, , , , , , , , , ,

Continued from here:

iii) Takeover Offers are a catalyst with a much shorter duration than Liquidations or Wind-downs, usually within 2 to 8 months. In the UK, for example, Takeover Panel rules keep things on a fairly strict timetable. In terms of risk, they probably fall somewhere between the two: Your Gross Return is reasonably stable/well-defined, but price volatility and the chances of failure are a lot higher.

It’s not so prudent to give examples of current takeover offers, as price volatility and news flow can change things all too quickly. But I’ll give a brief update on a current Risk Arb situation in which I’m investing, and share my own observations and approach to this type of catalyst:

As I detailed here, I’m currently investing in a Recommended Cash Offer. It’s been tough going, but I’ve managed to increase my holding from 1.1% to 2.6%, with little impact on my expected gross return (now 16.1%). Also, my expected outcome probabilities haven’t changed, so the Expected Value of the gross return is also slightly lower at 14.3%. The decreasing timeline continues to ratchet up the expected IRR: As of today, it’s improved to 220%+, with a possible 660%+ IRR if the consideration’s paid on the earliest possible date. Now, for a more general overview:

First, and most obviously, rumours of a takeover are definitely not a catalyst! Journalists, market-makers and message boarders favourite sport is to spread takeover rumours, sometimes multiple times. And some folks fall for it every time..?! Sure, now and again one of these turns into a genuine offer, but so what? Think: If a punter’s excited enough to pay a 3%, 5%, 10% or even (on occasion) a 20% premium on a rumour, and you stack that up against the actual odds of an offer materialising (say, at a 35% premium), the expected value of their returns over time won’t be too hot. Unless a stock’s already on your buy list, with plenty of upside potential, I recommend you ignore the rumour mill!

Second, perhaps you own a stock that’s now the subject of an offer? Congrats, you’re enjoying an unexpected catalyst! Bearing in mind all I’ve said, it’s worth staying in ’til the bitter end, unless you think there’s a real risk the offer will fail. Also, an unexpected takeover may renew your faith in value investing…who needs a damn catalyst, value will out! But a swallow does not a summer make. Yeah, value investing improves long-term returns, but adding catalysts as a focus will improve your returns in the short-term on average, by stacking the deck in your favour.

If you’re still interested, the first viable form of Risk Arb often presents itself when a company announces – usually in response to ‘media speculation’ or a ‘share price movement’ – that it’s received a preliminary approach. If I were to rank takeover situations in terms of decreasing risk, it looks something like this:

– Board’s in discussion with an undisclosed third party

– Board’s in discussion regarding a possible management buyout

– Board’s in discussion with a number of undisclosed third parties

– The potential acquirer(s) identity is announced by the board, or acquirer(s)

– A potential offer price is announced, by the board or acquirer. Confirmation it’s a share offer, or even better a cash offer, helps

– A potential offer/price is announced by another acquirer

– A recommended share offer’s announced by the board

– A recommended cash offer’s announced by the board

– A recommended offer is declared unconditional

Obviously your potential gross return will generally decrease hand in hand with the level of risk (but your expected value and IRR will likely improve). Before an offer price’s announced, it’s useful to remember offer premiums usually average out between 25-45%. A lot of this premium’s eliminated even when just potential discussions are announced, so be careful! Patience can often really help at this point. A lot of talks drag on, with precious little news flow, and people get bored… I’m amazed how many stocks subsequently sink back within 10-15% of their pre-announcement price!

Of course, risk vs. reward is a v personal affair… One investor may be perfectly happy to clip a 3-5% return from a recommended offer. To another investor this is sheer madness, they’d much prefer to bet on a situation (say, with a possible 20% upside) where just a preliminary approach has been announced.

Share offers are a tougher proposition. Read the text books and it’s simple, just hedge yourself by shorting the acquirer’s shares – not so easy for many private investors, and/or certain (smaller) situations. I prefer cash offers anyway, I believe they present lower deal risk, but share offers can occasionally be intriguing – don’t forget to evaluate the acquirer! Particularly if you see a significant drop in their share price. You may well conclude that foregoing a hedge is attractive, or even that the takeover offers a cheap entry into the acquirer as a value investment. Just be sure to decide what your strategy is in advance! When an arbitrageur (or a trader) ends up with a bad situation, they may suddenly decide to become an investor. This can often prove even more painful… I know!

Value investing’s actually the best evaluation tool for takeover analysis. Just remember to focus on Sales (growth), Gross/Operating Margins, Debt and Cashflows. I’ve never met an acquirer who gave a toss about EPS (growth), P/E or PEG ratios, etc.! A Fair Value Price Target confirms your Margin of Safety, and often flags up the possibility of a higher or separate offer. It can also save your ass! I can think of two recent situations: Greencore (GNC:LN) announced a preliminary approach last October. The price immediately jumped, and for the next couple of weeks traded 10-30% higher. Read my opinion of GNC here and here, and you’ll understand why I ignored this opportunity..and why I wasn’t so surprised to see the offer talks called off in December.

IFG Group (IFP:ID) was worse: They announced an approach last May, and a second approach later that month. Eventually a potential EUR 1.80 offer came in August. With talks dragging, investors grew bored and IFG’s price drifted, offering a v tempting 12.5% gross return.  I knew IFG well, have bought and sold it a number of times before, and yeah I wanted to invest…but couldn’t make sense of the offer price. Sure, IFG’s Adj EPS put it on a really cheap P/E, but cashflows bore no resemblance to EPS or Adj Operating Margins for the past few years? I couldn’t reach a Fair Value of more than EUR 1.20-30. I passed out of sheer prudence, but certainly didn’t expect to see the offer/talks terminated in September due to market conditions..! The lesson? If the current mkt price and/or offer price exceed your Fair Value, even in the advanced stages of a takeover, it’s probably better to move on! There are better and safer situations to contemplate.

So, where do you find these situations? Well, if you’re an avid daily reader of the financial news, websites, blogs etc. you’ll come across them nearly every day. The challenge is keeping track of them! I can’t overemphasize this: A systematic tracking approach is invaluable both for individual situations, and for developing your general Risk Arb savvy and experience. Reuters has a good site here (check/change your region), and they/Bloomberg regularly publish Arbitrage Spread tables. However, you’ll invariably find the media focuses on v large cap/US/global deals, exactly where hedge funds aggressively compress spreads to levels that are unattractive for private investors. Smaller/more local situations can definitely offer an investing edge for smaller investors.

If you prefer UK/Irish situations, the simplest approach is to input ‘Takeover Panel’ as a keyword on Investegate. This throws up daily (or weekly) UK (and Irish) Takeover Panel Disclosure Tables (just open the last UK Table of each day). They don’t have all the info. you want (you’ll need to do plenty of research anyway!), but it’s the best summary you’ll find of ALL current potential/actual Takeover Offers.

OK, just a few more to go..!