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Takeover Tales…

Takeover Tales…spotting “mergers and acquisitions” targets

I am often asked, “who’s next?” Clients, colleagues, industry professionals naturally want to own the next big takeover target. Why are investors interested in companies potentially subject to a takeover? Generally, because it gives a swift and significant uplift to their share price.

While 2015-6 from an index viewpoint has delivered weak investor returns, there have been major acquisitions of diverse companies. So far we have seen BG Group, the UK oil and gas company bought by Royal Dutch Shell in a takeover announced in April 2015 and finalised in February 2016. CSR, (formerly Cambridge Silicon Radio) a Cambridge-based semiconductor company which specialised in Bluetooth technology was acquired by Qualcomm, a U.S.-based multinational semiconductor company in a deal announced in October 2014 completed in August 2015. SAB Miller, the former South African Breweries whose international expansion saw it move it primary listing to the London Stock Exchange in 1999, acquire the U.S.- based Miller Brewing Company in 2002 to form SAB Miller, and in October 2015 Anheuseur-Busch InBev the world’s largest brewer based in Belgium announced a bid to acquire them. I had heard rumours of SAB Miller for years but thought SAB would present approval problems.

One of the reasons behind a rise in these company mergers and acquisitions has been “ZIRP” the “zero interest rate policy” which has helped buyers fund acquisitions very cheaply. The growth slowdown could increase the attractions of Research consolidating market share. A more robust US Treasury approach to “tax inversions” (the practice of US companies using an overseas merger to reduce US Report: taxes) has also led to an acceleration of M&A activity.

It is worth recapping the M&A / takeover process:-

Step 1; A “buyer” “approaches” the “target” company. The buyer asks to conduct “due diligence” i.e. a close examination of the target’s management accounts.

The target’s board of directors either permits due diligence or rejects the buyer’s approach. The acquisition target must disclose an approach to investors. The due diligence process can take a few months to complete.

Step 2; The buyer either makes a formal offer to the target company providing precise terms for the offer with the price being offered per share, details of how the buyer will finance the acquisition and further conditions, or ends the approach.

Step 3; The target’s directors either, “agree” to recommend the offer to shareholders or reject the offer (often on the basis the offer undervalues the target).

Step 4; The buyer either improves his offer to gain the directors recommendation or “goes hostile” ie makes an offer direct to the target’s shareholders (these days this is rare) or ends the takeover approach.

Step 5; Should the target board agree to recommend the buyers offer to its own shareholders then there is a takeover agreement subject to conditions.

Step 6; The buyer moves to obtain regulatory clearance, a key condition.

Step 7; Assuming regulatory clearance and other conditions are met, shareholders of the target company are required to vote to back the acquisition. Shareholders can still reject the offer, and if sufficient numbers do (ie 25%) then the offer would fail.

Step 8; Completion, the target’s shareholders receive the offer’s terms.

The process lengthens if other companies make offers or if the combination presents regulatory risks and takes longer to obtain clearance in multiple locations. Investors tend to like M&A for a number of reasons:-

Should the offer fail, the target’s share price would likely reverse the gains made.

What makes a good acquisition target?

Now for the corollary…. what makes a bad acquisition target?


Lok n’ Store – LSE AIM BUY

Lok’n Store is a UK based owner/ operator of warehousing facilities in large towns/ cities in the South East, Midlands, Kent, Essex, West and East Sussex. Typically Lok’n Store warehouses hold the home removals, items of clutter, sporting equipment from individual clients and palletised items, office, exhibition equipment, documents for business customers in lockers ranging from 25 sq ft to 250 sq ft. Both clients pay a hire and insurance fee based on their locker sizes/ duration of the rental period. Lok n’ Store has grown turnover from £10m to £16m since 2011 with a rise in EPS and dividends via acquisitions of new sites, capacity expansion of existing freehold sites, and profits from developing/trading new sites via the planning process.

Company  Lok n’ Store
Share Price  330
Target Price  400
52 Wk Hi/Low 370/280
Shares O/S  26.64m
Market Capitalisation  £87.9m
Avg Daily Volume  6.2k
Dividend Yield  2.52%

Key Catalysts

Lok’n Store interims showed revenues +4.7% to £8m whilst expenses fell 0.6% – profit before tax jumped to £3.79m +155%. Adjusted net assets are 307p per share. The board have drawn down c £29m of its £40m borrowing facility at a margin of 1.6% to LIBOR.

