Eating the sundae: the continued exodus from the LSE

Takeovers have been a frequent theme of our daily reports, and are an ongoing source of return for investors in the UK market.

However, I can’t be the only one - and judging by our comments sections, I’m not - who is concerned about what this means for the long-term health of the LSE. Judge for yourself, but it seems to me that the companies being targeted for acquisition tend to be of higher-than-average quality, and in some cases they are being snapped up at rather underwhelming takeover premiums. And they certainly aren't being replaced by IPOs of a similar quality, as there have been hardly been any IPOs for years. In fact, IPO fundraising has hit a thirty-year low.

Source: dealogic via CNBC

This personally impacted my portfolio recently when International Personal Finance (LON:IPF) (I still hold) announced a recommended offer from a US investor. The premium against the prevailing share price was only c. 24.9%.

I acknowledge that this is very much a first world problem, but IPF is a stock that I intended to hold for the long-term, and I was excited about what the company might achieve in the years ahead. It was a company that I had researched, had gained familiarity with over a period of several years, and where I felt that I understood many of the pros and cons of an investment. If its share price had gained 25% in a year without any takeover offer, I would not have been terribly surprised.

Seeing this leave my portfolio is therefore not a prospect that I’m looking forward to, even if it will give my portfolio an immediate boost. I don’t come across opportunities like IPF every week, so I won't immediately know what to do with the proceeds.

An overview of takeovers we’ve noticed in recent months

To give some context for what I’m talking about, here are some companies where we’ve had the colour “PINK” (signalling takeover activity) in our daily report. I've tried to sort them roughly by the takeover premium.

Empresaria (LON:EMR): possible offer from a UK source at a 148% premium (will it go ahead?).

Spectris (LON:SXS): a private equity battle between Advent and KKR, with KKR ultimately offering £41.75 plus a dividend. This is a 104.9% premium to the undisturbed price.

Spirent Communications (LON:SPT): this is a long-running regulatory situation (for over a year), but US-based Keysight are buying Spirent at an 85.9% premium to the undisturbed price.

Just (LON:JUST): takeover by a Canadian-based financial group, at a 75% premium.

Direct Line Insurance (LON:DLG^G25) : takeover by Aviva (LON:AV.)  at a 73% premium (admittedly this one was originally announced last December, but it completed in July).

Alpha International (LON:ALPH): a US trade buyer offered a 55% premium to the undisturbed price.

Renold (LON:RNO): another US private equity takeover, with a 50% premium.

Deliveroo (LON:ROO): takeover by DoorDash at a 44% premium to the price when Doordash gave Deliveroo an offer letter, or a 29% premium to the price when everything went public.

Assura (LON:AGR): a long-running saga over who will buy this, KKR or Primary Health Properties (LON:PHP). KKR’s offer is a 39.2% premium to the undisturbed price.

Dalata Hotel (LON:DAL): a European hotel consortium offered a 35% premium.

Epwin (LON:EPWN): UK trade buyer offers 31.9% premium.

International Personal Finance (LON:IPF) (Graham holds): a New York-based financial firm offers a 24.9% premium.

Bakkavor (LON:BAKK): merger situation with Greencore (LON:GNC).

Ocean Wilsons Holdings (LON:OCN)/ Hansa Investment (LON:HAN) : this is a merger of two investment vehicles that was enabled by a large business disposal at Ocean Wilsons.

Empiric Student Property (LON:ESP): takeover by Unite (LON:UTG). 10% premium to the undisturbed price (lower premiums can sometimes go through for property companies).

S4 Capital (LON:SFOR): a possible merger with a UK-based advertising agency, although press reports have subsequently suggested that it’s not going ahead.

Dewhurst (LON:DWHA): delisting to become a private company. Tender offer to go with this.

John Wood (LON:WG.): Wood Group shares were suspended due to its failure to publish results. There is a possible offer of 35p from a Dubai-based firm.

Frenkel Topping (LON:FEN): possible offer from Harwood Private Equity at a 19.5% premium.

Anexo (LON:ANX): DBAY Advisors offered a 17.6% premium.

Warehouse Reit (LON:WHR): Blackstone takeover at 8.3% premium.

