How to assess whether a takeover offer is good value

When is a takeover bid for a company pitched at a fair price? Most likely when the company’s directors recommend the offer. Generally, that’s what happens. A takeover bid waltzes through its formal acceptance procedure because the target company’s directors recommend it.

Most of the time, that’s quite right, too. After all, a large part of the reason the directors are there in the first place – especially the non-executives – is to look after the interests of the shareholders, who usually lack the inside information to do the job for themselves. So, if the directors say a bid is pitched at a fair price, it must be. End of.

Except that for right-thinking shareholders that logic obviously falls short. No delegated task is always done well and directors’ job performance complies with that rule. Thus, expecting company directors to make the right call – or even a sensible call – on every takeover bid must lead to disappointment.

What’s a poor shareholder to do? Think for yourself and learn how to assess whether an offer is pitched at a fair price or whether it leaves too much for the acquirer. It is understood that private investors have minimal power to change the course of a takeover bid. All the more reason they should be able to assess whether their company’s directors are talking sense or spouting drivel when they respond to an offer, especially if they recommend it. Let’s work through that via two contrasting offers currently in the London market. Both are recommended by the target company’s directors and both are for cash only: 125p per share for air-charter broker Air Partner (AIR) and 608p per share for airport-services provider John Menzies (MNZS).

True, the offer for Menzies is only provisionally recommended and has yet to go into formal mode. That’s because the company’s directors played hard to get. Two proposals – at 460p per share and at 510p – were put forward by Kuwait-based logistics and warehousing group Agility Public Warehousing. Both were summarily rejected. Agility now says the 608p offer is its final one – barring a third party entering the fray – and Menzies’ directors will recommend it assuming the usual regulatory hurdles are cleared. As things stand, Agility has until 9 March to make a formal offer, although that deadline is likely to be extended.

What scale of offer might Air Partner’s shareholders be looking at had its directors taken an equally-tough line? Intuition allied to some number crunching indicates the figure might be a whole lot more than 125p per share. Sure, it may be unkind to say the directors eagerly snaffled the first offer that came along. Yet the assumption must be that the 125p offer, from Wheels Up Experience, a New York-based air taxi operator, was its first serious proposal, otherwise the directors should have said so.

True, in their gushing recommendation of the Wheels Up offer the directors point out that 125p is 54 per cent higher than Air Partner’s closing price immediately before the bid announcement and 44 per cent higher than the average price for the previous three months. Funny there was no mention that the offer was 20 per cent below the share-price high of four years ago or 53 per cent below its all-time high. Sure, that was 15 years ago, but Air Partner is basically the same business as it was then – hiring aircraft of all sizes both on contract and at short notice to ferry all manner of passengers and freight – and facing similar risks.

Besides, the group tends to do rather well when times get risky, as its response to the Covid-19 pandemic demonstrates. Profits were savaged in the year to January 2020, but recovered strongly in 2020-21 and in 2021-22. So much so that either side of Christmas management rushed out profit upgrades, the first of which basically said “trading is great” and the second added “trading is even better than we thought it was three weeks ago”.

Not that you would guess that judging by the level of Wheels Up’s offer. This is where quantification becomes vital. Always when valuing a well-established company it helps to have an idea of the profit it could make, or the free cash it could generate, in an average sort of year. In the valuation exercise, average profit in effect becomes the annuity whose value is quantified by capitalising it at an appropriate interest rate, much as a fixed-interest bond is valued by capitalising its annual coupon via an interest rate. As to defining the ‘average sort of year’, Bearbull usually takes the weighted average of the past five years, with the weighting biased towards the present, although the simple average often does just as well.

Meanwhile, the interest rate used to capitalise average profit needs to be on the high side since the exercise assumes such profit can roll on almost indefinitely in real terms, but it won’t grow. This is important since the suggested value is sensitive to the interest rate, which is also a target rate of return; the higher the return aimed for, the lower will be the value that comes out. The rate Bearbull uses for the equity portion of a group’s capital is usually 8.5 per cent, which is a rough average of the nominal long-term total return generated by UK equities.

