The 2022 financial year has so far provided excellent entertainment on the ASX given the amount of takeover offers we have seen.
A takeover offer refers to a bid from one company to acquire another company. Typically, the bid comes in the form of a cash offer, a stock offer (the acquired receives shares in the acquirer) or a mix of the two.
We have seen the biggest offer in ASX history with Square (now known as Block) buying Afterpay, Sydney Airport is on track to be removed from the ASX and taken private, and Woolworths and Wesfarmers battled it out for API Pharmaceutical. Sometimes these offers go ahead without a hitch. However, many offers may fail, are revised or subject to counteroffers.
How to maximise your return
As an independent party, takeover battles between companies can be interesting to watch and see how things unfold. The same cannot be said for a shareholder. Deciding how to act and maximise your returns can be difficult in these situations.
The Board of the company subject to a takeover will usually provide advice to shareholders on how they should vote. However, it is good to assess the offer personally as they may not always have shareholders’ best interests at heart. There are normally two courses of action an investor can take in this situation. The first is to hold onto the shares and wait for the offer to go through. Otherwise, you can wait and see if a competing bid comes in at a higher price. Secondly, if you believe the takeover may not proceed, the offer is too low, or you can achieve better returns elsewhere – then you can sell.
Of course, every situation is different, but I wanted to outline some points in this article, using current examples, that may be helpful to investors when deciding a course of action.
Before I get into the specifics, I want to say that I don’t have a crystal ball and I cannot predict how these takeover offers would play out. However, it’s beneficial to reflect on and learn from these examples as there were some key signs on what the outcome would most likely be.
Competing Bids
Despite only being early into the new year, we have already had a high-profile takeover offer playout between Wesfarmers and Woolworths. We own Wesfarmers and Woolworths in the Oracle Australian Equities Portfolio, for the pharmaceutical retailer and distributor, Australian Pharmaceutical Industries (API).
The API share price chart below demonstrates the volatility investors can see when multiple company’s enter bids for a business. The distinct V shape on the left of the chart signifies an offer from Wesfarmers. This saw a small rise in price with the offer being a 3% premium to the share price at the time. Woolworths then came to the party with a significantly higher offer, which is the obvious sharp incline in the middle of the chart.
Source: Factset
If you were an investor in API prior to the Woolworths bid, a great outcome would have been to sell on the news, as shareholders could have cashed out at the bidding price. If you held on too long, the price dropped significantly when Wesfarmers blocked the Woolworths bid.
As always hindsight is 20:20, but a key lesson from this scenario for investors involved in takeover offers is to look at the share registry.
Wesfarmers had taken a 20% substantial holding of API in July last year after they put in their first initial bid for the company. When Woolworths came out with their bid, Wesfarmers said they would not back the offer. This would have left Woolworths owning only 80% of API and their rivals holding the remaining 20%. Knowing this, it was difficult to see how Woolworths could have taken control of API. Woolworths then withdrew their offer and unsurprisingly, the share price then fell back to the Wesfarmer offer level.
Takeover offer falls through
A recent takeover offer made on the ASX was by a consortium led by TPG Global for Smartgroup, a company we own in the Oracle Emerging Companies Portfolio. This was a 32% premium to the price Smartgroup was trading at the time, so it would have been a good windfall for investors. This original offer was subject to due diligence by the consortium into Smartgroup’s books, which as you can see in the graph below didn’t work out for Smartgroup. After performing due diligence, the consortium lowered their offer and Smartgroup subsequently decided not to proceed with talks.
Source: Factset
On reflection of the Smartgroup offer, it may be said that the original offer was too high. If the market expects the offer to be fair and to proceed then the share price of the takeover company will normally trade in line with that price. In this instance the Smartgroup price still traded at an 11% discount to the offer, a sign that the market thought the offer was too high. A further interesting factor to note with this offer was the exclusivity granted to the consortium while due diligence was undertaken. This meant there was no chance another party could come in and propose a higher offer for Smartgroup.
Successful Takeover
For the third and final example, we’re looking at a successful takeover, one which is big news in the Australian financial universe. This deal was not only the largest deal in 2021, but the largest deal in Australian history.
The deal I am talking about was Square’s $39bn takeover of Afterpay, Square has since changed its name to Block. This was a huge price, valuing Afterpay at a whopping 41 times sales. The offer was made fully in stock and not cash, whereas Afterpay shareholders would receive 0.375 of Square shares for every 1 Afterpay share they held. We don’t own either Afterpay or Square in our Australian Equities or Global Equities portfolios, so we didn’t have a vested interest in the deal.
At the time this looked like a good deal for Afterpay shareholders. However, since the first offer, the Square share price has declined sharply, taking the Afterpay share price with it. The deal has now been completed and Square is trading on the ASX as a CHESS Depositary Interest. The current Square share price represents $60 for each Afterpay share Australian investors had prior to the deal, a decrease greater than 50% since the offer became public and equated to $126.21 per Afterpay share.
As the offer was made fully in shares and not cash, the Afterpay share price was going to be tied to the Square share price until the deal went through. As an investor in Afterpay you would have had to come up to speed quickly on Square as a company and their valuation to gauge the best response to the offer. If you were unable to take a view on Square’s intrinsic valuation and the prospects ahead for the company, selling your Afterpay shares at the time of offer and taking profits was likely your best move.
Key Takeaways
After analysing the three scenarios presented in this article, there are a few key takeaways you can use when deciding the best course of action in future takeover offers.
- Always check the share registry of both companies. By knowing who the top shareholders are, you will gain an understanding of anyone with enough voting power to block the deal. A list of a company’s top shareholders can normally be found towards the end of a company’s annual reports.
- When an offer is made at a premium to the current share price and the gap between the two doesn’t close, the market is telling us the original offer is most likely too high for the company being taken over.
- If it is an all-scrip deal (all shares), the decision to sell on the news may be your best one. Especially if the buying company is one you are not overly familiar with and have not completed any research into the acquirer. The share price of the takeover target will be tied to the future performance of the acquirer.
As I stated earlier, each takeover scenario is different, but there are normally indicators investors can be on the lookout for when deciding how to proceed. By keeping these lessons in mind, it may assist the shareholder to make the best decision on what to do when your company is offered to be acquired.
Written by Jack Magann
Oracle Emerging Companies Portfolio Manager
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