UK fund managers have warned investors not to get too excited about takeover bids, as even those made at a large premium to the current share price can represent poor value when viewed from a long-term perspective.
Data from PWC shows there were 5,033 M&A deals in the UK in 2021, a record amount. While this tailed off in the second half of last year, the region remains attractive to foreign buyers thanks to low valuations in the equity market and the weakness of the pound against the dollar.
Many analysts have claimed that private buyers will be vital in helping to push valuations in the UK market back towards the long-run average. However, a number of fund managers have warned that bids that seem high compared with the current share price often undervalue the long-term potential of a business.
Kartik Kumar, manager of the Artemis Alpha Trust, said: “If you think a stock is going to return 30% per annum for three years, getting a takeover premium of 30% is a value loss to you, especially if you think those returns are durable.
“Obviously you can take the capital and put it in different stocks but, in the medium term, having stocks taken out on those premiums is not brilliant.”
Gervais Williams, manager of the Miton UK MicroCap Trust, agreed with him: “I say to all of my companies, ‘please don't get taken over’, even if it’s at a 50% to 70% premium. Once they've announced the fact they’ve had a takeover approach, it's only a question of what the price is. So keep it quiet and tell them to push off.”
Kumar said the notion that UK stocks are being bought too cheaply is not just a subjective one – it is backed up by hard data.
As an example, he pointed to funeral director Dignity, a former holding in his trust, which was taken private at 550p a share. This represented a premium of close to 30% above its closing share price.
“Because there was a paper offer, Morgan Stanley was required to value the bid – and it did so at 750p,” the manager continued. “So there's the board recommending a bid at 550p, when the buying broker has valued it at a 50% premium.
“We rolled over our shares into this bid, but I’d rather not have done – I'd rather it had stayed a public company. But it just shows that when you're required to be honest about it from a regulatory standpoint, the value is outrageous – people who are buying assets right now are making out like bandits.”
Not every UK manager is so dismissive about takeover approaches. Georgina Brittain, who runs the JPMorgan UK Smaller Companies Investment Trust, said the last time one of her portfolio holdings was even approached was 18 months ago, when Royal Bank of Canada bought out Brewin Dolphin.
“I'm actually getting cheesed off about this,” she said. “We've had a couple of months this year when there's been a bid a week, sometimes three bids a week, and not a single one has been for one of our holdings.
“There is almost no listed car retailer left, except for the one we own – it's become very frustrating.”
She added that she is currently close to the trust’s maximum gearing level of 10%, meaning she has to sell to buy. As a result, she said that any takeovers of existing holdings would mean she had money to put into new ideas.
This doesn’t mean the manager is always happy to receive bids for her holdings, with Brittain saying she will “categorically” vote against any approach that she feels undervalues a company’s potential.
“If they’re not paying a significant price above where I think a company’s going to be in two years, the answer is no,” she added.
She is also sceptical of the notion that M&A activity will be needed to help lift the valuations of UK equities towards historical and global levels. Instead, she said the turning point for the domestic market will be more straightforward.
“It will be when people stop selling,” she said. “I'm not expecting a big bang on the day interest rates peak or inflation starts to come down, even though both of these will be important.
“When people stop selling and other people realise this, they will start buying. Then we could have a 30% to 40% melt-up. It’s a vague answer [to the question of what will be the catalyst for a recovery]. But I don't think we need one.”