performance at their Nortek business, we have moved to a hold on GKN due to the shares rising almost 40% since the initial bid in January.
Another noticeable trend has been for bidding companies to target entities larger than themselves, often known as reverse takeovers. That was true of the Kraft Heinz/Unilever bid and also the Melrose /GKN situation. It is clearly a higher risk strategy for the bidder, and as a result it can be more difficult to persuade investors of the merits of such deals.
UK cinema operator Cineworld recently completed the acquisition of Regal Entertainment, a much larger US cinema group, but only with the help of a large amount of debt financing and a rights issue. Cineworld has a good track record in the UK and Eastern Europe, and hopes that applying its expertise at Regal will reap even greater rewards, but they are clearly giving themselves a lot to chew on. Investors being asked for further capital to fund the deal can see the appeal of gaining entry to the largest cinema market in the world, but with little previous track record in the US to go by the company is asking its backers to make a leap of faith. Given the relatively high price paid for Regal the pressure is on Cineworld’s management to quickly demonstrate that they can make good progress. We retain our buy recommendation on the shares due to the good growth in the European business, potential for earnings from the Regal deal and the attractive 4.5% prospective dividend yield.
What all of this shows is that while takeovers can look similar on a superficial basis they are all unique situations and must be judged individually on their own merits. There can be good reasons for selling up when a bid is first revealed. Those with a short term investment horizon, a lower risk approach or unwilling to wait for a long regulatory approval process to grind its way to a slow conclusion, can often find that it pays to do so.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.