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Takeovers: what would 'The Gambler' do?

“You've got to know when to hold 'em
Know when to fold 'em
Know when to walk away
And know when to run
You never count your money
When you're sittin' at the table
There'll be time enough for counting
When the dealin's done.”
The Gambler, written by Don Schlitz and made famous by Kenny Rogers

Analysing the lyrics to country music songs can provide insights into managing money and dealing with the game theory that investors must analyse when faced with a takeover offer. Recently we have been receiving requests from clients about the takeovers of Asciano and Investa Office Trust. In this Kenny Rogers-themed piece, we look at different kinds of takeovers and the strategies investors should employ when a stock receives a takeover bid; namely ‘hold ‘em’, ‘fold ‘em’ and ‘know when to walk away and know when to run’.

Rising Australian corporate cash balances, global low interest rates and fading memories of the GFC are likely to lead to increased takeover activity. A feature of the recently concluded February reporting season was slowing organic growth across most Australian listed companies, as the levers to drive profit growth of cost cutting and renegotiating debt have mostly already been pulled. In this environment, an acquisition funded by cheap debt can allow a management team to satisfy the stockbroking analyst’s demands for profit growth that supports a high price to earnings multiple.

Know when to hold them

Even when there is only one suitor, the initial offer is rarely the final price. This occurs for two reasons: the first offer is usually a deliberate ‘low ball’. It provides the bidder some ‘wiggle room’ as the Board of the target usually rejects the initial advance. When the bidder offers a second higher price, it paints the picture that they are being generous to investors. It also allows the takeover candidate’s board to claim that they fought hard for shareholders, rather than merely rolling over.

Where there are competing bids for a company the best strategy is generally to sit back and enjoy the action. There is little incentive for an investor to tender their stock to a particular bidder before the outcome has been determined, as additional gains may be given away. In 2006, anatomical pathology products Vision Systems was the subject of an intense three-way bidding war which pushed the company’s share price from $1.64 to quite dizzying heights in a short amount of time. Three separate parties over a six-month period made cash offers for Vision Systems’ stock and all amassed significant holdings. Investors who accepted Cytyc Corporation’s antepenultimate cash offer of $3.25 ultimately saw Cytyc selling those same shares shortly afterwards to the winning bidder for $3.75. Obviously this represented a transfer of wealth from Australian shareholders (including the fund that the author of this piece was helping to manage) to a large US corporation. Similarly, during the bidding war for Commonwealth Property Office Fund in 2014, investors that accepted GPT’s initial bid effectively gave GPT a free option over the rights to these shares. GPT ultimately used these shares to extract five of Commonwealth Office’s office and retail assets from the winning bidder, Dexus.

Know when to fold them

Whilst it is often profitable for investors to remain cool and do nothing in the face of a flurry of strongly worded “last and final offers”, there are also situations where investors can be better placed to take the offer and move on to another investment. Typically, this occurs where there is only one bidder in the picture, the bidder is under no pressure to do the deal and that bidder has a longer investment horizon than most investors.

When car brake maker Pacifica Group received a $2.20 per share offer from German manufacturing giant Robert Bosch GmbH, I viewed that this offer was below the intrinsic value of the company and also significantly below our average entry price for the 14% stake in the company owned by my investors at the time. However, given the clouds on the horizon for the Sport Utility Vehicles in the US market and after doing some research into the acquirer, the best move was to sell into the offer. The company remained listed on the ASX, but made life unpleasant for the remaining shareholders after cutting dividends and selling off assets. Three years later Bosch GmbH paid $0.23 for the shares it did not own.

It can also be a wise move to fold if you suspect that the bidder may withdraw their takeover offer after due diligence or the regulatory authorities (such as ACCC) may oppose the transaction. In late 2013 Graincorp fell 33% after a surprise decision by the Federal Government to block the $3.4 billion takeover of Australia's largest grain handler by US firm Archer Daniels Midland. Similarly, in 2012 and 2013 Billabong’s price plunged after several private equity groups withdrew takeover offers after conducting due diligence on the troubled surf retailer. Investors could have sold their holdings for around $3, whereas the stock currently trades at $0.311.

Know when to walk away

Far too often we see that when competition hots up in a takeover battle, the end result is a transfer of wealth from the shareholders of the acquirer to those owning the takeover target. An example of this phenomenon was seen in the Australian regional banks. In 2007 Bank of Queensland put forward a proposal to merge with Bendigo Bank with an offer that would have delivered $17.18 to Bendigo Bank shareholders. As a shareholder I was delighted by the proposal. However, Bendigo countered with a proposal to defeat this, by merging with Adelaide Bank, whose primary business was in 'low-doc' loans and tax-driven lending for agricultural managed investment schemes (MIS), funded not by deposits but via global wholesale funding markets. Bendigo’s shareholders paid close to $2 billion for Adelaide Bank’s business which has both been earnings dilutive and an ongoing headache for the conservative bankers from central Victoria. BEN’s earnings per share remains well below pre-merger levels, the bank had to raise capital numerous times to bolster its balance sheet. The stock price has never come close to matching BOQ’s original $17.18 offer.

This is relevant when we look at the Asciano bidding war, because as shareholders of both Asciano and Qube, we would have preferred Brookfield to win the bidding war as the price was a very full one; see our piece Company Changing Events. However, rival suitors Qube and Brookfield decided to call a truce and submit a joint bid for Asciano rather than further bid up the price. The bidders took a leaf out of the playbook of Dexus and GPT in the takeover of Commonwealth Office and decided to split up the assets. While this is a positive for Qube shareholders, it limits the final price received by Asciano shareholders.

Final thoughts

When one of the securities that an investor owns becomes the subject of a takeover offer, a measured approach is most often the best one to take. The acquirer (and their advising investment banks) will deliver hundreds of pages of offer documents (Asciano investors received over 1,000 pages in the last few months). Inevitably these documents will have firm closing dates and tough language to inspire the investor to vend their stock into the takeover bid and thus strengthen the bargaining position of the acquirer. An investor tends to lose in a takeover situation when the acquirer may walk away or may face regulatory hurdles.

 

Hugh Dive is Senior Portfolio Manager at Aurora Funds Management. This article is general information and does not address the personal circumstances of any individual.

 

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