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Offers to refuse

The UK is where the world’s private-equity industry comes to do its bargain-basement shopping; or, at least, that’s the current impression. Perhaps we should be thankful for this small mercy. It might mean the UK is spared the worst when an adult bear market comes a-rampaging.

High profile names, such as Pearson (PSON) and Ted Baker (TED), have recently had close encounters with private equity that may yet root out formal offers. Others – such as bus-services operator Stagecoach (SGC) and specialist plumber HomeServe (HSV) – have been more accommodating to private equity’s proposals.

Even among holdings in the Bearbull Income Fund, a second in the past six months might soon succumb to private equity; sandwiched between these two, another was bought by a US-listed company. Sure, this takeover activity helps the income fund’s immediate returns. Yet it’s not necessarily what’s wanted. The concern is that short-term gains, which are forced on the fund, are posted at the expense of bigger gains in the long term.

The holding in danger of falling into private equity’s maw is in insurance specialist Randall & Quilter Investment Holdings (RQIH). This Friday (20 May) R&Q’s shareholders will vote on whether to accept a 175p-per-share cash offer from 777 Partners, a Miami-based private equity house perhaps best known in Europe as the owner of Italy’s oldest football club, the perennially under-achieving Genoa CFC.

Then again 777’s offer, which values R&Q’s equity at £482m, might well fail. R&Q’s second-biggest shareholder, Slater Investments, which owns almost 10 per cent, says it will reject the offer and the share price has responded accordingly. It is back to 140p, the level at which 777 made its move. At a 20 per cent discount to the offer, essentially the market price is saying “Come up with a lot more than 175p or shove off back to Miami”.

There is no getting away from it, 777’s offer is underwhelming. It is at a level R&Q’s shares almost touched in February, is 7 per cent below the 12-month high and 10 per cent lower than October 2019’s all-time high. As such, the directors’ recommendation is redolent of the inadequate offer earlier this year for specialist travel agent Air Partner, another Bearbull holding, which was recommended and blithely waived through by shareholders. In both cases, the offer was below recent highs and – more important – was recommended even though each group’s trading was good and its prospects were better.

As with Air Partner, R&Q’s directors are keen to tell shareholders that 777’s offer “demonstrates the strength of both our business today and the opportunities ahead of us”. In which case, runs the thought, why on Earth are you recommending such an inadequate offer?

Sure, it’s tricky to value R&Q. Partly, that’s a function of how insurance companies operate, generating most of their income upfront and only meeting the associated costs at some indeterminate point in the future, if at all. That is chiefly why insurers are valued in relation to the net assets on their balance sheet; at least that provides hard and fast figures from which to start. Even on that basis, 777’s offer at 1.8 times estimated net tangible assets at the end of 2021 is tight-fisted. A ratio of at least 2.0 times would be more like it.

Meanwhile, R&Q is in the process of transforming itself from a capital-intensive conventional non-life insurer into a capital-light fee-based business. When that’s mostly done, it may be generating $90m (£74m) of operating profit in 2023, which could feed down to 15p of earnings. Rate those earnings at the sort of multiple on which shares in full-service insurance brokers trade – maybe 20 times – and a share price of 300p is within reach. Granted, that’s a top-end value. Even so, it highlights the inadequacy of 777’s offer. Whether enough shareholders will see it that way will soon be known.

Then there is the inevitable speculation about where private equity will hunt next. Among holdings in the Bearbull fund, the obvious target would be Vesuvius (VSVS). At 333p, shares in the supplier of consumables to steel makers and foundries are 44 per cent below their 12-month high – a reaction that seems out of proportion even to the depressed demand for steel consistent with a world wobbling on the edge of recession.

Yet, currently, almost every equity portfolio will have its equivalent of Vesuvius – shares in a quality company getting hammered. For investors, the solution is not just to stay calm while paper losses mount, but to remain open minded. Is the market telling you something you can’t see, or don’t want to? It’s a topic for next week, to be discussed with reference, among others, to Vesuvius, which – helpfully – will have issued a trading update by then.

bearbull@ft.com