Institutional shareholders need to be as agile and active as private equity in dealing with failures of leadership.
3 minute read
After the recent surge in bid activity, culminating in a premium offer for Peppa Pig owner Entertainment One from the American toys giant Hasbro, investors must ask themselves why so many companies are being bid for now, what this signals and how they should respond in terms of corporate governance and portfolio positioning.
Most of the recent bids have come from private equity (PE) players, which are focused on the longer-term resale value of the companies they buy. Companies are only attractive to PE when there has been mismanagement of their strategy, operations or balance sheet, or the market does not appreciate their long-term value prospects. Both these issues are failings of company leadership.
The way forward is not to focus on tired solutions to public market short-termism and PE financial engineering, but for institutional shareholders to step up. Specifically, they must hold company leadership to account for poor performance, and push for more decisive and swift action in replacing chief executives, finance directors and chairmen when they fail to deliver. It can be argued that PE firms are good for public markets in the same way that activist investors help to create management and price discipline.
However, institutional investors cannot rely on them to facilitate change. We have to be active ourselves.
If a bid materialises, particularly from PE, the board and shareholders must be fighters, not quitters. Boards should look first to resolve internally the valuation issues that have been highlighted by the bid, engaging with their long-term shareholders as part of the process.
There have been many high-profile examples of bids that were rebuffed, with the target companies going on to flourish — including Unilever and Astra Zeneca. If this is not possible because of a lack of shareholder support and the board decides to sell, they must strive to achieve the best price. Shareholders should also look to the long-term value of the business and ensure that boards of target companies follow this process.
Sadly, this behaviour has not been apparent in recent months, with companies selling out too cheaply — either because of boards being driven by the personal agendas of executive managements who have tired of public markets, a general tendency for boards to raise the white flag too early, or shareholders being too happy to sell out too soon.
The air-to-air refuelling specialist Cobham only started to recover after new leadership was installed in 2016. It is now being bought out before the market can benefit from the stronger foundations put in place.
At Merlin Entertainments, the leadership team had ample opportunity to impress the market after floating in 2013, but failed to hit earnings objectives consistently before blaming investors for undervaluing the company and selling out quietly to private equity.
At RPC, the packaging company, the board failed to adapt after investors no longer favoured an acquisition-led strategy and in effect gave up the option of being an independently quoted company. After a protracted PE bid process, they sold out below the shares’ 2016/17 highs.
Meanwhile, brewer Greene King’s difficulties in dealing with business headwinds and communicating a convincing growth strategy led to a material undervaluation of the asset base by investors, allowing a bid to come in at 50% higher than the market price. It was immediately accepted by management.
Underperforming management and shareholder diffidence isn’t the only driver of the increase in bid activity. While Brexit fears explain why domestically focused listed businesses have been valued at a significant discount to global peers since the referendum, recent bids suggest some international and PE acquirers have decided the impact of no-deal is now fully discounted, both in terms of economic and currency risk. If they are right, we are likely to see more bids — unless the UK market starts to value domestic assets more highly and boards defend themselves more robustly.
The evidence of recent bids shows a lot still has to be done to avoid British companies being sold too cheaply. Management and shareholder behaviour has to change to limit the risk of a bid, and boards must respond effectively to maximise shareholder value if one emerges. Investors and boards must be more proactive in instigating management change where necessary, and be aware that these bids may be signalling excessive negativity around UK-based companies.
Momentum has been against UK stocks for some time. These bids signal it may be time for investors to pivot toward the UK equity market. During times of change, investors would do well to remember that only dead fish swim with the stream. Active investors should change direction and look more favourably on the outlook for the UK, deal or no deal.
This article originally appeared in The Sunday Times.