Sure, these are artificial constraints and they can be played around with. Their aim is to tease out core value. Do this for Air Partner and the results are shown in Table 1. Assume that Air Partner can do no better than produce its £6.6m weighted-average operating profit of the past five years and Wheels Up’s offer is slightly more than the 116p of estimated value. However, assume the year just finished or the one before are more representative of the long-term average and the offer falls well short. Work back from the 125p-per-share offer and the implication is that Wheels Up assumes Air Partner is capable of no more than £7.2m in underlying profit on average.

It is also noteworthy that the table’s per-share estimates take no account of the £20m or so cash that Air Partner holds in deposits from its Jet Card private jet hire operation. Assume these deposits are a semi-permanent interest-free loan and shareholder value could be usefully enhanced.

Be that as it may, Wheels Up is acquiring a lot of net cash – about £13m-worth – in its offer. Strip that out of the bid’s value and, in effect, it is offering less than 11 times earnings for the year just ended. That might be great for Wheels Up, a young business that has yet to turn a profit, but what should Air Partner shareholders care about that?

Granted, Bearbull has an axe to grind as Air Partner shares have been in the Bearbull Income Fund since 2014. The 49 per cent gain the fund will make might seem okay and the annualised total return might just scrape my 8.5 per cent target. Even so, I can’t recall an occasion when a target company’s management has rolled over more easily than this.

As ever, it is the little things that annoy most – the fact that the offer means no final dividend in respect of the year just ended. Adjust for the loss of what would have been, say, a 1.8p payout and Wheels Up is acquiring Air Partner for close to a single-figure multiple of earnings.

But it is the big things that are important – the point that Wheels Up’s offer falls short of a reasonable estimate of value, and especially if attention focuses on Air Partner’s ability to generate free cash – 14.2p a year as the weighted average of the past five years. Capitalise that at 8.5 per cent, add on a little for growth-orientated capital spending and estimated value goes clear of 170p per share (see Table 2).

Yet shareholders will almost certainly have to grin and bear it. Owners with approaching 28 per cent of the shares have said they will support the bid, although the biggest holder, Schroders, has been selling in the market. And the market price – 123p – indicates only that the offer will go through when shareholders vote on it next week. Pity.

On the same day, 8 March, John Menzies is set to announce its 2021 results, confirming that its business is very much in recovery mode. The first-half results pointed the way with revenues only 4 per cent lower than 2020’s first half, even though 2021 was much more affected by Covid-19’s restrictions. More important, management says it has taken about £25m a year out of costs, a significant amount for a group with underlying operating profit of approaching £40m. Additionally, onto Menzies’ annual revenue of around £820mn, management has added £120mn a year of new contracts, is confident of securing another £80m and hopeful of a further £175mn in the “short to medium term”.

Maybe such a backdrop encourages a spirited management response to a bid. Yet by squeezing more from the Kuwaiti suitor management has almost certainly brought the offer close to estimated value (see Table 2). The back of the same envelope from which Air Partner’s value was estimated struggles to find convincing value for Menzies by focusing on accounting profit. No matter. Focus on cash flow, especially the past three years when Menzies morphed into its current corporate shape, and there seems to be a value-generating machine in its worldwide collection of baggage-handling, cabin-cleaning and aircraft refuelling services at over 200 airports.

Certainly, it is feasible to see £5 per share of underlying value. If capital spending reverts to levels of two or three years ago, there should be more value to follow. That might be just a contrived way of capitalising the value that should come from the contracts management is confident it will win. Either way, the impression is that the Kuwaitis will still pay a full price for Menzies.

Not that the market is convinced the formal offer will materialise. Hence the 7 per cent gap between the market price (568p) and the proposed offer (608p). Given the world’s present worries, that gap is understandable. But it also offers investors a low-risk way to tie up a slug of capital for the next few months.