James Henderson, Co-Portfolio Manager of Lowland Investment Company, Henderson Opportunities Trust and Law Debenture, said: “A number of UK stocks have been on the receiving end of bids this year, particularly from US companies including private equity, and this is a reminder of the value in the UK equity market. The valuation of corporate earnings totally outstrips the long-term cost of debt, and the gap is so large it has to change. This will most likely occur when the cost of long-term debt goes up and the valuation of corporate earnings also goes higher. However, if sound companies are taken over at low valuations it is detrimental to long-term returns from the quoted sector so, in my view, it’s important the current owners of these companies don’t allow this happen.”
How can investors benefit?
Ed Wielechowski, Manager of Odyssean Investment Trust, said: “We would never advocate investing in a company only because it may seem to be an interesting takeover candidate for private equity – any investment should be made on its individual merits. However, you can potentially tilt the balance of probabilities in your favour by adding certain negative and positive filters to your investment selection criteria. For example, private equity bidders like market leaders with strong cashflows, which are not generating the levels of sales growth and profit margins that the businesses are capable of. They also like businesses which can add value by consolidating industries, and companies which are asset rich and/or have high barriers to entry. On the flip side, in our direct experience, private equity buyers struggle to acquire companies with large defined benefit pension schemes, significant cyclicality or high capital intensity.”
Jonathan Winton, Co-Manager of Fidelity Special Values, said: “Investors are more likely to benefit from takeover bids if they own attractively valued businesses, or those with desirable technology or innovative products. With Fidelity Special Values, our focus is on attractively valued companies that are ignored or underappreciated by the market. It might be because they are experiencing internal issues or are impacted by headwinds in their sector or the wider economy. The key is that we feel these issues are temporary and our due diligence gives us the conviction that the business will positively change over the medium term. The uncertainty and its impact on the valuation create an opportunity for acquirers who typically take a longer-term view. From an external perspective, Brexit clarity and vaccine progress potentially remove two large areas of uncertainty whereas valuations remain attractive, giving acquirers greater confidence to deploy capital.”
James Henderson, Co-Portfolio Manager of Lowland Investment Company, Henderson Opportunities Trust and Law Debenture, said: “The reason we buy shares in a company is because we believe in the sustainable long-term outlook of the business and think the valuation does not reflect this. These factors may also be why another company will want to buy them. Therefore, our investment process can lead to us being invested in companies that receive approaches. This has been very evident in the last year, but we don’t invest purely on the basis that a company may be taken over.”
What does this trend show about UK businesses?
Ian Lance, Portfolio Manager of Temple Bar Investment Trust, said: “I think it shows us three things. First, that the level of private equity bids is elevated because they are flush with cash and can borrow very cheaply. Second, that the UK is being targeted because it is very cheap – it is at the biggest discount to the MSCI World for fifty years. Thirdly, it shows that the UK is quite friendly to takeovers from a regulatory point of view.”
Ed Wielechowski, Manager of Odyssean Investment Trust, said: “Whilst we do not believe UK listed companies as a whole are undervalued, there are pockets of above average quality companies which are trading at below their intrinsic values. Fundamentally, this drives bid activity.