The offers in question are, first, 620p a share in cash for milk processor Dairy Crest (DCG) from Canadian dairy group Saputo (TSX:SAP), which values the UK group at £975m and, second, 215p a share in cash for telecoms services provider Manx Telecom (AIM:MANX) from Basalt Infrastructure Partners, a specialist asset manager, which values the Isle of Man monopoly supplier at £256m.
The important offer from Bearbull’s perspective is the one for Manx Telecom because its shares are in the Bearbull Income Portfolio and their exit at the offer price would turn around a lossmaking investment.
Assessing both offers conventionally, comparing price/earnings multiples between similar companies, indicates that shareholders should concur with each board’s recommendation to accept, but let’s focus on Manx. It has one close comparator, Hull’s telecoms provider, KCOM (KCOM). Its shares are rated higher than Manx’s even after the bid – almost 21 times compared with 15.4 times for Manx. Superficially, that indicates Basalt’s offer is lacking. If anything, it’s KCOM’s earnings that are lacking; they are depressed, hopefully only temporarily. Compare the two companies’ ratings on the basis of price to sales – an underlying measure immune to earnings bouncing around – and Manx’s exit rating is 3.1 times sales compared with 1.3 times at KCOM.
However, making an assessment in relation to other companies’ ratings is risky. It’s a variation on ‘greater fool’ theory – if everything is wrongly valued, then investments only work out so long as sufficient numbers of greater fools come along to maintain the illusion. Much better that each of us makes an assessment based on what we want from an investment. If you like, that’s the grown-up way to do it where values are derived from the returns that each of us seeks from an asset. This is the world of discounted cash-flow analysis, of the opportunity cost of capital, internal rate of return and net present value.
In effect, we consider an offer as a mini-investment project in its own right and ask: do I want to take a lump sum of cash up-front (ie, accept the offer), or do I prefer the cash that may come to me – however lumpy the flows – in the future (ie, reject the offer and stick with what I have)?
Let’s think about this in the context of Basalt’s bid for Manx. The evening before the offer was tabled, Manx’s shares closed at 187.5p with a 7.9p final dividend in the price and shareholders were asked if they would sell for 215p, including that dividend. In other words, they were offered a premium of 27.5p or 14.7 per cent on that closing price; and – from another view – they were offered about 2.5 years’ worth of future dividends as a lump sum, assuming the payout continued at the current rate of 12p a year.
Seen from that perspective, the offer seems stingy. After all, a shareholder might say, in just 2.5 years I would have what Basalt is offering now but would still have that steady stream of Manx dividends stretching far into the future to look forward to. So is Basalt’s offer so great?
We can begin by arguing around the edges. First, it is debatable whether the starting point should be the closing price immediately before the bid was tabled. As Basalt says, its offer is 31 per cent higher than Manx’s average share price for the three months leading up to the bid. An investor who was fortunate to have bought recently at that price – 165p – might be more receptive to be offered 207p (excluding the final dividend) than, say, Bearbull, who paid 202p over three years ago.
Then there is the question of what may happen to Manx’s future dividends? The more they are likely to rise, the meaner Basalt’s bid appears. Yet, judging by Manx’s struggle to generate the net cash to fund the dividend, the payout may be threatened.
The solution is to do a simple cash-flow analysis, an exercise that’s easily performed courtesy of Excel or a financial calculator. If I had bought the shares immediately before the offer, took the dividends implied in the offer price, which would cover the payout for the next 2.5 years, and then sold at Basalt’s offer price (as if it were on the table then), what would be my return? In finance jargon, what would be the discount rate that reduced all those cash flows – money out, then money in – to zero? The answer is about 12.5 per cent. So, Basalt is offering a deal that’s better than an annual return of 12.5 per cent stretched over the next 2.5 years.
Am I likely to get better if I stick with Manx where, admittedly, the dividend yield alone brings 6.7 per cent? Probably not, if only because the dividend is unlikely to grow much, if at all. Besides – purely from Bearbull’s viewpoint – the 12.5 per cent return that Basalt is offering is easily better than the 8.5 per cent return I generally target and therefore use as the discount rate for most of my value calculations.
So, okay, I’m not thrilled with the offer, but I’ll accept it and – more important – have a clear idea of why I’m doing so.