Will the 2021 takeover surge continue?

It has been a busy six weeks for UK equity markets. The new year has already seen not just a flurry of IPOs – including bootmaker Dr Martens (DOCS) and online greetings card retailer Moonpig (MOON) – but also a surge in takeover activity.

Nine takeover bids have been announced since the start of the year (see table), with a total value of almost £22bn. There are four firm offers that are being recommended by the companies’ boards for shareholder approval – including the $4.7bn (£3.4bn) proposal to purchase jet servicing group Signature Aviation (SIG) – while others such as portable power specialist Aggreko (AGK) are still thrashing out the terms of a potential deal.

So far, takeovers in 2021 are being dominated by private equity rather than mergers and acquisitions (M&A) between publicly listed companies, and the financial services sector has been a particularly popular hunting ground. Armed with cheap capital, private equity firms are looking to snap up UK bargains, especially now that the spectre of a no-deal Brexit has disappeared.

Simon Moon, co-manager of the Unicorn UK Income Fund (GB00B00Z1S94), says that buyers are being enticed by a “double discount” on UK assets as Brexit uncertainty hit not just equity valuations, but sterling as well. “With a damaging no-deal Brexit avoided and significant associated future risks removed accordingly, UK assets are looking attractive,” says Moon. “Relative valuations remain cheap and sterling is still depressed which presents a buying opportunity.”

But a resurgence in deal making in the fourth quarter of 2020 suggests that Brexit is not the only factor at play here – Covid-19 vaccines and hopes that the economy will soon reopen have also been a catalyst. Anthony Cross, manager of the Liontrust Special Situations (GB00B57H4F11) and UK Smaller Companies (GB00B57TMD12) funds, says the spike in transactions is therefore the culmination of “a few things coming together – cheap debt, cheap-looking things to buy, and a road to recovery”.

Private equity will no doubt continue its somewhat opportunistic cherry picking of UK assets, but companies’ M&A activity may also pick up. “Private Equity is certainly awash with cash, but corporate credit is affordable and readily available,” says Moon. “As such, we wouldn’t be surprised to see M&A taking a greater share.”

The PE effect

Private equity (PE)has been a significant driver of recent bid activity and this trend will continue. Law firm Morrison & Foerster estimates that globally private equity firms are sitting on a record $1.9 trillion of dry powder (uninvested capital), so a release of pent-up investment demand is inevitable.

Research by Morgan Stanley shows that businesses in sectors less impacted by the pandemic have been the most sort after thus far. But, as economies exit lockdowns and support schemes are phased out, the emphasis could shift.

This year, there is likely to be an uptick in PE firms buying distressed businesses once their easy access to cheap emergency short-term funding is reduced, according to private capital-focused research group PitchBook. Also, the end of cost-saving fiscal policy interventions like furlough schemes and tax holidays will add to pressures, creating opportunities for PE buyers.

The weak balance sheets and highly leveraged models of some businesses meant they were on borrowed time even before the pandemic, with lockdowns just accelerating their demise. Money raised by international PE buyers suggests they are eyeing distressed businesses in 2021 – the PitchBook report notes that Monarch Alternative Capital, based in New York, raised an oversubscribed €2.5bn (£2.19bn) distressed fund for targeting Europe.

The UK may have offered relative value in the run up to the Brexit trade deal, but the European Union could become more of a focus for deals in 2021, especially in attractive sectors such as technology and healthcare.

There was more than a whiff of opportunism about some of the approaches made for UK businesses last year. Now, with Brexit uncertainty lessened and an exit route from the pandemic within grasp, more of those low-ball bids could be rebuffed. The best opportunities for PE firms to snap up quality businesses below their intrinsic value may have passed, but we expect to see some failing companies taken private, asset-stripped and sold on.

Signs of opportunism? 

An announced takeover is not a fait accompli. Only 36 of the 87 UK Plc deals proposed last year have been finalised. A third are still pending and more than a fifth have been ruled out or withdrawn.

Quite apart from achieving the necessary regulatory clearances, a buyer’s chances of success are guided to an extent by the verdict of its target company’s board. A bid recommended by management will inevitably differ from a hostile approach in the eyes of voting shareholders.

Two high-profile transactions have fallen through already in 2021 after directors failed to give their blessing, arguing that the proposals significantly undervalued their companies. Such rebuffs could become precursors for further rejections as bosses resist opportunistic offers, flagging longer-term prospects beyond the Covid-19 pandemic – particularly as vaccine roll-outs progress.

Last month, US-based MGM Resorts (US:MGM) dropped plans to acquire Entain (ENT) for £8.1bn after the FTSE 100 gambling group’s board turned down its advances. Weeks later, Stateside investment group Platinum Equity Advisors chose not to make a firm offer for Marston’s (MARS) after the pub group spurned its proposal.

Entain and Marston’s sit in two of the sectors most ravaged by coronavirus-induced lockdowns. But signalling their takeover appeal – and, equally, management’s unwillingness to sell on the cheap – both have invested in their future growth trajectories.

Marston’s argued that Platinum’s 105p a share bid represented a 19 per cent discount to its share price at the beginning of 2020. Admittedly, virus restrictions have marred the fortunes of many a pub, bar and restaurant since then, and Marston’s is weighed down by considerable leverage. But it signed a “transformative” £780m joint venture last year with beer giant Carlsberg and unveiled plans to operate 156 pubs within the SA Brain estate in Wales.

Entain is also heavily indebted. MGM’s 1,383p a share bid, a 22 per cent premium to its market value at the time, could be seen as an opportunistic swoop before the new chief executive Shay Segev settled in. In fact, Segev has since resigned to take another job, perhaps paving the way for another approach.

But bidders will also hope to get major shareholders on side; not necessarily an easy feat. ​Blackmoor Investment Partners, a top 10 investor in Aim-traded industrial and healthcare group Scapa, whose board has recommended a £403m takeover by Schweitzer-Mauduit International, told the Investors’ Chronicle they feel the offer undervalues the stock and seemed opportunistic. The 210p a share bid on 27 January constituted an 18.6 per cent premium to the prior day’s close. Scapa declined to comment.

Financial services in the crosshairs 

If there is an in-vogue sector in the run of UK takeovers, it appears to be medium-sized financial services firms. Three out of the 10 bids for listed London stocks so far this year have been for companies loosely involved in asset management.

Last week, after several months of courtship, investment wrapper platform Nucleus Financial (NUC) accepted a 188p a share bid from the private equity-backed pensions group James Hay, while non-performing loan investor-manager Arrow Global (ARW) said it would consider a 305p approach from TDR at the fourth time of asking. This followed another private capital bid for AFH Financial (AFHP), from Chicago-based Flexpoint Ford.

In each case, cash flows have held up better than companies in directly virus-hit industries, and offer reasonable growth opportunities. The recent strength of sterling, and the apparent absence of Brexit-linked complications, is also likely to have played a role. 

There are other parallels between the targets. Shares in Nucleus tanked last spring as falling markets and a relatively high cost base dashed investor hopes for a leap in profits, only to rebound as asset prices recovered. Similarly, Arrow lost three-quarters of its market value in March as investors feared deteriorating loan quality could exacerbate an already stretched balance sheet, only for credit markets and government support schemes to ride to the rescue. For its part, AFH management claimed that life under private equity ownership would give it the firepower and flexibility to “unlock the full potential of the group over the long term”, and that a public listing had failed to provide it with reasonably-priced and timely capital. 

Although the acquisition price seems cheap, the deal could be a sign that unloved financial stocks might finally catch a premium. “In this environment, either the market brings valuations up or M&A will do it. We expect a combination of the two,” says Numis.