Market Musings 03/07/21: UK Buyout Bonanza in the offing?

3rd Jul '21 by Edmund Shing

17 comments 3566 reads

UK Buyout Bonanza in the offing?

Summary:

Podcast: Is Artificial Intelligence taking over the world?
LBO Fever: UK in the crosshairs
What is an LBO anyway?
What should we be looking for in potential LBO target companies?
So what UK companies might fit this description?

Podcast: Is Artificial Intelligence taking over the world?

1) How do we benefit from AI, directly and indirectly, in our daily lives?

2) For all its benefits, could AI become a big threat to humanity?

3) What factors will accelerate AI in the near term?

4) Apart from equities and funds how else can people invest in the future of AI?

5) Which subsector or subsectors within the semi-conductors space do we currently like??

Is AI taking over the world?

You can also listen to our podcasts on Apple Podcasts, Podcast Addict (Android) and Spotify, Just search for “BNP Paribas Wealth Management”

LBO Fever: UK in the crosshairs

A trio of private investment groups led by SoftBank-owned Fortress have struck a £9.5bn deal to acquire Wm Morrison, Britain’s fourth-largest supermarket chain.

Under the terms of a deal unveiled on Saturday morning, Fortress along with Canadian pension fund CPPIB and a unit of Koch Industries will pay 252p a share along with backing a 2p special dividend to buy the grocer. It values the equity of Morrisons at £6.3bn before the inclusion of £3.2bn of net debt.

The deal comes two weeks after the Bradford-based group said it had rejected an unsolicited 230p-per-share approach from private equity group Clayton, Dubilier & Rice.

UK Merger & Acquisition deal volumes

Source: marktomarket.io

What is an LBO anyway?

First of all, for those not in the know, here is a very short primer on Leveraged Buy Outs (LBOs).

According to Investopedia: a leveraged buyout is the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. This is usually done by one or a consortium or private equity funds, as is the case here with Morrisons.

One of the largest LBOs on record was the acquisition of Hospital Corporation of America (HCA) by Kohlberg Kravis Roberts & Co. (KKR), Bain & Co., and Merrill Lynch in 2006.

In a leveraged buyout (LBO), there is usually a ratio of 90% debt to 10% equity, in order…

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gus 1065

3rd Jul '21

Hi Edmund.

Entertaining article as always. I agree the U.K. market is ripe for corporate takeovers activity. Not just private equity backed LBO’s but also trade acquisitions and merger activity where post COVID shake out the fit and healthy (and increasingly retained cash rich/deleveraged) corporates are in a good position to prey on those that have been slower to recover.

I think there’s also a fair bit of MBI potential from founders/large director shareholders with either PE or debt backing looking to buy out their own businesses that have maybe recovered more than the wider market has given them credit for - Cambria Automobiles (LON:CAMB) is a recent example of this.

On the subject of embedded hidden asset value, a big deal driver can also be freehold property. A lot of older established companies are sitting on freehold property that’s on the books at historic cost which can be a fraction of its realisable value, especially when the property is not part of the core operation and is capable of being realised with potential alternative use. Even if it is core, sale and leaseback can be used to squeeze out yet more leverage from an acquired business. Coupled with some creative financial engineering, whole industries (such as the U.K. tenanted pub sector) have in the past been completely redesigned through M&A activity - I think we’re on the cusp of another wave of this sort of thing right now.

Gus.

Momoko Miyamoto

with all this money looking to pick off tasty UK mid large caps stocks, maybe the easiest way to play this theme is with a low cost tracker e.g. £LCUK

Edmund Shing

Completely agree Gus,

any stocks in mind?

Edmund

Takeover targets? I think several U.K. house builders are still undervalued, especially some of the second tier players with with full land banks and not too much leverage. Defence sector is due for some consolidation. You’ve mentioned Avon Rubber (LON:AVON) already and Ultra Electronics Holdings (LON:ULE) is in the sights of Cobham and their PE backers. I think Qinetiq (LON:QQ.) could be both a buyer and also a target itself. I also like the regulated utilities, especially what’s left of the listed water sector such as Severn Trent (LON:SVT) , where most of the core cash flows are locked in and inflation indexed and there’s still substantial surplus asset backing behind the scenes. Itv (LON:ITV) is much touted as a takeover - assets such as IP don’t need to be tangible to be readily monetizable in a takeover - and Gattaca (LON:GATC) and other recruitment/ staff agencies are being widely talked about. Also online gaming seems still to be a bit down on regulatory noise so someone like 888 Holdings (LON:888) is probably a decent bid shout. Basically it’s open season for U.K. plc IMO for the various macro reasons you mention such that deals could come in virtually any market sector.

