Here’s the sort statement a company will never make in response to a takeover bid: “The directors of Pile ’Em Hi Groceries, despite having been advised by Goldberg Sucks & Co, neither have the ability nor the confidence to assess the offer for the company by the Leverage Corporation of Delaware LLC. Accordingly, the directors recommend that the company’s shareholders do what they should anyway, which is to make up their own mind as to the merit of the offer.”
It’s a pity really, because one is fast getting the impression that – more or less – this is the only judgement company boards are competent to make when bids comes along, as they are with almost monotonous regularity nowadays.
Perhaps it was ever thus. A company’s directors are charged with the task of being the intermediary between those who run a company (the executive board) and those who own it (the shareholders). As such, they carry much responsibility and, implicitly, have a commensurate amount of ability and that extends to being able to make a sound call about the company’s value when push comes to shove, as it does when a bid emerges.
As ever, there is a gap between the theory and the practice. Just because company directors are supposed to have the ability to assess their company’s value – at least with a little help – and just because they have little choice but to recommend acceptance or rejection of a takeover offer, it does not follow that their recommendation is much better than a toss of a coin and, if so, it should not carry the weight it does.
Increasingly, this truth is dawning. The best example is the merry-go-round at FTSE 100 grocer Wm Morrison Supermarkets (MRW) where it seems any offer its directors recommend accepting is topped by a competing one in less time than it takes to check out of a quiet store on a week-day afternoon. And at security-software provider Avast (AVST), which faces a £6.2bn takeover bid, the company’s biggest independent shareholder has told Avast’s directors that their recommendation to accept the cash-and-shares offer is rubbish. Obviously, I exaggerate. The shareholder in question, Schroders (SDRC) hasn’t been nearly so blunt. But, in effect, that what the firm’s fund managers think of the Avast board’s recommendation to accept the offer from Nasdaq-listed NortonLifeLock (US:NLOK).
Two questions arise: why this sudden lack of deference towards directors, whose writ normally runs; second, what does this tell us about directors, especially the non-executive variety, who generally make up the majority on listed-company boards?
The erosion of deference is surely linked to the notion that UK plc – inundated with takeover offers perhaps as never before – is being sold off too cheaply. That logic easily stacks up if the prices keep rising but the offers still keep coming. True, it leaves unanswered the thought that, if UK companies are so cheap, why wasn’t the good value spied earlier; in particular, why wasn’t it spotted by the very parties who now do most of the complaining, the UK institutional investors who were at least tacit in UK plc becoming progressively cheaper after 2016’s Brexit vote? After all, it did not take a genius to see – as many did at the time – that UK companies were becoming serially underrated compared with their overseas counterparts, especially in the US. In practice, that thought is just annoying, adding to the dissatisfaction of missing out. Factor in the notion that directors recommend any serious offer pitched at a half-decent premium to their company’s share price over, say, the previous 12 months and it is easy to understand why shareholders are miffed.
Besides – and this is the second part of the question – directors are not necessarily any more capable of assessing that a takeover offer is at the right price than you or me. Take Morrison’s directors who first recommended acceptance of a 254p per share offer from private equity way back on 3 July. Eight weeks on – after two further recommended offers and the share price 15 per cent higher at 292p – shareholders are happily hunkered down waiting for the next predatory move.
Yet given the lack of financial know-how on Morrison’s 10-person board, is it any wonder that its willingness to accept offers has been made to look silly? Seven of the board are non-executives, where there is plenty of retailing and marketing experience – and hopefully expertise – but little in finance; the exception is Jeremy Townsend, an accountant and former finance chief at Rentokil Initial (TRO) and Mitchells & Butlers (MAB).
Over at Avast, there doesn’t even seem to be that excuse. Its nine-person board has six non-executive directors two of whom should know the ins and outs of corporate valuation like the back of their hand. One is a former managing director at UBS, the other was a senior partner in corporate finance at Deloitte. Despite that – or perhaps because of it – Avast’s board is eager and willing to recommend Norton’s offer.
Of course, there is also a problem with this logic. It’s a stretch to correlate expertise in finance with the ability to assess an offer astutely. It isn’t just that many academic studies have shown that, on average, experts only make better assessments than lay people when there is limited information available (give them more information and their confidence in their assessments rises though accuracy stays unchanged). So what’s the point of being loaded up with finance’s most complex inter-active spreadsheets?
