Takeover feast

Seven companies ready to be eaten up
Thursday 01 Dec 2016 Author: Tom Sieber

Takeovers are back on the agenda for the UK stock market. We aren’t surprised, given favourable conditions for M&A (mergers and acquisitions) have been in place for some time.

The cost of borrowing is low; sterling devaluation makes British companies a more attractive proposition to overseas buyers; and volatile conditions in certain sectors have left some decent businesses in a vulnerable position.

After building up steam since the summer, the acquisitions train is now speeding up and investors should be prepared to get on board.

The catalyst

Takeovers are among the catalysts which can change the market’s view on an under-appreciated stock, alongside management change, a refinancing or better-than-expected trading.

To tap this theme we look at companies where an activist investor could provide the impetus for bid interest, as well as reviewing several bombed-out stocks which we believe look vulnerable to a takeover approach.

We also revisit the sterling weakness theme and consider why companies with unique assets are often in play.

Finally, we consider what can be learned from the latest batch of deals announced over the past month or so.



TAKEOVERS ARE COMING THICK AND FAST

A bid war is underway for water utility Dee Valley (DVW) and several parties have shown interest in workforce management specialist ServicePower Technologies (SVR:AIM) as well as aerial platform group Lavendon (LAV).

Bids for marketing agency Creston (CRE) and in-flight catering group Journey (JNY:AIM) look like done deals.

And takeover offers have emerged from private equity and industry players for industrial components supplier Brammer (BRAM), walkie talkies expert Sepura (SEPU) and IT and telecoms provider Alternative Networks (AN.:AIM).

It is possible to group some of these takeover situations into distinct categories:

Unique assets

As we discuss elsewhere in this article, many companies stand out from the crowd by being the only company of their kind on the stock market. It is quite easy to sort out the companies that have significant appeal to ones which don’t have rivals because their business model is flawed.

Dee Valley is the only small cap water utilities stock on the UK market. The utilities sector is ever-shrinking as it has been a popular target for third party investors – often private equity firms – to use cheap funding to buy a business that pumps out significant amounts of cash over time.

Steady cash flow effectively covers the cost of acquisition debt repayments and should still leave money over to reward shareholders and/or grow the business.

Infrastructure investor Ancala is competing against FTSE 100 utilities group Severn Trent (SVT) to buy Dee Valley.

Share price weakness makes them a 'sitting duck'

Most companies trade on low valuations as a result of financial, trading or reputation problems. Share price weakness has over the years been a trigger for takeovers – and we expect this trend to remain in play for years to come.

Interested parties typically have to make two decisions. Firstly, is the current problem fixable? If not, you won’t see a bid. Two, does the target have a good track record in its industry?

Many problems are the result of a short-term bout of market weakness or a contract issue that is only temporary.

Taking a longer term view can often result in your view of a stock shifting from ‘I wouldn’t touch that stock as it just had a profit warning’ to ‘this is a once in a blue moon opportunity to buy a great company cheaply’.

Brammer definitely fits into the latter category. Five years ago this was a major player in the European markets.

The distributor lost its way and has suffered financial and operational pressures; but private equity bidder Advent believes it can put the business back on track.

Advent will be able to inject a chunk of money and capitalise on its experience in the distribution and power manufacturing sectors to put the spark back into Brammer.

Don’t rule out a counter bid for the company.


CURRENCY-DRIVEN DEALS

Although sterling has staged a few recovery rallies since its lows in the wake of the Brexit vote, it remains at historically depressed levels versus other major global currencies.

EURO TO UK £ (WMR&DS) - Comparison Line Chart (Rebased to first)

For example, against the dollar it trades at $1.24 versus an average for the last decade of $1.62.

This makes the economics of a deal for a UK company more compelling to a foreign rival. Particularly if said company has a lot of its costs in sterling but generates revenue overseas.

This was the case for UK tech champion and microchip designer ARM before its £24bn takeover by Japan’s Softbank (9984:TYO) in the summer.

JAPANESE YEN TO UK £ (WMR) - Comparison Line Chart (Rebased to first)

Fellow chip specialist Imagination Technologies (IMG) has some similar dynamics and seems very much ‘in play’ right now with regards to takeover appeal.

Drug companies like AstraZeneca (AZN) and Shire (SHP) could be in the sights of their peers from across the pond, both having flirted with US ownership in recent years.

