Originally written for Livewire
A takeover frenzy is currently underway on the ASX.
In the Forager Australian Shares Fund, there have been four takeover offers in this financial year alone – ReadyTech (RDY), Nitro (NTO), MSL Solutions (MSL) and iSelect (ISU). If you include the soon-to-complete merger between Tourism Holdings (NZD:THL) and Apollo Tourism and Leisure (ATL) from late last year, that is six in a portfolio of approximately 30 stocks where there has been a takeover deal during the past year.
Private equity likes what it sees
The simplest answer for the large number of takeover offers is that stock prices have been hammered, particularly at the smaller end of the market. Despite being at substantial premiums to recently traded prices, the offer prices for Nitro and iSelect, for example, are still well below where they were trading a year ago.
And private equity is cashed up to bid on these cheap assets. Potentia Capital, the private equity firm bidding for Nitro, raised $635m for a second fund back in July. This is just one example of the significant amount of dry powder ready to be deployed for takeovers in the current environment.
Finally, technology stocks are perfect private equity assets. Take a nice recurring revenue stream, bolt on a few additional businesses, take a knife to the cost base and, in a few years’ time, bring it back to market as the next Technology One (TNE). It’s not hard to see private equity selling these businesses back to us for 3-4 times the price.
While it’s no surprise we are seeing plenty of offers, shareholders need to weigh up the pros and cons of selling. Even if they do want to sell, not all offers translate to successful takeovers.
How to assess the likelihood of success
There are three ways takeovers fail.
Most bids start out as “non-binding and indicative”, meaning the bidder can still walk away. This can be due to something they discover as part of the investigative process, a change in the market environment or a view that they can’t afford to pay enough to convince shareholders to sell.
Current shareholders can reject the offer due to a belief that the company is worth more and, finally, other parties, primarily regulators, can intervene when deals are not in the public’s best interest.
Those risks are all relevant to our current portfolio. iSelect is an example of one that has had to seek ACCC approval, which it is currently in the process of doing. Tourism Holdings and Apollo also went through a lengthy approval process, coming out of it successfully after divesting some assets. MSL is highly likely to go through, given the attractive price and relative lack of conditions, but current investors still have to vote in favour. And Readytech’s second-largest shareholder, Microequities, has publicly stated that the $4.50 bid was not significant enough to attract its support, making this one far less likely.
You can see those probabilities reflected in the current market prices of the respective securities. MSL trades at a 3% discount to the offer price. Readytech at a much larger 13% discount.
Healthcare sector vulnerable too
Another market sector ripe for takeover action is healthcare. The Covid-related disruptions of the past few years have tested this sector’s reputation for resilience. Revenues suffered due to lockdowns and then the recovery has been hampered by staff and patient illness impacting utilisation and profit margins. As rising interest rates inevitably curb discretionary spending in 2023, however, the economically resilient nature of these businesses should come back to the fore.
KKR’s bid for Ramsay has fallen over but don’t think that means a lack of interest. Recently, Industry SuperFund’s IFM bought a private diagnostic imaging company, PRP, for a bumper price. Another Fund investment of ours, Integral Diagnostics (IDX), is similar but much larger and trades at a multiple some 30% lower than the PRP acquisition price. If the market does not start to recognise the inherent value of these companies, private equity will be on the scene.
Cheap stocks should get bought
It has been an eventful few months for takeovers but not particularly surprising. Our Australian Fund portfolio has been hammered over the past 12 months. Yet our underlying valuations of the businesses have barely changed. If we are right about that (it is, of course, very easy to say), the four recent takeover offers are a perfectly natural consequence of dramatically lower prices. There should be plenty more to come.
