Companies acquiring unloved assets, those merging with rivals and those that could be bought out by overseas peers are the three types of M&A play Richard Penny is employing in his L&G UK Special Situations fund.
The manager, who has run the four crown-rated fund since 2014, said he is using all three strategies in the fund, which looks for undervalued, mispriced or unloved stocks.
He said he looks for companies that look ready for a rebound through scenarios such as refinancing, mergers and acquisitions (M&A), secular growth or event driven changes.
Since he took charge, the fund has returned 45.23 per cent, placing it in the top quartile of the IA UK All Companies sector.
Performance of fund vs sector and benchmark since manager start date
Source: FE Analytics
And one of the main areas he has been looking to take advantage of is M&A, with the first aspect being those companies that have made transformative acquisitions in recent times.
“In terms of M&A what we’ve been looking for more if anything is companies that can do transformative deals,” he said.
“We see a lot of companies and we turn down most of them but some of the stocks that have been great successes for the fund are companies that can buy things.”
One area that has seen more mergers than most is the online gaming industry, with Paddy Power merging with Betfair, Coral joining Ladbrokes and – the merger he bought into – GVC Holdings acquiring bwin.party.
The manager said: “An area we are interested in are relatively fixed-cost businesses so some of the online gaming companies have got a cost of maintaining their websites and their infrastructure but if they merge it with something else you can rip out a huge amount of that costs.
“That isn’t 10 or 20 per cent savings they’re big numbers around 20 or 30 per cent and the benefit of that cost reduction is then available potentially for equity shareholders.”
GVC, which previously bought SportingBet in 2013, completed the £1.1bn bwin.party deal in 2015 and has since seen its share price rocket.
“bwin was an unloved quoted entity that was badly managed some would argue and was not producing the right outcomes – sponsoring Real Madrid and spending too much on trophy advertising,” Penny said.
“bwin fully listed for hundreds of millions not billions but was the sort of company that no one would really own.
“When we looked at it we took a couple of meetings and we thought it was a really good prospect to make a good return – which has panned out.
Performance of stock over 2yrs
Source: FE Analytics
“It was taken over by GVC and we still own it but shares have gone from 415p to the best part of £8m,” the manager said.
“Now you could say that they are fairly valued for what they have though there could be upgrades but in reality one for could foresee more rationalisation of the online gaming space.
“It probably won’t happen until the review of fixed-odd betting terminals but the UK is pretty well placed in terms of the growth in online gaming.”
Another example of a company that he has bought after a transformative deal is pharmaceutical giant Shire, which completed the $32bn merger with US peer Baxalta last year.
“We bought Shire as a special situation when they did the deal with Baxalta which has worked reasonably well – certainly it worked well for the first six to nine months though the last three months have been less good,” he said.
However, he also includes companies that make smaller deals as those that are performing transformative M&A, with sales, marketing and support services group DCC among those that he owns.
“Some of the companies I own – one would be DCC – buy assets off the very big companies,” the manager said.
“Sometimes very large businesses have small businesses that don’t quite get the care or they don’t give the motivation to the management and DCC have been buying petrol stations off oil majors.
The firm has been buying these stations from oil major Shell, which he said is selling assets in order to cover its dividends.
“Now I happen to think it will pay its dividend and that Shell can be a good investment but you also would quite like to be a buyer of some of the things that they are selling,” he said.
“Either you’re going to get them at an attractive price because there aren’t many buyers or you’re going to get them at 60-80 per cent of the profit cost because they’ve been a little bit unloved for a number of years,” he explained.
Performance of stock over 2yrs
Source: FE Analytics
Last month, the company revealed that its pre-tax profits had jumped 24 per cent for the year to the end of March 2017 compared to the previous year after its acquisitions.
Indeed, over the last two years the company has gained 48.62 per cent, and since the start of the year is up 24.42 per cent so far this year.
DCC has made a number of announcements this year, including three large acquisitions across its energy, healthcare and technology divisions.
The final area he invests in is potential M&A targets, with pharmaceutical firm Smith & Nephew Penny’s top prospect in this department.
“In terms of the prospects of UK companies being bought and taken over the currency is weak, there is low growth, acquiring earnings and using cheap debt to buy it,” he said.
He points to the slump in the pound as the main factor for UK companies being among the top M&A prospects, which has fallen 12.73 per cent since the EU referendum in June last year.
“We think with the currency cheap American companies buying British companies is quite possible and Smith & Nephew has been a perennial story,” he said.
“It’s always difficult specifically to pick the companies that are going to get bid for but if they are reasonably priced and the currency is cheap then that’s feasible.”