Besides, all sorts of dynamics shape a board’s decision to accept or reject an offer; from the overbearing personality of the chief executive, to the future relationship between the executive directors and the suitor, or the unwillingness of lay people on the board to challenge their advisers whose assessments must be good because they are delivered with such assurance by people who are paid to know; and so on, down to the weird factors that simply could not be guessed.
But that’s how it is in every situation where valuation is called for. As to where this leaves outside shareholders in a bid situation, especially those private investors with no clout, work with the following ground rules:
● Do your own company valuations as normal. Be aware, however, that any valuation you come up with is likely to be less than the value of a target to a corporate rival or a private-equity firm. The corporate rival is likely to have synergies and economies of scale it can put to work. Private equity will aim to lever up returns by removing equity and adding debt into the financing mix.
● Vote on the takeover according to your own valuation plus your intuition, but in doing so . . .
● Understand how the dynamics of takeover markets may affect company valuations and that directors’ assessments are likely to be lagging indicators. The board’s recommendations, which lean heavily on the advice of investment bankers, may well rely on the rear-view mirror, judging value in relation to benchmarks provided by the ratings of similar companies and to bid premia for similar deals. Thus, when takeovers are booming – as now – recommendations will incline to the low side. However, when markets are slack and takeovers a rarity, the opposite seems more likely – in order to extract the directors’ approval, a predator must gauge its bid in relation to benchmarks that no longer apply, which may mean offering more than is necessary.
Granted, this is stated as contention and not as fact. Yet, for an eager student of finance, there is a PhD to be written proving up the idea or not, as the case may be. Meanwhile, shareholders facing a bid for one of their holdings can run with the notion that directors’ recommendations do have their uses, just not at the moment.
How volatile can dividends become before a stock is unsuitable for an equity-income portfolio? Simple answer: it depends. But it is a relevant question, especially for those with mining stocks in their portfolio.
The best times to discuss such things may be when times are good as they are for miners currently. ‘Build back better’ might just be more than a vacuous slogan, in which case there would be lots of extra infrastructure spending in the US, calling for hard commodities of almost all sorts. Even without that, the imperative to pursue ‘net zero’ will ironically will mean lots of extra carbon emissions to mine the minerals and build the infrastructure that could eventually permit some reduction in greenhouse-gas emissions.
Meanwhile, miners are recovering strongly from 2020’s miserable year, as first-half results from both Anglo American (AAL) and Antofagasta (ANTO) demonstrate. Late last month, the much-diversified Anglo American announced revenues more than twice 2020’s first half, propelling earnings per share (EPS) 10 times higher. And last week, the copper specialist, Antofagasta, said its first-half revenues were two thirds up on the previous first half and EPS up almost four times.
True, not all is good at Antofagasta. Prolonged drought in Chile will hit production. Copper mining uses lots of water to separate small amounts of copper ore from vast amounts of waste material that becomes ‘mine tailings’. As a result, management has cut its production estimate for 2021 from about 745,000 tonnes to about 725,000 tonnes. But that didn’t stop Antofagasta announcing an interim dividend almost three times last year’s depressed level and, for the whole year, City analysts expect the pay-out to rise about 30 per cent. That has nothing on Anglo American, which is returning excess cash to shareholders, so the interim dividend rose nine-fold. For the year, analysts expect a dividend about three times higher than 2020’s.
I focus on these two because Anglo American is a holding in the Bearbull Income Fund and Antofagasta has been. Obviously, Anglo American’s presence is currently good news. But, as the table shows, it is only a matter of time before one or other cuts its dividend (or both do). In five of the past 10 years Antofagasta has cut its pay-out. Anglo’s record is just four times, but one year – 2016 – that included axing it completely.
|Miners dig dividends|
|Share price (p)||1,445||2,953|
|2021 est'd div'd yield (%)||3.6||9.8|
|Years when div'd cut*||5||4|
|Ave yield (%)*||3.3||4.0|
|Ave % change in div*||73||17|
|St'd dev'n of change (%)*||199||105|
|* for period 2011-21. Source: Co accounts, FactSet|
Some investors can live with such volatility in income and compensate themselves with the thought that, on average, a holding in these stocks produces an acceptable yield. For those who really need the cash, the income volatility may be too much. You pay your money and take your choice, but it’s important to have no illusions and know upfront what you’ll be getting.