David Clark, UK Analyst, explores the “cheapness” of the UK market…
Buy Now While Stocks Last
With every passing day the likelihood of a hard Brexit seems to grow.
The Prime Minister is in full pursuit, like Captain Ahab before him, of his own personal white whale and be damned as to the consequences. His “do or die” rhetoric certainly appeals to sections of the media and the political classes, and it is without doubt a refreshing change from the torture of his predecessor’s premiership. However, it has done no favours for investor sentiment which has improved not a jot since his ascension.
The consequences of Mr. Johnson’s position are debated furiously and have filled millions of column inches in newspapers, periodicals, blogs and websites. There seems to be little that they can all agree on.
Actually, there is one thing. As a result of a hard Brexit sterling will fall further. This small but rather important fact does not seem to be in dispute.
The value of the currency has been highly volatile since the 2016 referendum, having traded down to $1.205 in early 2017 then bounced back to $1.434 a year later. Prior to the referendum, the last time sterling was trading below $1.25 was nearly 35 years ago, and since Boris became PM the already pressurised pound has faced further headwinds.
From an international investor’s point of view this is all very fortuitous. It is clear that many LSE quoted companies are trading at significant discounts to historic norms and their international peers, and sterling weakness exacerbates that. This naturally makes them more attractive to overseas investors, and that is all fine and dandy and part of the natural way of things.
However, this has coincided with a time when there is a great deal of money being set aside by private equity firms, corporates and other investors to make outright bids for a chunk of UK (and other) companies. UK merger and acquisition activity has significantly accelerated over the last few months. Only last Monday a veteran stalwart of the market, Greene King, was bought by an international investor (CK Asset Holdings) at a 51% premium to the prevailing price in the market because it made sense to the acquirer.
Greene King is far from alone. We have seen other private equity bids of late with Merlin grabbing the headlines not so long ago, as well as the likes of Inmarsat, Tarsus, RPC and Millennium & Copthorne all in the process of being taken private. The PE industry is sitting on over $2 trillion that it needs to invest. In addition, we know that there is even more money due to come in from investors with much of this cash going to mid-market buyout funds. Prequin Investor Interviews suggested that 54% of investors thought that the best opportunities were to be had in small to mid-market buyout funds.
Obviously, the UK market is not the only one in the sights of the buy-out funds, but they would have to be a special kind of stupid to ignore the opportunities that are being thrown up on these shores, especially while sterling remains supressed. And these people are not stupid.
The last time there was a private equity acquisition boom was in the years 2006 and 2007 when over $800bn of listed companies globally were bought up in only those two years. This time the PE industry has more than twice the firepower it had then. Over the same period this buyout trend saw the ‘stock’ of equity in the UK market fall 8% over those two years according to Datastream.
As a domestic investor in UK stocks this trend is of great interest. Clearly, the extra sweetener provided by the currency aspect does not apply, but there is no harm in speculating as to which other companies may come under scrutiny from the men with deep pockets.
No one should ever buy a company just because they think that it is going to be taken over – that way lies madness (and bankruptcy), but it does no harm to be cognisant of the possibilities. Which brings us to the tricky bit – trying to figure out what sort of business would be attractive to potential acquirers.
There are umpteen different types of buy-out funds who all employ different criteria in order to assess potential investment opportunities. Screening for every eventuality is not a particularly good use of one’s time (unless you have a great deal of it), so sweeping generalisations will inevitably be called for and it should be taken as read that any stock which the rational investor considers for purchase already ticks the appropriate boxes according to one’s own favoured criteria.
That the opportunities are out there is beyond question and it is inconceivable that anyone will identify every takeover target. However, catching just one or two can make a world of difference to a portfolio’s investment returns. It is worth the effort.
UK Investment Analyst, Saracen Fund Managers