Wrong answer

PORTFOLIO POINT: Boards give all manner of excuses for saying no to takeover offers, but the result is usually the same: a share price fall.

The collapse in Nufarm’s share price to about $3.50, just seven months after it knocked back an all-cash bid of $12 from China's Sinochem, is only one example of how boards that reject takeovers usually do their shareholders a huge disservice.

As someone who has traded takeovers for many years, I’ve found that it's rarely a good idea to hang on to shares when boards act in this fashion; it often sets off a chain of events that destroys millions of dollars in shareholder value.

Before we list the impact of recent rejected bids, it's worth examining the reasons boards put forward to justify such actions and what they are inclined to say when presented with a bid they don’t want to accept.

"The bid materially undervalues the company"

In the old days, when directors possessed prophetic insight into future share price performance of their company, this explanation might have held sway. These days, however, shareholders are far more sophisticated than was once the case, and are usually capable of making up their own minds whether a bid is reasonable or not.

"The company is better off maintaining an independent future"

In my opinion this is code for: “We, the incumbent board, do not want to lose our well-paid, part-time jobs.”

"The bid is designed to take advantage of the company's weak share price!"

Perhaps not such a bad point. Warren Buffett once suggested that you should never count on making a good sale. Instead make the purchase price so attractive that even a mediocre sale gives good results; however it might do well for the board to consider that they are very responsible for this sad state of affairs in the first place.

"The bid is highly conditional and not in a state to be put to shareholders"

Fair enough, but engagement with the bidder (rather than ignoring it) and access to the company books for due diligence can often overcome such uncertainties.

Whenever shareholders see such reasons trotted out for takeover rejections, and the target's share price subsequently underperforms, hard questions should be asked at the next general meeting.

There are also examples when shareholders go against board recommendations and reject bids themselves. This is what happened in the case of Qantas and APN News & Media, where shareholders rejected the planned management buyout. This is their right, of course, but again is also rarely a good idea, as proven by the massive fall in the share price that followed

Let's look now at recent examples of rejected bids. I'll group target companies into underperformers and outperformers, based on their post-bid share price relative to the value of the takeover bid originally offered:

-Underperformers
	Takeover offer	Current price	% change (July 19)
GRD	$2.75	$0.55	-80%
AMP	$20.00	$5.27	-74%
Nufarm	$12.00	$3.26	-73%
APN News Media	$6.20	$1.97	-68%
Qantas	$5.45	$2.27	-58%
Rio Tinto	$121.00	$66.00	-45%
Redflex	$3.50	$2.33	-33%
Transurban	$5.57	$4.50	-19%
Orica	$32.00	$24.52	-15%
Sigma Pharmaceuticals	$0.55	$0.43	-22%

Now there are some caveats that are worth covering off on. In the case of Rio Tinto we are talking about a scrip offer, not cash; and in the case of Sigma Pharmaceuticals a final decision as to whether the bid is ultimately rejected has not been made. However, the trend is clear: boards that reject bids because they “know better” ultimately destroy shareholder value.

There have, however, been rare examples where companies have rejected bids and gone on to do better. One of the more famous examples was Shell’s bid for Woodside in 2001, which was rejected by then Treasurer Peter Costello as not being in the national interest. Woodside’s price has appreciated by about 12% per annum since then.

Another resources company that rejected a bid was Western Mining, which knocked back a takeover from Anglo American in 2001. Ultimately, a better result was achieved for shareholders by the company’s decision to accept a later bid from BHP in 2005. It’s worth considering, however, that both of these companies have benefited enormously from China’s booming appetite for resources.

So what lessons can we as investors learn from this?

First, over the past 10 years it has definitely been better to accept bids than reject them.

Second, companies that reject bids often find that bidders return, and not necessarily with the same offer. Witness the lower offers tabled for Redflex, Nufarm and GRD.

And third, in the case where a board does reject an offer and/or refuses to engage in negotiations, the balance of probability suggests you can expect your shareholding to be worth a lot less in the future.

Tom Elliott, the managing director of MM&E Capital, may have interests in any of the stocks mentioned.