Lok’n Store is small relative to its peer group, (Big Yellow £1.33bn/ Safestore £707m) hence our belief it is unlikely to be around forever. In our view, it is “bitesize” for either. Our timeframe is a deal in the next 5yrs (hence 2016-2021).

Key Risks to Price Target

  1. Lok’n Store profit is sensitive to UK property market activity, lower completions.
  2. Competitive pricing due to larger competitors Big Yellow and Safestore could hit profit growth.
  3. Sensitive to UK base rates due to financing facility being set at a margin to LIBOR.
  4. AIM-listed, hence may experience periods of low liquidity, higher bid/offer spreads. Lok’n Store should be considered a smaller, higher risk company than its peer group.

Pennon Group – FTSE 250 BUY

Pennon is often mentioned as a potential acquisition target, and it is relatively straightforward to see why. It is the smallest of the large utilities, owning South West Water (mainly Devon & Cornwall, and parts of Dorset and Somerset), Bournemouth Water and Viridor Limited (a leading UK recycling, waste management). Pennon has a colossal stretch of UK coastline relative to other utilities and is nearing the end of the clean-up programme to meet EU waste water regulations. It has been linked to potential interest from Veolia, the French utility giant, the Abu Dhabi Investment Authority amongst others. The Water Act opened up the possibility of takeovers within the water sector, without the automatic referral to competition authorities.

Company Pennon Group
Share Price 809
Target Price 950
52 Wk Hi/Low 876/713
Shares O/S 412.6m
Market Capitalisation £3.33bn
Avg Daily Volume 620k
Dividend Yield 4.03%

Key Catalysts

The water assets (SW Water & Bournemouth Water) are allowed to earn 11.5% returns on their regulated capital values of £2.92bn and £147.7m respectively. The Water Act has improved Pennon’s attractions to its peers.

EU Revised Bathing Water Directive requires stringent water standards quality, Pennon has a 97.2% pass rate at the new standard- hence risk of lower quality standards. Pennon reported 5 “serious” Category 2 incidents out of a total 204 total incidents in H1 2016.

Key Risks to Price Target

  1. Debt levels and trend in debt might deter an industry buyer / sensitivity to interest rates.
  2. The trend in Pennon Group net debt has been up in recent years; net debt is £2.34bn representing a 62.1% gearing of SW Water’s assets.
  3. Integration risks following recent purchase of Bournemouth Water, Pennon has targeted £27m of net synergies over the K6 regulatory period (2015-2020)

Talk Talk Group – FTSE 250 BUY

Talk Talk is the UK’s leading “value for money” provider of “quad-play” services ie. the “bundled” fixed line telephony, high speed broadband, mobile and TV. It is one of seven partners behind “YouView” a broadband based TV offering. Talk Talk has a strong network of high speed fibre optic cable for delivering corporate data at a lower price to traditional Ethernet technologies. In 2015 Talk Talk acquired Blinkbox from Tesco. Talk Talk was hit by cybercrime in October 2015, resulting in it receiving ransom demands and the disclosure of personal details relating to 1.2m of its c. 4m customers.

According to Ofcom data, UK superfast broadband is experiencing strong growth (7.1m high speed lines/ 30% penetration rate end 2014 v 5.3m & 23.2% end 2013). There is also higher adoption of mobile internet (61% 3G by Q1 2015 v 57% Q1 2014).

Company TalkTalk Group
Share Price 251
Target Price 350
52 Wk Hi/Low 409/189
Shares O/S 955.62bn
Market Capitalisation £2.4bn
Avg Daily Volume 0.856m
Dividend Yield 6.18%

Key Catalysts

Talk Talk reported 2016 pre-tax profit of £14m down 56% on 2015 £32m. EPS were just 0.2p due to net exceptional charges of £83m in total £42m in relation to October 2015 cybercrime attack with rest invested in “Making Talk Talk Simpler” programme. Cash costs for these items should decline to £30m-£35m for FY17.

Talk Talk has 14% of the UK fixed broadband market (BT 32%, Virgin 20%, Sky 22%, EE 4%, others 8%). Its share declined 2% from 2014 levels. We think an approach for the company for market share reasons is likely by 2020.

Key Risks to Price Target


Conclusion

When considering our M&A “school of thought” bear in mind:-

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