The life stages of a public company are many. It starts with an IPO, learning how to run a successful listed business, and in some cases, the resulting goliath may receive a takeover bid--or want to acquire another company.
There are several reasons a company will choose to merge with or acquire another. One of the main ones is increased output, often at a cheaper price, as M&A is an inorganic form of growth and can achieve economies of scale. It may also grant either or both parties access to better technologies, or geographical expansion opportunities. Both can ultimately save time, and reduce competition by increasing market share.
We’ve seen several large-scale companies make these kinds of changes over the past year, with 2021 becoming a record year for mergers and acquisitions (M&A). Supermarket Morrisons was the subject of a bidding war before it was subsequently sold to a US firm, while Goldman Sachs has announced a takeover of NN Investment Partners. Don't forget LV= either. No wonder experts believe we haven’t seen the last deal of the year made yet.
We’ve previously written about the pros and cons of larger companies going private, following the takeover battle for Morrisons. Benefits include generous offers, easier structures and the potential to own shares in a bigger group at a later stage. Disadvantages could include missing out on future growth as well as less transparency on profits and ESG.
As is often the case when a takeover bid is on the table, however, the share price of the company being acquired often jumps, while the company making the bid often experiences a fall. Morrisons’ share price is up 50% on the start of 2021, for instance.
A Strategic Move
M&A is often a positive sign for investors--but the fundamental reasons behind any deal must be absolutely sound, with the right price and a strategic fit. The risks are high. As the Harvard Business Review noted in 2016, M&A can be a "mug's game". Between 70% and 90% of strategic acquisitions are "abysmal failures," it argued.
Alpha FMC’s CEO Euan Fraser says M&A is all about acquiring companies with a market-leading reputation that can provide a foothold in new markets or add a certain expertise.
“We recently acquired a company called Lionpoint which specialises in the alternatives space and had a great client base in the US--both of which were a perfect fit with our strategic expansion plans," Fraser says.
So how do you identify the right company? It comes down to a huge amount of due diligence. The focus must be on the long-term benefits. “Many M&As don’t succeed because they aren’t the right ‘fit’ or because stakeholders aren’t on board with the move. And if M&As fail, this is risk for investors," he adds.
Small-Cap M&A
One sector where takeovers are very common is among companies in the small cap space. They are often evolving at a rapid pace, and in dynamic markets. Brendan Gulston, co-manager of the LF Gresham House UK Multi Cap Income Fund and LF Gresham House UK Micro Cap Fund, adds that private equity firms are currently well funded as well, which makes bidding wars among small and mid caps more common.
The increased activity does mean there are plenty of pitfalls too, so having resources to conduct thorough due diligence becomes the most important factor.
“It does require a specialist to really drive returns out of [the small cap space] because you’ve got so many companies and you’ve got such a range of different sectors,” Gulston says.
“You need to have a well-resourced team and approach to do that at scale.”
Through The Storm
So what should you think about as an investor? It is important to remember the period between the announcement of a merger or takeover and its completion is an uncertain one, during which much can (and will) happen.
Take Aon’s failed takeover of competitor Willis Towers Watson, for example. It fell through because of monopoly concerns, but despite having to pay a billion-dollar break fee, Aon’s shares soared as it meant the situation was settled. Normally, however, if a deal makes it through the period of uncertainty, then fallen share prices should recover and offer long-term benefits to investors.
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