Takeover Merchant

The ASX is enjoying an exceptional bout of takeover activity and Tom Elliott is in the thick of the action. As a director of MM&E, a hedge fund that specialises in exploiting takeover situations, Elliott has a box seat on the biggest deals in the market.

As he explains, the odds are in favour of any investor making money from a takeover bid if stock in the target company is acquired immediately after the bid is announced. Elliott explains his formula for profiting from takeover announcements in the interview transcript below.

Elliott also warns investors that despite endless speculation of impending foreign takeovers of blue-chip stocks on the ASX, such bids are quite unlikely for reasons exemplified in Xstrata's failed all scrip bid for Western Mining.

The interview will also disappoint speculators holding out for a takeover bid for John Fairfax Holdings.

However, Elliott is game enough to name a number of potential takeover targets including Australia's biggest listed beef producer, the Australian Agricultural Company.

James Kirby: What an amazing time it is for takeover activity. We now have the Alinta AGL takeover. Can you tell us how did you read that particular story?

Tom Elliott: Look I think it was a recognition by both sets of management that each of them was good at different things. Alinta is a younger, more aggressive company led by an American who had certain skills. AGL, much larger. Because they were both trying to buy each other there was only so much they could do in terms of increasing their respective bids because it was the same pool of assets they were playing with, so demerging '” which, remember is what AGL wanted to do in the first place was demerge its operations '” I think is actually the best outcome and it allows both sets of executives, especially the CEOs, to save face. They both walk away with what appears to be a victory.

I’ve been looking at takeover coverage, takeover lists '” takeover target lists in particular that have been published over the last year '” and so often I notice that we often pick the wrong takeovers, don’t we? Why don’t we see more foreign takeovers in Australia?

Look I think so. The myth of the foreign takeover is indeed just that. There aren’t that many foreign bids. One of the reasons of course is that the vast majority of foreign bids tend to be script bids and Australian investors aren’t interested in owning foreign shares so if Xstrata, as it did bids for Western Mining Corporation, if Xstrata wants to bid for any other companies it can’t use its shares because Australian shareholders don’t want to own them. Also the Australian stockmarket, sector by sector, is probably more expensive than its global peers right now so it wouldn’t actually make that much sense for, say, European or US companies to be buying any Australian businesses because in fact the Australian companies are trading at a premium rather than a discount and that may or may not be warranted.

Can you tell Eureka Report subscribers how you approach takeover activity? You have a mathematical formula, I believe, for assessing the prospects of takeovers once they’re announced.

I’ve got data going back about 10 years that I’ve collected myself on takeovers. There’s usually between 25 and 45 sizeable bids a year '” that’s for companies the size of the ASX300 or greater; roughly $80 million in market cap or higher. So of the bids that are announced, about 34–35% '”a bit over a third '” get a higher bid and those that get the higher bid, the winning bid tends to be 17–18% higher than the initial bid, so the maths are pretty simple. Two-thirds of the time you’re not going to make money but you’re not going to lose it either. One-third of the time you might make 17–18% and if you can pick the ones after they’ve been announced that are more likely to get the increases, it’s a very good way to make low-risk money, and that’s what we’ve found.

Now if we could just focus for a second on sectoral activity in relation to takeovers in different parts of the market. What’s happening in the media sector? We look at Fairfax and the share price has barely changed for weeks and weeks now.

I think there’s two things. In terms of media deregulation it’s not big on the Governments “to do” list. I mean there’s calls for tax reform. The average person on the street doesn’t see media deregulation as being a fantastic thing so that’s the regulatory environment. Second, Fairfax itself. In my view, Fairfax is in a fairly declining industry. If you look at classifieds now '¦ I mean Seek, the employment classifieds online company, is showing fantastic growth in its revenue and that growth in revenue can only be coming out of Fairfax’s essentially print revenue.

Personally, I think the way the market’s going '” and I’m talking about the market for online classifieds, and remember these are the rivers of gold that everybody used to think that Fairfax had '” I think that’s going to dry up in the next few years. I don’t think Fairfax has made the transition to the digital age particularly well. So when people say that it’s going to be taken over I disagree. You might get someone who wants to buy it because they love the idea of owning well-known newspaper mastheads, but will they pay a big price? I’m not so certain.

And could you tell us, Tom, which sectors of the ASX might we see more takeover activity in the future?

Oh, that’s a difficult one but I think apart from the obvious ones in resources, and I think resource stocks have gone a bit high to actually attract too much takeover activity, I’d be having a bit of a look at the agriculture and food sector. I think that inevitably Australia’s going to be seen as a clean and reliable producer of global foodstuffs and I think that’s where I’d be looking so there’s quite a few targets there, from timber to wheat and wool and things like that, that people could be looking at.

And would you be prepared to mention any names to us?

Oh well, the usual ones crop up. Australian Agricultural Company might be a target. I think it owns something like 1% of the land mass of Australia and has quite a few cows on that land mass. That would be difficult to replicate offshore, especially if we get more mad cow disease. And also I think some of the bigger timber companies. We’re talking some of the plantation ones, Great Southern and so forth, but that’s a business model that I think could prove quite attractive to some others.

Tom Elliott, thanks very much for talking to Eureka Report.