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Livingbridge's Wotton: In search of the deal

04 June 2018

Ken Wotton, fund manager at Livingbridge Equity Funds, explains why investors should look for businesses able to perform over the long-term rather than gambling on stocks that could be M&A targets.

By Ken Wotton,

Livingbridge Equity Funds

Investors buy shares in businesses they hope will perform well over time, often in the expectation that the price of the shares will rise accordingly as other investors buy the stock too. But in some cases, the actual return can come in a variety of ways including by the business being taken over.

There is no shortage of such transactions right now. Global merger and acquisition (M&A) activity hit an all-time high in the first quarter of 2018 according to data from Thomson Reuters, with the value of deals around the world reaching $1.2trn.

M&A activity continues across the whole of the market, and small- and micro-cap stocks are no exception. Livingbridge’s own fund portfolios have benefitted from two separate deals in the last three months: travel business Hogg Robinson was acquired by Amex Travel at a premium of 54 per cent to the prevailing market price, while the IT testing business SQS Software was bought out by Assystem Technologies at a 56 per cent premium.

 

On the look-out for M&A

Gains of that magnitude are enticing. So, is it possible to spot a company that is ripe for a takeover offer in order to get in ahead of a deal and try to secure a premium once a transaction is announced?

The short answer is that it is very tough to try to pick out a business that you can say will definitely be acquired within a short-term window. Investors who buy a stock because they expect M&A activity within, say, the next 12 months risk finding themselves disappointed. There are just too many different factors, many of them unknown to the outside world, that influence potential acquirers of a business, whether they’re trade buyers – rival companies in the sector – or investment buyers such as a private equity fund.

That said, we believe it could reasonably be said that the criteria that investors could apply when choosing stocks are the same criteria that an acquirer would consider. We believe that if you invest in a business with features such as good management, a proven track record, high-quality earnings, scalability and a positive outlook for growth, you’re investing in the type of company that is more likely to attract takeover interest.

There are no guarantees this M&A interest will ever materialise, let alone any certainty about when, but the qualities that attracted an investor to the business may well prompt interest from other parties too.

Another way to look at this concept is in terms of potential M&A activity offering a degree of insurance. If you can see that a business offers good value and prospects, it’s likely that buyers will recognise the potential too. If the market as a whole doesn’t spot the growth story, the shares could take longer than hoped to rise, but in situations like this a takeover offer could be a good Plan B.

 

Spread your bets

Nevertheless, M&A activity is unpredictable. Investors with a diversified portfolio of stocks held individually or via a collective investment fund stand a better chance of successful M&A activity than those buying a small number of shares they think could potentially be good candidates. This is potentially why investing across the whole of the market, from large-caps to smaller businesses, makes sense.

Utilising the expertise of fund managers could also help you capitalise on M&A potential, particularly those with a good understanding of the private equity sector, one important source of acquirers for many businesses. Such managers are likely to have a better feel for what buyers are looking for at any given moment. Our private equity team spends its time trying to help businesses build long-term strategic value and we believe that perspective helps us to recognise that value in listed businesses.

The bottom line is that buying a stock simply as a short-term takeover candidate is a high-risk strategy. Instead, businesses with the qualities required to perform strongly over the long term may offer a safer option. A buyer for the business may or may not materialise, but if not you’ll have the compensation of holding a stock with good prospects in any case.

Ken Wotton is a fund manager at Livingbridge Equity Funds. The views expressed above are his own and should not be taken as investment advice.

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