PORTFOLIO POINT: A good rule of thumb when buying a takeover target in a shaky market is to pay 3-4% below the bidding price.
Although takeover bids have been somewhat thin on the ground since 2008, a recent uptick in corporate activity bodes well for 2012 and 2013. Assuming that the number of both announced and contested bids increases soon, here are a number of tips and strategies I've developed over the past 15 years to trade such situations profitably.
1. When a bid is not yet a bid
Thanks to the ASX's 'continuous disclosure' rules, companies now have to report corporate interest the moment they're aware of it. This means that whereas in the past, a takeover might not be unveiled to the market until all its 't's were crossed and its 'i's dotted, these days the receipt of an 'incomplete proposal' that may or may not lead to a bid has to be announced publicly.
Risk averse investors should avoid potential takeovers that fall into the latter camp, as often these fail to develop into full-blown proposals, thus leading to losses. In other words, don't buy a target stock until you can see the whites of the predator's eyes (in the form of a fully-detailed takeover proposal).
2. Regulatory stumbling blocks
There are three main regulatory bodies whose powers can make or break takeover bids:
(a) ACCC. This body has blocked (and will continue to block) proposals that lead to an unacceptable concentration of market power, which may act to the detriment of Australian consumers. Should one of the big four banks try and buy another, for example, the ACCC would almost certainly block the deal. In some cases, the potential abuse of market power can be dealt with via enforceable undertakings. In other situations, however, the ACCC will simply block a deal (e.g. as occurred when GUD Holdings attempted to buy Breville Group).
(b) FIRB. When foreign companies launch bids for Australian ones, FIRB advises the federal treasurer whether the acquisition would be in the 'national interest'. Having received this advice, it's then up to the treasurer to decide 'yea’ or 'nay’. Rumour has it that when Shell tried to buy Woodside a decade ago, FIRB actually approved the deal only for Peter Costello to publicly knock it back. As a nation, we are yet to decide whether a state-controlled Chinese company would be allowed to take over a major Australian resource group, for example.
(c) Takeovers Panel. This body adjudicates on actions taken by both bidders and targets during bids, and has as its modus operandi that target company shareholders should receive the best deal possible. In the current bidding war for Ludowici, for example, the Panel abandoned its 'Truth in Takeovers' rule (i.e. when bidder FLSchmidt was permitted to raise its 'final' price) in favour of facilitating a higher bid for Ludowici shareholders.
3. Cash vs scrip bids
The consideration for almost all takeover bids consists of cash, scrip (i.e. shares in the bidding company, usually locally listed) or a combination of the two. Sometimes overseas-based bidders offer overseas shares in exchange for the Australian target's stock, but such bids are both rare and unpopular here.
If a bid is primarily cash, then it's relatively easy to gauge its worth. If, however, the bulk of the consideration offered is scrip, then the final price paid will vary with the movement in the bidding company's shares. Unless you have the ability to short-sell the bidder's stock, I do not advocate trading predominantly scrip takeovers, as downwards pressure on markets during the takeover process can easily turn a potentially profitable trade into a loss maker.
4. The three main types of takeovers
Somewhat confusingly, there are three main takeover types with which Australian investors may be confronted:
(a) The on-market bid. This is the least common method, and involves the bidder simply standing in the market for as many shares as it can get in the target, at a set price for a certain period (legally this must be at least a month). The main advantage to target shareholders is that such a bid is unconditional during its tenure, and can be accepted (simply by selling on market) right up until the day it's due to expire. The main negative is that as the bidder accumulates a larger and larger position in the target, potential counterbidders may be deterred from entering the fray.
(b) The off-market bid. This is probably the most common type of takeover that occurs in Australia, and it involves a bidder making an offer at a set price for a certain period. Investors accept the offer via submission of a form provided (off market) by the bidder, but are often not certain the deal will proceed due to the existence of various conditions. Such conditions usually relate to a minimum level of acceptances, which is most commonly 90% (i.e. the point at which the remaining 10% of target shareholders must compulsorily accept the offer). Such conditional off-market bids can be withdrawn if their conditions are not met right at the end of the takeover period. Having said this, such conditions also allow counterbidders to step in with a higher offer at any time.
(c) The scheme of arrangement. With this method, instead of investors individually accepting the offer and hoping the combined acceptances meet the minimum level, at a set date the target company shareholders meet to vote on the bid. Should the vote be passed, it is then referred for approval within a few days to the relevant state court, after which the deal is done and dusted. Schemes of arrangement are increasingly popular with bidders, as they only require an approval level of 75%, as opposed to the 90% requirement associated with off-market takeovers (see above).
5. Industry vs private equity bidders
Industry buyers are companies in the same (or a similar) business as their stated target. They will frequently pay over the odds for target companies, as the internal cost savings and synergies they can extract can be considerable.
In contrast, private equity buyers are investment funds that usually buy a number of discrete and unrelated businesses designed to be onsold at a later date. Private equity funds generally have very strict rate of return targets for individual businesses, and are less likely to pay up for target company shares. As a result, traders of takeovers should look more favourably towards deals involving industry buyers, as they tend to be less 'flinty-eyed' then their private equity counterparts.
6. Friendly vs hostile bids
Put simply, a friendly bid is one agreed to by the target board. In contrast, a hostile bid is one that for whatever reason (usually, but not always, based on price) the bidder and target board do not see eye to eye. Takeover bids stand a much higher chance of succeeding when they become friendly, as many shareholders will tend to follow the recommendation of their own board, an entity which unlike the bidder is reasonably well known to them.
As a result, initially hostile takeovers are more likely to result in counterbids than friendly ones. Sometimes, boards will only decide whether a bid is hostile or friendly after seeking the opinion of an 'independent expert' (usually an investment bank or accounting firm) on the value of their business in a change of control situation. Because such experts are ultimately paid by the shareholders of the target company, however, their independent assessments will usually arrive at a takeover value in excess of the bidder's initial offer.
7. Amount over the offer investors should pay
Finally, discipline is extremely important for successful traders of takeover situations. When markets are generally strong, takeover target shares should be bought for no more than 3% over the initial bid price.
Given markets have been somewhat shaky of late, most takeover bids (with the exception of the rare on-market ones) can be bought at a discount to the offer price. On the assumption that most bids take at least three to four months to complete, I try to pay around 3-4% below the takeover price. This means that assuming no other bids eventuate, and the bid is not delayed, I'll make a return of roughly 1% per month, or 12% annualised – a more than acceptable return in the current financial environment.
|-Takeover Action March 26-30, 2012|
|Wah Nam International||
|Kalahari offer unconditional|
|16/12/2011||Gold One International||
|BCX Gold Investments||
|29/03/2012||Living and Leisure||
|Ext to Apr 19|
|Ext to Mar 16|
|Schemes of Arrangement|
|Vote Apr 16|
|30/03/2012||Austar United Communications||
|See GGG Resources - 50/50 merger. Approved. Suspended|
|Magnitogorsk Iron and Steel Works||
|See Auzex Resources - 50/50 merger. Auzex suspended|
|Yancoal (Yanzhou Coal)||
|64.5% holder Noble Group in favour|
|Hanlong Mining Investment||
|Angline Pastoral Pty Ltd||
|Angline and shareholders to control 67.6%. Vote early May|
|Indicative 22% support for proposed scheme|
|Pacific Equity Partners||
|Non-exclusive due diligence|
Source: News Bites