Fegger

4th Jul '21

Scs (LON:SCS) is small but often mentioned as a target co due to the relative low price, consistent performance and high cash pile

Harry Hindsight

Royal Mail (LON:RMG) - loads of cash, loads of property, have paid down some debt.

Safestore Holdings (LON:SAFE) - shed loads of property.

But maybe where more distressed and where management don't have much skin in the game.

sam_whiting

Just wondering if the smarter way to play this is to invest / look at the merger and acquisition sector, i.e the companies paid fat fees to facilitate such deals? I personally don’t like the idea as I don’t understand how they work fully. Maybe someone can suggest something ?

Hi sam_whiting.

It’s a nice idea to try and play an M&A boom by buying into the facilitators but it’s quite hard to pull off. First, you have to identify the firms that stand to gain the most new business. To some extent you can get an idea of this from looking at the M&A advisory league tables. Not all of them are listed and of those that are many of them will be part of much bigger organisations so an M&A earnings spike will be diluted by being spread over a wide range of other activities. Also, the advisory fees are often relatively small beer compared to the other fees involved in a transaction, especially where there’s a substantial chunk of acquisition fundraising through debt and equity involved. This also tends to spread the jam across quite a broad cross section of the City.

You also have to deal with the City business model which is essentially one of “heads we win, tails you lose” whereby a lot of the fat year profits are leeched out in performance related bonuses to the key rainmakers rather than being dividended out to shareholders whereas in the lean years the rainmakers have to make do with a not inconsiderable base comp package and again shareholders are at the back of the queue. Just because the advisors make a lot in fees doesn’t necessarily feed through to the shareholders getting a substantial dividend/capital gain.

One way to play it is to identify successful brokerages/advisors where the directors/ senior deal makers retain serious equity in their firms thereby aligning themselves more closely with fellow shareholders. Cenkos Securities (LON:CNKS) and Numis (LON:NUM) have in the past had a reasonable record for being decent dividend payers when times are good although even here if you look at the director shareholder activity the tendency is for share options to be exercised and largely sold immediately upon vesting rather than retained long term. An alternative could be to take the view that an M&A boom, if it occurs, will be good for the financial sector in general and buy a focused FI ETF and play the “rising tide floats all boats” card.

Thanks much appreciated, it goes in the too difficult pile for me to figure out.

SaarfLondon

interesting article Ed - but why mention TMF - their articles and writers are junk with no research.They usually start with "XYZ company down 30% what I would do now " ..... yawn

5th Jul '21

Hi SaarfLondon,

haha! the real reason to mention TMF amongst others, is that I was frankly too lazy to do the legwork to come up with my own LBO candidate list, so I opted to take names from a number of sources as suggestions for further investigation...

Hi Momoko,

personally I m a bigger fan of trackers like XMCX to get more mid-cap exposure, but this tiome around, FTSE 100 companies could be targets too...

simoan

Hi Edmund,

I think you'll find taking anything from TMF is the equivalent of scraping the bottom of a long empty barrel :) As a point of order, the Fortress offer for £MRW is $9.5bn, not £9.5bn, as you quoted in your article. As a holder, I wish it was the latter!

All the best, Si

LOL you rascal. I hunt down these take-over articles everywhere -Twitter, Facebook ,under manhole covers etc ! If I had a £1 for every time I read ITV as a bid target !?!(Although I do hold )

eggbaconandbubble

8th Jul '21

LBO's - I thought it illegal to borrow money to by shares in a quoted plc!

Wasn't that Tiny Rowland's gripe with Mohammed Al- Fayed buying Harrods?

LongValue

12th Jul '21

Largely agree with much that has been written. But giving it some perspective, Shares Magazine recently mentioned that of around 50 takeovers of UK listed companies since October 2020, the average premium paid was about 36% over the prevailing share price. I suspect that for long-term shareholders, it may not make sense to accept some of these offers. They don't appear to be overly generous.

Wilbraham

In-depth article on PE raids in FT this morning (unusually, it seems free to read) https://www.ft.com/content/315...

Market Musings 03/07/21: UK Buyout Bonanza in the offing?

UK Buyout Bonanza in the offing?

Summary:

Podcast: Is Artificial Intelligence taking over the world?

Is AI taking over the world?

LBO Fever: UK in the crosshairs

What is an LBO anyway?

Unlock the rest of this article with a 14 day trial

About the Author

Edmund Shing

17 comments

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