Hostile takeover bids – once a way of life in London’s stock market – are now a rarity, a quaint throwback to an earlier era. Where once James Hanson and Sir Owen Green prowled, now there are prissy statements from private-equity houses who say they will only make an offer if, first, they get the consent of the target company’s board.
So it’s fitting, now that London actually has a hostile bid worth the name, that the target company should be synonymous with the time when Britain’s manufacturing base was so steeply in decline that Hanson, Green and others could find easy prey to pick upon and then to pick apart. GKN (GKN) – the target in question – seems as much a part of that past as, say, Tube Industries, Joseph Lucas or Dunlop, who all succumbed.
The difference is that GKN remained independent. Even if it never quite prospered, its production of stuff such as car axles for BMW and casings for the Rolls-Royce Trent aero engines meant it got by. However, maybe not for much longer as it’s on the end of a £7.2bn bid from Melrose (MRO), a company whose boss, Chris Miller, appropriately enough learnt his trade crunching numbers for Lord Hanson.
True, Melrose’s business model is more considered than Hanson’s slash-and-burn approach. Then again, we live in a different era from the 1980s and not just because a mobile phone is no longer the size of a brick.Nowadays a hostile takeover bid stretches the bounds of acceptability - the high testosterone way once common in boardrooms just does not work any more, not least because it offends jittery politicians. So it is possible that Melrose’s cash-but-mostly-shares offer will be scuppered by politicians anxious to show their caring side.
In fact, that does not seem too likely. Thirty years ago GKN employed 69,000 workers in the UK, so its impending dismemberment would terrify any politician. Today, it employs fewer than a tenth of that total in the UK, so there is every chance the bid will run its course. In which case, GKN’s shareholders must eventually decide what to do and outsiders can consider whether there is anything still worth punting on.
At Melrose’s current price – 227p – the offer values GKN at 419p per share compared with its market price of 428p. That implies the market reckons – albeit tentatively – that Melrose will raise its offer. That seems a decent assumption. In its opening play Melrose is stingy with the cash element – 80 per cent of the offer is in new Melrose shares. Meanwhile, the cash element – 81p per GKN share – will cost almost £1.4bn in extra debt. Yet neither Melrose nor GKN carries much debt – just over £1bn between them. Add in the effect of the cash component of the bid and the enlarged group would still carry only about £2.5bn of net debt compared with a market value for its equity of around £11bn.
In that context, Melrose’s bosses could afford to add, say, another 40p per share in cash, bringing the total offer to around 460p, or 10 per cent more than what’s on offer now. That would make it tempting. What seems less likely is that Melrose will want to add to the equity component. Already the plan is to more than double Melrose’s issued shares from 1.7bn to 4.5bn. There is a limit to how much more Melrose paper the market could soak up.
Besides, what would be the point? From the perspective of institutional shareholders the bid is really about which top management team should run GKN’s assets – the unknown quantity at GKN where there is a temporary chief executive and a new finance director, or the team at Melrose which is well established and has a great track record even if they only know GKN from the outside.
That both management sets have a similar plan does not make the decision easier. Both intend to sell the Powder Metallurgy division – the smallest of GKN’s big-three divisions, which makes components for the auto industry – and return the proceeds to shareholders. The only difference is in the timing. GKN’s bosses plan a quick disposal. Melrose will attempt to apply the company motto – ‘Buy, Improve, Sell’ – to the division then ditch it.
Beyond that it is all about raising GKN’s profit margins, which have been disappointing for many years. In the past 10 years GKN’s revenues have grown at about 9 per cent a year, but none of that has fed through to growth in earnings per share, which peaked at 29p in 2012 and should have finally made it back to that level in 2017. Static profit margins and dilutive share issues have been behind this. In 2016, group-wide operating margins were 6.7 per cent. This was the fourth year running that they were lower – having peaked at 7.6 per cent in 2012 – and compared with an average of 6.3 per cent for the past 10 years.
Clearly, adding a percentage point or two of margin onto GKN’s £9bn or so of revenue would transform earnings. Easier said than done, although both sets of bosses claim they are the guys to deliver it. At this stage it probably does not matter which set is more likely. All that really matters is that there is a plausible scenario for improvement, a contested takeover bid and egos are at stake. Seems like a good situation on which to take a punt.