A big increase in the average takeover premium in 2023 highlights how parts of the UK stock market continue to be undervalued. The average bid premium for UK stocks in 2023 was 51% against 37% in 2022 and 43% in 2021, according to analysis by AJ Bell.

Most London-listed takeovers last year involved small-cap firms. Buyers were a mixture of private equity firms or industry players looking to buy rivals to gain scale or to get a foot in the door in a new sector or geography.

The lack of large-cap deals means takeovers were not a contributing factor to the performance of the UK’s flagship index, the FTSE 100. Indeed, none of the 2023 London-listed takeovers involved FTSE 100 companies and only three FTSE 250 companies received a bid.

Yet this situation could change if interest rates start to fall. Private equity firms flourished during the extended period of low interest rates, borrowing money cheaply to buy companies and using their cash flow to help pay off the debt. The sharp rise in interest rates over the past two years has made debt financing more expensive and multi-billion pound or dollar transactions harder to stomach.

With signs that interest rates may have peaked and central banks could begin cutting in 2024, we could see private equity firms go after bigger targets, particularly as many are sitting on significant amounts of cash (also known as ‘dry powder’ in the industry). We might also see large industry players make opportunistic bids for similar-sized rivals.

WHICH COMPANIES MIGHT BE TARGETS?

Reckitt (RKT) and Unilever (ULVR) are ones to watch as potential large-cap takeover targets. Both are companies that investors feel have lost their way and are now trying to get back on track.

Advertising agency WPP (WPP) could also be a takeover target given share price weakness and an undemanding valuation, trading on 7.8 times forward earnings and an EV to EBITDA (enterprise value to earnings before interest, tax, depreciation and amortisation) ratio of 8.9 times.

However, concerns over the global economy in 2024 could throw icy water on the idea that someone would try and buy WPP in the near-term as earnings are likely to come under pressure if clients scale back promotional activity.

Analysts have touted diversified miner Anglo American (AAL) as a potential takeover target for someone like Glencore (GLEN), after the firm saw its market value shrink by 39% in 2023 due to operational setbacks, weaker commodity prices and downgraded production guidance.

While there is merit to this line of thinking, the mining sector has a history of buying at the top and not at the bottom. Miners show a tendency to only want to do deals when everything is going well, rather than risk spending money when key commodity prices are flat or falling as they are at present.

FOUR COMMON THEMES

There were four common themes among UK takeovers last year and we could expect similar trends in 2024.

The acquisition enables the buyer to expand into a new country 

That is the rationale behind CoStar’s £100 million bid last year for property portal OnTheMarket. The purchase price is tiny compared to CoStar’s own $36 billion valuation but strategically interesting as it gives the buyer a foot in the door in the UK market and the opportunity to try and take market share from Rightmove (RMV). CoStar is a big player in the US and this acquisition could give Rightmove and UK peer Zoopla sleepless nights.

Opportunistic bid following share price weakness in a rival 

Mars pounced on Hotel Chocolat (HOTC:AIM) while its shares were depressed, offering a large premium to the market price to buy the business.

Private equity firms think about the bigger picture when buying undervalued companies

Buy-out firms often use the acquired business as a roll-up vehicle to make acquisitions in a certain sector or tap into a network of contacts to help improve the acquired company.

For example, Brookfield is in the process of buying London-listed Network International (NETW) and has indicated a desire to merge it with another payments group it majority-owns called Magnati.

The buyer takes the view the target would be better under private ownership

One of the downsides of being a listed company is constantly being in the spotlight. Investors are judging every move, and that can be a distraction if a business is going through a challenging period and wants to focus on the recovery.

For example, Apollo just bought Wagamama-owner Restaurant Group and believes it is better away from public markets. Restaurant Group has suffered mixed fortunes in recent years – its posh pubs arm and Wagamama have been successful while there have been troubles elsewhere. The share price was incredibly volatile when Restaurant Group was a listed entity, but Apollo is taking a long-term view and believes it can get the business back on track under private ownership.