US $ TO UK £ (WMR) - Comparison Line Chart (Rebased to first)

In October 2014 AbbVie (ABBV:NYSE) pulled a £32bn bid for Shire after a tax loophole was closed, while Pfizer (PFE:NYSE) failed with a $118bn approach for AstraZeneca in May of the same year.



Unique assets

A likely takeover candidate is a company with a brand, technology or market position impossible or prohibitively expensive to replicate. Add share price weakness and you have all the ingredients necessary for M&A.

There are several UK-listed examples. Free-to-air broadcaster ITV (ITV) has an unrivalled position in the UK television market and ability to attract a mass market audience.

Virgin Media owner Liberty Global’s (LBYTA:NDQ) 9.9% stake means it has been consistently linked with a potential bid. Concerns over weak advertising revenue have seen ITV’s share price get significantly lower in 2016 too.

Trench coats-to-cashmere scarves seller Burberry (BRBY) has a unique luxury brand which has been around for more than 150 years. Its history as a producer of high quality goods is extremely well established.

The shares have stuttered of late after initially enjoying a strong run off the back of the currency tailwind delivered by the Brexit vote. There have been rumours of a potential merger with US firm Coach (COH:NYSE).

Engineering consultant Ricardo (RCDO) is another unique business on the UK stock market. It specialises in environmental matters such as automotive emissions and water scarcity and has a good reputation in the transport industry. It has several blue chip firms on its roster of clients including Volkswagen (VOW:ETR), McLaren and Network Rail.



FOLLOW THE ACTIVISTS

Keeping an eye out for activist investor stock purchases can be a way of identifying potential takeover targets or deal-related catalysts.

Among the two largest activist investors in the UK are Crystal Amber and Toscafund – and both have been fairly active this year.

Activist investors usually buy strategic stakes in companies and then attempt to influence board members and management to make changes that increase shareholder value.

However, the approach is not always successful and investors should never purchase shares in a company on the hope of a takeover alone.

Tooled up

We’ve covered Toscafund’s interest in tool hire plays Speedy Hire (SDY) and HSS Hire (HSS) in many previous editions of Shares.

Crystal Amber also has an interest in the sector through a 4% stake in the UK’s biggest van rental business Northgate (NTG).

The activists believe poor shareholder returns delivered in this sector are down to the industry being too inefficient, meaning few of the main players can earn enough in profit to cover their cost of capital.

Consolidation makes sense, they argue, and those that refuse to take part may end up with less palatable options further down the line.

Cover

Media sector opportunities

Crystal Amber has been sniffing around for opportunities in the media sector too. In April 2016, we flagged Wireless Group (previously called UTV) as a special situation after it offloaded TV assets to ITV, returned capital to shareholders and refocused as a smaller business around radio broadcasting.

Within a few months it was taken over by Rupert Murdoch’s News Corporation (NWSA:NDQ) at a substantial premium.

Also in media, small cap Johnston Press (JPR) recently said it was considering selling some of its publishing assets after stake-building from Crystal Amber, helping shares gain around 20% on the day of the announcement before falling back.

The activist fund has been adding to positions including STV (STV), which broadcasts ITV programming in Scotland.

Keep your eyes on these stocks

Crystal Amber has a 24% interest in foreign exchange and corporate cards provider FairFX (FFX:AIM) after a strategic investment in March.

At Toscafund, as well as recently upping its stake in HSS Hire above 21%, it has also been busy hoovering up shares in Esure (ESUR) prior to its spin-off of GoCompare (GOCO), owning around 15% of each stock after the demerger.

Spin-offs are often a catalyst for M&A activity. In this case we believe Esure is the more likely to receive a takeover bid because GoCompare was marketed to potential buyers prior to the separation of the two businesses so the M&A opportunity on the latter has passed, in our view.

As an online-only operation, Esure could prove an attractive target to established UK insurers because of the potential cost savings which could be delivered.



PREYING UPON THE WEAK

Bombed-out stocks can be vulnerable to a takeover approach. To help generate some M&A ideas, we’ve run the numbers to find FTSE All-Share constituents which are down 20% or more year-to-date.

Here we rate a selection of companies from that list in terms of their takeover viability.


Inmarsat (ISAT) 728.5p 

The company is one of only a handful of commercial suppliers of satellite connectivity with several geostationary satellites surrounding the globe. The share price has been weighed down by its $3bn of net debt but it could interest a purchaser with deep pockets given the unique nature of its assets.


