Supermarket sweep

Mark it – 8 July, my first day back in the office since 18 March 2020. My triumphant return was driven by the need to record our multi-asset investment team’s first podcast. You will be able to tune into the first episode of The Sharpe End soon, with more to come each month. Look out for them on our website and on whichever app you use for podcasts.

Seeing the team in 3D rather than the two digital dimensions was a good moment – as was the after-work drinks (the ‘wrap party’, as we call them in podcast land).

It’s not yet normality as we knew it, Jim, but it’s getting closer. What struck me though was the unproductive time while commuting. I’m out of practice! Commuting every day sucks up a lot of people’s time, so I doubt we’ll be going back to that daily rat race anytime soon. But when you do jump back on the train, make sure you take a book or some research to keep you occupied. Or better yet – listen to a podcast. Why not our podcast? Do it for UK productivity.

The Sharpe End is effectively a chance each month to be a ‘fly on the wall’ for one of our weekly ‘Costa meetings’. These are informal, formerly in a coffee shop, and a chance to throw ideas around. Anything goes and we see what sticks. We wanted to give our investors an insight into how we go about generating ideas, something that’s hard to replicate in usual formal reviews.

Chasing bids

One of the topics we discussed this week was the outlook for M&A in the UK. Five years after Brexit, are UK assets undervalued – bargains even? There’s been a lot of buzz about this as private equity bids ramp up. One investment bank has listed 40 high-profile UK companies that it believes are potential targets. We only hold three of them. One is a very high-quality business with global scale, the other two we hold because they represent what we think are the best investments on our doorstep.

So will we be buying more of those on the list in the hope of them being taken out? Let me think … No, no and, er, NO!

You see, this list isn’t necessarily one of the great and the good. There are a few great companies in there, but most of them can be more accurately described as the average and the mediocre. Targets tend to be cheap because of problems with the investment case: they have poor management, their sectors are being disrupted, or they lack the capital to evolve and thrive. This is why most deals send the acquirer’s share price falling even as the target’s price jumps: typically, a higher-quality company is adding a lower-quality business to their books. Of course, optimists tell you the deals will increase earnings as the bidder creates synergies and manages the business more efficiently.

This can happen, but on many occasions, it doesn’t.

So if you try to select a portfolio of companies that might be taken over you need patience. Lots of patience. Returns are likely to be low, at best, until the knight in shining armour appears. In most cases they never do and you’re stuck with an underperforming, rusty asset. It’s a high-risk game, which is why most fund managers choose not to play it.

There’s another element to think about. You don’t always want to be a bondholder of a company that’s a target, particularly when private equity is the bidder. Aggressive corporate engineering (also known as piling on debt), can be very dilutive to bondholders’ interests. For an in-depth case study of how that can go, read The Caesars Palace Coup, by Max Frumes and Sujeet Indap, which is the best thing I have read on this subject.

Read it and think, “Morrisons… maybe”. Perhaps you can read it on your next commute!