By Karl Hunt, Portfolio Manager
When a company makes a bid to buy another company there is most often a significant premium paid. To own shares in a company targeted for takeover can be very beneficial to your wealth since the share price will often rise higher than the initial bid in the expectation of an even higher price or rival offer. Sometimes the market will also reward the acquiring company since this displays the willingness to deploy capital in the pursuit of higher returns.
However takeover bids are relatively rare and the target company share price performance often displays signs of financial stress and management upheaval which makes investing in the target company quite a challenge.
In short, following a portfolio strategy of just investing in what are believed to be takeover targets or acquirers is unlikely to be rewarding.
There are however times when M&A or takeovers are more likely and there are patterns in the takeovers that make it possible to profit systematically as an investor. For certain industries discussed below, the signs look like an uptick in M&A is on the way. We hold some companies we hope will acquire and possibly some which get acquired.
These patterns or characteristics are:-
- When organic revenue growth is hard to achieve. Large companies with good balance sheets are prime examples.
- When an industry is under stress and consolidation is essential to reduce cost
- When all cost efficiencies have been attained and management wishes to focus on ‘the next big thing’. The share market will reward the aggressor and management knows this.
- Takeovers often come in bunches – companies receiving bids are likely to see their competitors receive bids too. Investment bankers perform the same analysis and submit the same ideas for growth and consolidation to numerous clients.
In a low GDP growth environment, companies are struggling to obtain meaningful top line (sales) growth, and there’s only so much cost you can take out of a business so it becomes difficult to grow earnings as a consequence. But with cheap and plentiful finance available, companies then have to start thinking about acquisitions as a way to grow earnings.
Some industries where substantial economies of scale can be achieved through size are particularly vulnerable to takeovers. The investment management industry is one industry where people have been competing strongly on “price” – lowering fees, and this has accelerated with more money moving into index and other passively managed strategies. So as your competitors get bigger and can therefore use size to squeeze price to get even bigger, then so the second tier companies will also see the need to get bigger.
A recent example of a take-over or merger has been the combination of Janus, the Denver USA based investment manager, and Henderson, the UK/Australian based investment manager. The development and marketing of index, style-based and factor-based funds in the USA is probably ahead of anywhere else so we expect a fair amount of consolidation of cost from this ‘merger’ but a more rational and extensive product line. It is very unlikely that this will be the only deal in the asset management space.
A number of major banks have already stated that they want to expand their asset management businesses – Wells Fargo for instance. Right now the sector is relatively attractively priced with quite a few sizeable investment groups on relatively modest Price to Earnings ratios.
For a large bank like Wells Fargo (Market Value US$280bn) investment managers such as T. Rowe Price and Invesco in the US would be easily manageable acquisitions. The smaller investment managers would be even more vulnerable (more like sitting ducks) to a wide range of predators. For instance, there are companies like Schroders, Aberdeen Asset Management and Jupiter Asset Management in the UK. Some of these companies even have sizeable cash holdings on their balance sheets making them even more attractive. The High Conviction Strategy recently bought in to Julius Baer, the Swiss investment manager, which is similarly valued to these UK players. We are however somewhat cautious on Sterling right now, so it is a better “fit” for our overall strategy. It’s highly likely to expect more takeovers in 2017 in the investment management industry globally.
Another area where we are likely to see more deals is Media. SKY the UK based satellite TV provider was recently bid for by its largest shareholder Twenty First Century Fox. Not only are other media companies in the market to acquire media companies but also Telecom companies. Telecoms companies globally have come under pricing pressure both from regulators and competition generally. To mitigate this they want to try and provide a broader range of products to their customers. One of those is media. So a number have started to provide TV content in an attempt to boost revenue and strengthen their overall offer to customers. A number of mid-sized look potentially vulnerable here.
A number of media groups already have stalkers! ITV the UK TV company currently has Liberty Global the large US media company as a 9.9% shareholder and rumours continue to be heard of a possible full offer for the company. Mediaset, the Berlusconi dominated media group has received unwanted interest from Vivendi which has built up a 25% interest in the company. Other possible targets in Europe include TF1, MTG and Metropole TV. In the USA companies seen as potentially vulnerable to a takeover are Viacom, Tegna, Discovery Communications, and CBS Corp.
The Pharmaceuticals industry continues to attract a lot of M&A activity. The large pharmaceutical companies have seen disappointing product flow from their large R&D budgets. The cracking of the DNA sequencing code was expected to see a rich seam of new products coming from the majors but the reality is that this has been very disappointing. Innovation has been greater in smaller companies and Large Pharma has found it necessary to acquire mid-tier industry players for their product pipelines to replace products going off patent. So takeover targets are more likely to occur in the sub US$40bn area – but one or two of the $100bn companies could also be vulnerable. One we are looking at quite closely as a possible portfolio inclusion is Sanofi, where we believe the valuation is attractive.
In terms of current takeover activity, Actelion the Swiss biotech company is currently in play with Johnson & Johnson in the US the most likely acquirer. Other potential candidates in the mid-tier are Sino Biopharm, UCB, Shire Pharma, Biomarin Pharma and Jazz Pharmaceuticals.
So here we suggest three industries which appear ripe for activity and another, Technology, is already seeing a number of deals done in the last 12 months. If we are correct on this then it likely that the equity markets remain at least at current levels and quite probably trade higher. If share prices do drop then corporate activity is more likely since the target price has fallen. The only problem we see? Adverse changes in both regulation and protectionism, but we will write more about that another time.