UK mergers and acquisitions (M&A) activity has been at a rapid pace this year, with several small- and mid-cap companies being approached by private equity or corporate buyers for takeovers.
A few months ago Man GLG’s Henry Dixon warned that if it continued at its current pace (roughly 12% of market cap per year), UK equities would only have about eight years left to live.
Just last week, Marks & Spencer shares rose on rumours that the US investment firm Apollo Global Management is interested in buying the British retailer.
A few days after, UK fund management group River and Mercantile revealed that it had received preliminary approaches for possible buyouts from rivals Premier Miton and AssetCo.
Since it seems M&A activity is showing no sign of slowing, Trustnet asked several experts what they made of the current state of the market and where else investors could expect potential takeovers.
Brendan Gulston, manager of the LF Gresham House UK Multi Cap Income fund, said the reason for the recent activity was due to the “ongoing persistent valuation discount” in the UK equity market versus other global markets.
He said: “It has been interesting to note that corporate activity has been fairly indiscriminate with respect to size of company, as we have seen noticeable activity across the market-cap spectrum.
“We believe this is likely to continue, particularly as the further impacts of covid unfold and impact sectors to differing degrees.”
He highlighted UK small caps as the area that “continues to underpin the relative attractiveness of UK M&A”.
Neil Campling, a global TMT analyst at Mirabaud Equity Research also said the uptick in M&A activity in the UK was a reminder of how undervalued the market had become relative to other geographies.
He compared UK market valuations relative to Europe by looking at the absolute 12-month forward enterprise value to earnings multiple of the FTSE 350 index versus the Stoxx Europe 600 and found that on a relative basis the UK market was roughly 20% cheaper now than it has been for at least a decade.
He said: “If we were to pick one company we expect to fall under the spotlight of interest before Christmas, we would highlight BT. The stock is trading at 160p, a significant discount to a previous high of 500p, at a time when the need for fast broadband has never been higher.
“Private equity, in the form of activist Patrick Drahi, now has a stake and the 6-month takeover code restriction from his original purchase expires on 10th December.”
Campling added that the British telecom giant had significantly reduced the pension deficit and had a “clear path to return on investment” from its fibre build out.
He also pointed out that BT is now run by a chief executive officer (Philip Jansen) who has experience in both private equity and selling companies. On Monday morning shares in BT jumped over 8% on speculation that India's Reliance Industries is mulling a takeover bid.
Share price of BT in 2021
Source: FE Analytics
Alexandra Jackson, manager of the Rathbone UK Opportunities fund, said the defence sector could be an area that is ripe for takeover targets.
“The defence sector has boasted lots of M&A activity this year (Meggit and Ultra in recent months), thanks to the niche product sets and nice cash flow characteristics,” she said.
“Reasonable valuation multiples have helped too – with the broader Industrial space trading on historic premiums, the defence sector has lagged, probably because of the [environmental, social and governance] ESG hurdles. Long-term private capital is potentially less squeamish,
She added: “Chemring is one of the larger UK defence names left; we like it thanks to its government cyber security work and vastly improved cash flow.”
Share price of Chemring ytd
Source: FE Analytics
For James Burns, co-manager of Smith & Williamson Investment Management’s model portfolio service, small- and mid-caps are the place to be to ride out UK bidding war.
He said that many of the UK’s smaller and medium-sized companies were being left out and undervalued because earnings profiles were being dominated by larger companies.
“Coupled with this is a considerable amount of money in the US market, which continues to make great strides,” he said. “Understandably, asset allocators are sticking with the US and not diversifying away.
“However, the longer this lack of diversification continues, the more opportunities there are for private equity businesses to come over and reduce our already shrinking market.”
As such, Burns has a small- and mid-cap skew in his firm’s managed portfolios. He highlighted the BackRock Smaller Companies Trust as one good way to gain exposure.
He said: “In the past 6-8 weeks, the investment trusts in the smaller company space have seen their discounts widen, but fundamentally, they’re doing a great job.
“This particular trust has a phenomenal long-term record and has continued to perform under its new manager, Roland Arnold.”
Another fund Burns highlighted was the Premier Miton UK Multi-Cap Income fund, run by Gervais Williams and Martin Turner.
“Whereas BlackRock Smaller Companies Trust is more growth focused, Miton has more of a value tilt to it, and it sits within a part of the market we’re happy to have money allocated to,” he finished.