Overlooked opportunities in mid-caps
I’m sure most people have heard of middle child syndrome – some have no doubt experienced it...
Morrisons made the headlines last week – not for queues of people buying toilet rolls, but because a US private equity firm made an offer to buy the supermarket group for £5.5bn.
The share price consequently surged some 28%, giving a welcome boost to the funds investing in the UK’s fourth-largest supermarket chain – including Elite Rated Man GLG Income, Threadneedle UK Equity Income and City of London Investment trust.
Job Curtis, manager of City of London, talked more about the Morrisons’ bid in this video interview:
The UK stock market has been unloved for many years due to uncertainty over Brexit and then the pandemic. This resulted in investors abandoning the asset class and leaving UK companies looking cheap.
“Animal spirits, dampened already by protracted Brexit negotiations and the resulting uncertainty, were crushed by the pandemic last March,” commented Richard Colwell, manager of Threadneedle UK Equity Income fund. “Investors scarpered, there was little hope factored into share prices, and no consideration that these businesses might survive – it was act now, ask questions later.
“Much like at football grounds, we are now seeing the crowds return to the UK marketplace. But this is the irony: it is these new faces in the crowd – overseas investors who have perhaps not been emotionally scarred by being in the UK over the past few years – who are set to reap the rewards, rather than UK-based investors who are fearful of another “recovery” fizzling out and are instead shopping for global growth products.”
And indeed, we first saw signs of renewed interest in the second half of 2020, when the UK stepped up with the vaccine roll-out and merger and acquisition (M&A) activity increased.
Armed with cheap capital, private equity firms are also looking to snap up UK bargains, especially now that the spectre of a no-deal Brexit has disappeared and its private equity that is dominating takeover activity so far in 2021.
Chris St John, manager of AXA Framlington UK Mid Cap, commented in a recent podcast: “M&A really started to pick up in the middle of last year. And that said to me that there were people out there who were prepared to take a long-term view – people that saw this area as cheap and as having interesting value. And what I’ve also found interesting is that the M&A buyers we’ve seen have been not only private equity buyers and financial buyers, but corporate buyers as well. We’ve also seen a very broad spread in terms of the end markets [of these M&A targets], with companies like McCarthy & Stone on the housing side, Urban & Civic property, gaming company Codemasters, and RSA in the FTSE 100. So, a really broad, diverse spread of businesses and, given the spread between the cost of debt and the income that you can earn from these businesses, I suspect it’s going to be something that we see more of going forward.”
Charles Luke, manager of Murray Income Trust, added: “It is interesting that M&A activity has increased, signalling value in the market, with private equity buyers particularly keen to pursue companies with the characteristics of good quality such as resilient earnings, good growth potential and robust financial characteristics – we would expect this to continue through the remainder of the year.”
But while takeover bids can be positive for share prices, there is a worry that good companies are being snapped up too cheaply. Alex Savvides, manager of JOHCM UK Dynamic, told us in a podcast interview in November: “The worry is that we lose them too cheaply. Not everyone is going to say no to a bid. Some shareholders will be so desperately in need of the cash, they’ll take it and run.”
The board of Morrisons’ are obviously of the same view as Alex and they rejected the bid saying it “significantly undervalued” the business “and its future prospects”. There is now the potential of a bidding war in the coming weeks if other companies decide to throw their hats into the mix.