There has been a wave of takeover approaches for listed companies, both from rivals and from private equity buy-out firms in 2021.

Something we have noticed is that, where private equity is concerned, rather than looking for companies which are on their knees and in desperate need of turning round, buyers seem to prefer companies which have already begun the turnaround process and therefore require less money to be pumped into the business.

We have screened the FTSE 100 and the FTSE 250 for firms which seem to have taken a good dose of self-help medicine and are on the road to recovery, meeting private equity’s criteria, yet which haven’t as yet been rewarded by the market.

RICH PICKINGS

Of the most high-profile takeover bids in the last six months or so the majority have been private equity transactions. Most deals have either gone through or been recommended by the target companies, although there have also been some notable failures such as the MGM Resorts bid for Entain (ENT), which the company’s board rejected.

The most recent approach, and in a way the most audacious, was by US private infrastructure equity investor MSI Inc for hazardous waste recycling firm Augean (AUG:AIM).

On 26 May, Augean posted a trading update to say that, with respect to the HMRC’s assessment of landfill tax on its South Augean asset, it would put aside a provision of £1.6 million including interest in its final 2020 results.

With that, the firm drew a line under a bitter dispute which had dogged it for several years. It commented: ‘There will therefore be no impact on guidance going forward or on the group’s profit as a result of the receipt of the assessment.  The assessment will be paid forthwith in order to prevent further accrual of interest.’

A day later, MSI revealed it was ‘in the preliminary stages of considering making an approach to Augean regarding a possible offer’ for the company.

MSI has until 24 June to decide whether or not to bid, but it has put its cards on the table for all to see. Crucially, it waited for the news on Augean South before showing its hand.

POSITIVE CHANGE

By only targeting firms which have already begun a regime a self-help, private equity buyers are fishing in the same pond as fund managers like Fidelity’s Alex Wright, who runs the £2.8bn Fidelity Special Situations (B88V3X4) and the £850 million Fidelity Special Values (FSV) investment trust.

Both Fidelity funds focus on finding unloved companies which are ‘entering a period of positive change’ and where Wright believes the shares’ recovery potential isn’t being recognised by the market.

Wright says he is finding ‘a lot of opportunities and of better quality than usual’, especially among smaller-cap stocks and domestically-focused companies like specialist retailers and housing-related businesses which are ‘beneficiaries of the current backdrop but not     valued accordingly’.

Firms he identifies which are starting to change for the better operationally are Aviva (AV.), ContourGlobal (GLO), Dixons Carphone (DC.), Inchcape (INCH), John Laing (JLG) – already subject to a takeover approach – Imperial Brands (IMB), Pearson (PSON) and Vistry (VTY).

FIRST-HAND EXPERIENCE

Trevor Green, head of UK institutional equities at Aviva Investors, has seen four of his portfolio firms bid for this year alone: John Laing, Sanne Group (SNN), St Modwen Properties (SMP) and UDG Healthcare (UDG).

‘The interesting aspect for me is the timing of the bids’, says Green. ‘With John Laing, the new-ish chief executive had sorted out the firm’s problems in Australia and was really accelerating the reshaping of the portfolio, yet the share price hadn’t responded. For private equity, the execution risk in buying now is miles lower than a year ago so they swooped.’

In the case of St Modwen, the new chief executive ‘was only in the job six months and came from outside the industry, so he hadn’t had a chance to make his mark’ says Green. ‘Crucially though, previous boss Mark Allen had done all the hard work tidying up the business but the board wouldn’t do the big break-up, so buyers were circling ready to do it.’

The logistics part of the business was obviously a hot area, and while the housebuilding unit was sub-scale, the buyers ‘could probably sell it after a couple of phone calls’, which just left the land and regeneration part, which is much cleaner now, says Green. ‘Again, the execution risk is much lower now than it was a year or two ago’, he adds.

MISSED OPPORTUNITIES

There have been a few cases where management has orchestrated a turnaround, or at least convinced the market they have turned round, and the shares have bolted before private equity or other buyers have had a chance to pounce.

Obvious examples are Hargreaves Services (HSP), which simplified its structure by folding its legacy mining business into a German subsidiary which has subsequently shot the lights out, while its property site development business is benefitting from strong demand for new housing. A running Great Idea, the shares have almost doubled from less than 200p to 380p in under a year.

Two companies much talked-about as takeover targets, Premier Foods (PFD) and Royal Mail (RMG), have both seen their share prices soar since summer 2020, Premier more than doubling from less than 50p to 105p and Royal Mail almost quadrupling from 150p to nearly 600p.

POTENTIAL TARGETS

We have picked three firms which we believe have reformed themselves through hard work and would potentially appeal to private equity buyers.

All three firms are a decent size, meaning they are big enough to ‘move the needle’ for most private equity firms if they execute well.

Balfour Beatty (BBY)

Buy at 310p. Market cap: £2 billion

Under its ‘Built To Last’ programme, infrastructure firm Balfour Beatty (BBY) has upgraded its capability and its capital discipline to the point where it is now exceeding its internal cash-generation targets.

While 2020 put a brake on progress due to the pandemic, analysts at Numis say the company’s turnaround is ‘now substantively complete’ and they predict growth both in revenues and orders going forward.

With the investment case moving from turnaround to total shareholder returns – the firm has already committed to £150 million of share buybacks this financial year – this would seem the ideal time for private equity to get involved.

Add in an investment portfolio of £1.1 billion which until last week had seen no disposals since 2019, and there is a substantial ‘store of value’ for potential buyers.

Dixons Carphone (DC.)

Buy at 137p. Market cap: £1.6 billion

Thanks to its market-leading position in home electricals and tech kit and its strong online offering, Dixons Carphone (DC.) came through the pandemic in better shape than many analysts predicted.

‘We’re winning online, where we’re the biggest and fastest-growing specialist technology retailer in all our markets’, said chief executive Alex Baldock in the firm’s January trading update. ‘While the outlook remains uncertain, this strong performance makes us more confident than ever that we’re on the right path to create a world class business’.

While the mobile business has yet to break even, the wider strategy to simplify the group – which from September will just be called Curry’s, a rebrand the chief executive called a ‘no-brainer’ – and the firm’s substantially-improved balance sheet mean the execution risk for private equity is much lower than pre-pandemic.

Serco (SRP)

Buy at 135p. Market cap: £1.6 billion

Most readers will be familiar with the dramatic fall from grace of the UK public sector outsourcing firms during the last decade, but we feel that of the companies involved Serco (SRP) has shown the most progress in making itself fit for purpose and a reliable counterparty.

Ironically, the pandemic not only showed the essential role of outsourcing companies but has also likely sped up the procurement process with a particular focus on defence, employment and healthcare, three of the firm’s key markets.

Recent contract wins in UK with the Department for Work and Pensions and the acquisition of US defence services firm WBB – which will add to Serco’s already impressive US defence assets – are driving both sales and margin upgrades.

Improving momentum in its business combined with new contracts, and a strong balance sheet with no more onerous contract provisions, should make the firm an appealing target for private equity buyers, as long as they pass muster at government level.

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