WHO MIGHT BE BOUGHT IN 2024?

The following three stocks have the right qualities to be takeover targets:

FTSE 100 member Entain (ENT) has significant scale in the gambling industry, but setbacks have hurt the share price and it now has a caretaker chief executive. If ever there was a time for vultures to circle the business and pounce with an offer, it’s now.

The company is one of the world’s largest sports betting and gaming groups and scale matters in this industry. It owns big brands including Ladbrokes, Coral, Eurobet and STS.

Entain trades at 974p, having suffered a disastrous few years. An aggressive acquisition spree attracted widespread criticism and more recently it agreed a deal with the Crown Prosecution Service to pay £585 million in relation to a bribery investigation linked to its former Turkish business. Chief executive Jette Nygaard-Andersen quit in December 2023 and non-executive director Stella David has replaced her on an interim basis.

The logical buyer is MGM Resorts (MGM:NYSE), its partner in the US, which previously offered to buy Entain for the equivalent of £13.83 per share in January 2021. That same year DraftKings (DKNG:NASDAQ) also tried to buy the business, proposing to pay as much as £28 a share.

The company’s shareholder register includes three activists who could push for a sale or break-up of the business. They would no doubt seek the highest possible price, so if we do see a new takeover approach don’t expect the first bid to be the winning one.

Mr Kipling maker Premier Foods (PFD) was the subject of two takeover bids (at 52p and 60p) from US spice maker McCormick (MKC:NYSE) in 2016, both of which it rejected on valuation grounds. Since then, the business has transformed itself and it now looks ripe for takeover interest once again.

Japanese food group Nissin (2897:TYO) already owns 24.27% of the business, having formed a strategic partnership at the same time as it rejected the McCormick bids. Premier Foods distributes Nissin’s Soba and Cup Noodles products in the UK, and its Batchelors Super Noodles use Nissin’s noodle manufacturing expertise.

In recent years, Premier Foods has gone from being a zombie company drowning in debt to one that is reinvesting its surplus cash into product innovation and marketing. This has significantly de-risked the investment case.

While the current share price of 132p is more than double McCormick’s offer in 2016, it is important to consider some companies are happy to pay a higher price for acquisitions if they are not having to deal with baggage. Moreover, Premier Foods’s shares are not expensive at 9.9 times forecast earnings and 7.2 times EV to EBITDA.

Noodle-focused Nissin might seem the logical buyer given its existing stake, yet Premier Foods is a broader business involved in cooking sauces, cakes and meal kits. That suggests a more diverse food company might be a more realistic acquirer.

Revolution Beauty (REVB:AIM) struggled to win over investors after joining the stock market in 2021 and share price weakness created an opportunity for Boohoo (BOO:AIM). The latter bought a strategic stake in Revolution Beauty in 2022, building on an existing sales relationship. Now holding 27.13% of the shares, Boohoo could feasibly acquire the remainder of the business.

A disagreement over leadership is now in the past after Boohoo won a battle to replace certain senior directors at Revolution Beauty. The latter recently agreed a settlement with former chair Tom Allsworth regarding various issues, and the final piece of the jigsaw would be former chief executive Adam Minto agreeing to pay the group a sum a money to settle allegations he breached his fiduciary duties to the retailer. Talks are ongoing and assuming they conclude amicably, don’t be surprised if Boohoo pulls the trigger on a full takeover.

Boohoo wants to be bigger player in the beauty market so there is logic to owning Revolution Beauty. It could save money over the long term by getting rid of Revolution Beauty’s stock market listing and running the two companies on one platform. Allsworth and Minto each own 15.35% of the target company and might welcome a cash exit to start something new.

DISCLAIMER: AJ Bell referenced in the article owns Shares magazine. The author (Daniel Coatsworth) and editor (Ian Conway) of this article have an investment in AJ Bell. 

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