Private equity swoops on undervalued companies

After a fallow period for M&A in the Australian market, takeover activity picked up in March. Invocare (ASX: IVC), Estia Healthcare (ASX: EHE), United Malt (ASX: UMG) and Liontown Resources (ASX: LTR) all announced that they had been approached by potential acquirers. The combined value of these offers was close to $10bn.

As is the norm, the offers were both indicative and conditional on further due diligence. The proposed offer prices were at reasonable premiums to prevailing share prices, ranging from 28% to 64% and on average 44%. In good news for shareholders, the offers were made on a cash basis.

Private Equity groups featured prominently. Estia’s bid was from Bain Capital and Invocare’s from TPG. The offer for United Malt was from Malteries Soufflet, which is part owned by alternative asset manager, KKR. In contrast, Liontown’s bidder was Albemarle Corporation, a rival Lithium producer.

All four companies operate in industries which are capital intensive. Estia (aged care) and Invocare (funeral services) own substantial real estate portfolios while United Malt (brewing) and Liontown (lithium miner) require ongoing investment in large scale industrial plant and equipment. While Liontown’s mines are not yet operational, Estia, United Malt and Invocare operate mature and at scale businesses with strong and resilient cash flows. The last three of these are all holdings in our portfolios, the types of businesses that we think offer compelling value for investors, notwithstanding a takeover offer. These cash generative businesses with wide economic moats are particularly attractive given none are directly nor substantially exposed to slowing consumer discretionary spending.

Are the bids compelling?

The price premiums are attractive enough to warrant consideration from the boards of each target company, in our view. However, the terms and conditions will be telling. It is a troubling thought that private equity can access, non public information as part of their due diligence BEFORE making any investment. In essence, bidders are requesting a free option to acquire the company, subject to finding out information outside the public domain. A level playing field requires that no investor has access to inside information. All investors risk their capital when making an investment, offering preferential access to non-public information to one class of investor does not seem equitable.

It is highly informative that these bids are all for companies which require heavy investment in fixed capital and physical assets. This suggests an appreciation by the bidders that

1. the replacement cost of these assets is underappreciated by the market, and
2. higher costs of capital will reduce the threat of new entrants into these markets

The bids are also a timely reminder that equity markets are not always efficient. Market dislocations and the short term focus of equity markets participants provides opportunities for bidders who see a compelling outlook for sectors that were previously ignored. Adapting to a world of higher inflation and nominal interest rates has implications not only for the availability of capital but also for competitive dynamics.

It may be the case that the substantial pools of unallocated cash that private equity has built up in recent years is finally finding a home. Irrespective of whether the takeovers go ahead or not, offers on the table have boosted the share prices of target companies materially.

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