PRS Reit (LON:PRSR): a UK-based real estate investor has made a possible offer at 115p.

For the sleepy summer months, this seems to be quite a lot of activity! And as noted above, these deals have certainly not been offset by IPOs. And so the overall size of the market continues to shrink.

I note a mix of buyer types, but with plenty of North American buyers still involved. Considering that the US dollar has weakened by about 10% in the last six months, I’m impressed that they are still so determined to pick up UK bargains.

How to decide what to do after your stock receives a takeover offer: a very simple plan

I’m not going to overcomplicate this. I'm also not going to pretend that this is the only way, or even necessarily the right way, to respond when a takeover offer pops up in your portfolio. Please feel free to disagree with my approach and/or to offer your own techniques in the comments.

Step 1: compare the current share price against your opinion of its fair value

This might seem obvious, as it’s something that (in theory) we should all be doing, all of the time! But a takeover situation is a good chance to refresh our view on a stock.

For example, suppose you own stock XYZ which was trading at 100p until it received a takeover offer at 151p, and it’s now trading at 150p.

Great, we have just made a 50% gain overnight, at least on paper.

If you already had a price target for the stock that represented fair value, whether that was 130p or 170p, then Step 1 is easy: either the share price has reached that price target, or it hasn’t.

My position is a bit more difficult than that, because I don’t have explicit price targets. I simply try to buy excellent companies, and then my plan is to hold them until something on this list happens:

• A) their valuation becomes ludicrously expensive.
• B) they become far too large as a percentage of my portfolio (although even then I’m likely to keep holding them, perhaps with some top-slicing).
• C) something happens that significantly undermines the quality of the company and/or increases its riskiness. This can include situations where my initial assessment of the company was wrong.
• D) they get acquired.
• E) they go bust (although this shouldn’t happen if I’ve already sold out in a “C” situation!)

In a takeover, therefore, I’m likely to keep holding until it actually goes through. The market tends to reward patient holders with an additional few pence per share, if they continue holding.

The primary reason I wouldn’t continue holding is if I think that the valuation being offered, and therefore the current share price, is ludicrously expensive, i.e. we are in an “A” situation.

Step 2(i): if the share price has reached or exceeded fair value, then there is no shame in selling

If the share has hit or exceeded your fair value target, then it might be time to consider cashing out. If you do that, you avoid the risk of the deal failing to go through, and you are free to reinvest.

In my case, if I think we are in an “A” situation, i.e. that the valuation has become ludicrously expensive, then I’m going to want to get out before the buyer comes to their senses. The extra few pence that I might achieve by holding on are not worth the risk, in this situation.

Step 2(ii): if the share price has not reached or exceeded fair value, then consider being greedy

If I’m not greatly impressed by the offer, then I’m going to hold on and take the additional return that is available for continuing to hold.

There is a key point here: I am not afraid of the deal collapsing in this case. In fact, I might even want the deal to collapse, so that I can hold onto these shares and reap the rewards of the company’s long-term success.

In my view that is the main reason for continuing to hold, not because of the extra few pence that are available when the deal completes (although they don’t hurt!).

Does it matter if the share price is trading at a premium to the offer price?

This is a slightly unusual situation. It tends to imply that at least some shareholders are unsatisfied with the offer that has been made. They may expect a bidding war between potential buyers, or simply a higher bid from their corporate suitor.

My view is that, while interesting, the existence of a share price premium against the offer price does not necessarily matter very much. I simply go back to Step 1 and ask: is the current share price at or above fair value? Or as I like to put it: are the shares now ludicrously expensive? If they are, then I’ll sell. If not, then I’ll hold.

Yes, this attitude means that I’m risking some of the profits if I don’t sell, and if the deal then goes ahead at the offer price. But I’m not in this investing business for a few pence per share. I’m in it for the big moves! Or as Jared Vennett put it in The Big Short, I’m in it for the sundae. I let other people have the sprinkles.

Want to know what you get out of it? You get the ice cream, the hot fudge, the banana, and the nuts. Right now I get the sprinkles, and yeah, if this goes through, I get the cherry. But you get the sundae, Vinnie. You get the sundae.