Consolidation and the effect of COVID-19 have made many industries ripe for takeovers. While some took place during 2020, there are more to come in 2021.
Whilst logic might suggest lots of takeovers when share prices are low, that hasn’t historically been the case. Most potential acquirers are dealing with their own problems in a wider market downturn. And not all shareholders think their company is worth a lowly value just because a small number of investors are running for the exits.
Recovery before takeover
Experience suggests the recovery comes first, and then the takeovers. That was certainly true of WPP AUNZ (WPP), one of the Forager Australian Shares Fund’s larger investments. The marketing services business received a bid from its parent company WPP plc (LSE:WPP) in late 2020. The Brits already own 62% of the business and the local arm works within the sprawling 130,000-person international empire. In the November monthly report, we called the bid, then at $0.55 per share, opportunistically timed.
The independent directors agreed, negotiating with the parent to increase the bid to $0.70 per share. Details are still being finalised, but part of the cash is due to come as a $0.15 per share fully franked dividend.
When the Fund first bought into WPP AUNZ in June 2019, the investment case was simple. The company has a major local presence, was recovering from issues with one of its divisions while trying to sell another and had just appointed a new CEO. Trading at a price to earnings multiple of just six times and offering a 13% fully franked dividend yield, the valuation was attractive.
And there was a kicker. The low valuation also meant it made sense for its London-listed majority owner to eventually buy the whole business. It could also cut away the costs of a separately listed entity. The investment thesis stacked up, and the takeover appeal provided another way to realise the value in the business.
The final price makes for a 71% premium over where the local WPP shares were trading just a month ago, and a 54% return on our initial purchase including dividends.
Frequent form of value realisation
Corporate action has been a frequent path to value realisation over the history of the Forager Australian Shares Fund. Including WPP, 17% of the current portfolio has been the subject of publicly disclosed takeover approaches over the last few years.
This group includes panel beater AMA Group (AMA), which saw a bid from private equity group Blackstone two years ago before the deal was scuttled due to a tax issue. The business has become bigger and stronger since, continuing to consolidate Australian panel beaters. For now, a recovery to repair volumes and profit margins remain key. With private equity investors having lots of capital to deploy, AMA may once again be on the radar.
iSelect (ISU), the comparison website, was in the sights of its largest competitor just six months ago. Compare the Market already has a 29% stake in the business and the combination of the two would make for a strong proposition to health insurers. It would also be able to operate with much lower costs. Tabled at $0.40 per share when iSelect’s share price was trading closer to $0.20 the bid was opportunistically timed. After announcing a strong first quarter, a change of CEO and a marketing partnership deal with News Corp (NWS), iSelect seems to be getting on with business. Given the synergies on offer, a takeover remains a logical outcome.
Another to have attracted takeover speculation is fleet management business Eclipx (ECX). Two years ago the company was dealing with approaches from both SG Fleet (SGF) and McMillan Shakespeare (MMS). The suitors must have thought themselves lucky to miss out. Acquisitions by the old Eclipx management team soured and the business struggled under too much debt. A new team, led by CEO Julian Russell, then navigated the business through a radical process of asset sales, deleveraging and refocusing on the attractive fleet management segment. We can now add COVID-19 to the list of challenges the business has successfully overcome.
The case for consolidation among the fleet management and novated leasing players remains strong. Scale will bring more efficiency. There are possibly two major deals to be done before the ACCC starts to cast a disapproving gaze. Eclipx is more likely to be prey than predator.
Mainstream and RPM can demand a full price
Another 18% of the portfolio is made up of investments which are more valuable in the hands of an acquirer. This includes the Fund’s two largest investments.
Mainstream (MAI), the fund administrator, has been performing very strongly despite COVID-19 disruption. Last quarter the business surpassed $210bn of funds under administration. And a new US private equity administration business is going gangbusters. Mainstream brought in $12bn of new client money in the last quarter of 2020 and $24bn for the last year. The share price had a stellar run, up 87% for the year.
Meanwhile acquirers’ attention has turned to the funds administration space. Super admin business Link (LNK) has been fielding offers from private equity groups and SS&C Technology (NYSE:SSNC), an aggressive global acquirer. Fund administrator Onevue (OVH) was acquired by financial technology player Iress (IRE) in November at a 67% premium to the pre-bid price. Given the recurring revenue, scale advantages and growth opportunities, it wouldn’t be surprising to see Mainstream end up in the same boat.
The team at mining software business RPM Global (RUL) has been hard at work for years building new products for miners around the world. The industry-leading products were selling fast before the pandemic, with recurring software revenue rising 26% last year. While it has been tough to sign new deals while COVID-19 runs rampant in many important mining geographies, the business should be back on track as the virus subsides.
CEO Richard Matthews has form running and selling software businesses: first Mincom and then eServeGlobal (which remains listed but sold a big division). The growing recurring revenue will be attractive to a range of large suitors. With a high corporate overhead, any sale will allow the acquirer to reduce costs dramatically. Owning 3.5% of the company, all acquired on-market, Matthews has a big incentive to maximise value if any bidder shows interest.
Purely speculating on takeovers is not an easy way to make money. And when the prospect of a takeover has become your last bastion of hope for value realisation, it is usually a sign that the investment has soured. Businesses that are growing and performing well or have already turned themselves around make for far more attractive targets, with WPP being a case in point. But a takeover bid can help to accelerate the realisation of existing value. When an acquirer comes knocking, years of hard work can pay off in a day.
This is an excerpt from the December 2020 Quarterly Report. All prices and portfolio weightings correct as at 31 December 2020.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.