Don't get sucked into the short-termism of takeovers

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What do BAA, BG, SAB, P&O, ICI and ARM all have in common? They are all UK companies which have been the subject of takeovers, and in all but one case by overseas buyers.

Three of these transactions rank in the largest 10 UK acquisitions in history, the same three also taking place in the last year alone.

The table below provides some details of these transactions, which are by no means the only ones involving UK companies. Others in the last 10 years include Boots, O2 and Corus, not to mention the series of transactions involving UK banks during the financial crisis.

But do these deals genuinely 'add value'? Should investors buy shares in companies on the basis that they might be taken over for a premium valuation?

OVERPAYING FOR ACQUISITIONS

Anyone who keeps an eye on markets will know that share prices fluctuate constantly. So does that mean that on such a short-term basis investors are altering their views on the value of companies?

Of course not. As in any other market, the behaviour of participants is driven by a number of factors.

These include the often quoted human sentiments of 'fear and greed'; the availability of alternative investment opportunities elsewhere; the time horizons of the respective participants; regulatory and tax matters. The list goes on.

TargetAcquirerNationalityValueYear
SABAnheuser-Busch InBevBelgium£84bn2016
BGRoyal Dutch ShellUK£36bn2016
ARMSoftBankJapan£24bn2016
BAAFerrovialSpain£10bn2006
ICIAkzo NobelNetherlands£8bn2008
P&ODP PortsUAE£4bn2006

In all these takeovers the deal has taken place at a price well above that prevailing in the market before its announcement.

On the whole investors demand this as compensation for missing out on potential future growth in the company, and they ultimately show their acceptance of the deal by voting in favour of it.

So how can a corporate purchaser justify paying a price well above the market's ongoing valuation?

One explanation of a company's ability to pay a higher price than normal investors relates to a discrepancy in the way that the various parties' performance is assessed. Almost 60 per cent of all quoted UK shares are owned by institutional investment managers.

While the underlying investors may well be private individuals, their funds are pooled and invested on a collective basis. There are many benefits to this approach but one of the downsides relates to time horizons.

SHORT-TERMISM

Institutional investment managers are paid by their clients to pick stocks and avoid others with a view to outperforming the market as a whole. Investors can become impatient during periods of underperformance, which can lead to a tendency for short-termism.

Analysis of investment performance on a quarterly or even monthly basis can incentivise such managers to accept offers from corporate acquirers at prices below their genuine opinions, and the accusation that companies are bought 'on the cheap' as investors opt for the quick buck.

Corporate managers on the other hand can often take a longer-term outlook. Many companies exist for decades and decades and their fortunes can be built on strategic decisions which have a multi-year perspective.

While the directors of companies are not immune from short-term pressures (in their case from shareholders), they can use this timescale mismatch occasionally to their advantage.

A prime example of this would be the acquisition of UK software company ARM Holdings by Japan's SoftBank. In the immediate aftermath of the EU referendum ARM's share price did not suffer as badly as many; however, sterling did, and this may well have proven the catalyst.

At one point sterling had weakened by over 20 per cent against the yen, making a UK acquisition for a Japanese company all the more attractive.

I am certain that the referendum result was on Softbank's agenda but one can only assume that the long-term, strategic benefits of the transaction outweighed any concerns relating to the UK's political status in Europe.

Our approach is based on the notion that 'good companies produce good results, good results produce good performance'. We may well benefit from the premium delivered by an acquisition of one of our companies in the future.

If a corporate acquirer sees the same merits as us then all the better, but in the meantime we stick to our guns and our process and expect these companies to deliver positive returns nonetheless.

James Nield is investment manager at Thesis Asset Management.


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