Thomas Cook (TCG) 80.6p

It has a strong brand in the travel sector and one with a leading position in the European market. The most obvious suitor is China’s Fosun International (0656:HK), which has built an 8.2% stake in the company and with which it recently launched a joint venture aimed at wealthy Chinese holidaymakers.

Mt Otemanu reflected in swimming pool.


Cape (CIU) 156p 

The industrial services provider operates in a space which is seeing increased M&A activity. Despite its discounted valuation, with the shares trading on a price to earnings ratio of six times, previous spells of weakness didn’t encourage a bid. Historic asbestos liabilities could be viewed as a poison pill.


Game Digital (GMD) 47.5p

The specialist retailer may have a bombed-out share price but this is unlikely to attract any interest. It is hard to see why any acquirer would want exposure to a UK retail sector facing a consumer spending squeeze from rising inflation and the fall-out from the Brexit vote. Ask the question: ‘If Game Digital and its high street stores didn’t exist today, would you create such a business?’ The answer is definitely ‘no’.


Devro (DVO) 160p 

A share price collapse at sausage skins maker Devro could attract an overseas predator, with Spanish rival Viscofan (VIS:MC) likely to be among those watching developments with interest.

Devro supplies collagen casings for sausages, salamis and hams and is geared into increasing emerging market protein demand.

In August, Devro said a transitional period would be needed to extract benefits from £110m worth of new plant investment in the US and China.

Shares slumped again in November when it warned 2017 profit would disappoint; and debt, taken on to invest for growth in China and the US, was close to breaching commitments given to lenders.

Seeking to mitigate weaker volume trends, notably in Latin America where Devro is encountering disruption as it transfers customers onto new products, the food producer is accelerating restructuring plans and making investments in next generation products. This will improve its competitive position but hurt profitability next year.

Devro’s management have been buying shares on weakness and see plenty of long-term value in the business.

Four large sausages cooking in a cast iron skillet.


Capita (CPI) 572p

Possibly the highest profile victim of the uncertainty created by the Brexit vote, the outsourcer’s shares have crashed on a big profit warning (29 Sep) and amid suggestions a rights issue might be required to repair the balance sheet. However, this remains a cash generative business with material barriers to entry which could prove attractive to an opportunistic buyer.

Group of people meeting with technology. They are around a conference table with digital tablets and laptops. There are marketing and strategy documents on the table


Essentra (ESNT) 372p

The industrial distributor has suffered a big share price slump on a relatively mild profit warning but the inherent quality of its Pipe Protection Technologies (PPT) division and other business units could attract a suitor. Particularly one prepared to look through to a recovery in the oil and gas space.


Gulf Marine Services (GMS) 48.25p

The company operates a fleet of maintenance vessels mainly used by oil and gas companies. There is a good business in here somewhere. However, being an asset heavy operation during a structural downturn in your industry, particularly when you factor in a big debt pile, is never a good look. This could prove an obstacle to bid interest.


St Ives (SIV) 128p 

The company has been busy recycling cash from its legacy print operations into a digital marketing expansion drive. Although the company has hit some bumps thanks to a wider decline in marketing spend, it could prove attractive to an acquirer looking to build scale in this high growth area.


Laird (LRD) 144p 

Electronics and high performance materials outfit Laird (LRD) is in the doldrums after warning in October that 2016 pre-tax profit would come in 30% shy of expectations at £50m.

The warning raised the sceptre of a covenant breach and dividend cut and came shortly after the announced departure of chief executive David Lockwood. That leaves the company rudderless and potentially even more vulnerable to a bid.

Laird makes high-spec antennas, embedded wireless chips and various radio frequency (RF), microwave and electro-magnetic shielding which are mainly sold into smartphones.

The problem lies in a rapid slowdown in smartphone sales growth, particularly at key client Apple (AAPL:NDQ). However, Laird still generates valuable high tech kit.

There is scope to expand into new markets such as connected vehicles – or in other words souped-up cars filled with electronic gadgetry – and medical devices.

Close-up on computer circuit board.

On a long-term view it is possible to see the rationale for a bid. The stock trades on an 11% free cash flow yield for 2017 based on forecasts from Berenberg. These seem unlikely to be overpitched given it is a notable bear of the stock.

The limited cost of borrowing means this kind of return could prove highly attractive to a private equity firm which feels it can address the group’s balance sheet and operational issues.
(TS/DC/WC/JC)

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