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The Economist newspaper had an insightful report on private equity the other week. Private capital, it noted, continues to “supersize” as the number and size of funds swell. The global private equity industry is three times larger than a decade ago, The Economist estimates. The number of PE funds in America has leapt to 18,000. Private-equity dealmaking is hitting records. PE funds made up a fifth of all mergers and acquisitions globally – the highest in at least a decade – said The Economist.
This analysis provides context for takeovers of ASX-listed companies. As funds pour into alternative assets, global private equity funds are expected to pounce on some undervalued Australian companies, privatise them, and later exit their investment.
A key deal was US private equity giant Blackstone’s takeover bid for Crown Resorts, the beleaguered Australian casino and hotel company. In February, Crown agreed to Blackstone’s $9-billion takeover bid, having spurned other offers from Blackstone.
Speculation is rife that cashed-up global private equity funds are running the rule over more ASX-listed companies, some of which are trading near multi-year lows thanks to the pandemic and bearish market sentiment as interest rates rise.
Industry superannuation funds are another factor. The largest of them are participating in consortiums that are acquiring listed companies, such as Sydney Airport. Super funds, too, see the value in acquiring listed infrastructure assets and privatising them.
Clearly, there are new and stronger sources of demand for takeovers. The days of relying mostly on companies to acquire competitors in local or offshore markets are fading. Investment funds are transforming takeover dynamics in Australia.
So, will there be a spate of takeovers this year? Snapping up assets at the start of a rising rate cycle – and during heightened geopolitical and market volatility – makes sense. Now looks like a good time for private equity giants to put their ‘dry powder’ to work and target undervalued ASX-listed companies.
But that doesn’t mean boards will recommend low-ball private equity offers to their shareholders. More likely are schemes of arrangement that require the co-operation of the takeover target to proceed. My sense is there will more takeover approaches, more rejections, and a smaller premium for companies that are acquired.
I have long argued that investors should never buy companies on the basis of takeover speculation. The goal should be to find quality companies and buy them when trading at bottom-quartile valuations. Companies that are good investments, with or without takeover. This form of deep-value investing is usually a good basis for takeovers because eventually predators pounce when assets are mispriced for too long.
Here is a snapshot of three large-cap and two small-cap takeover targets:
5 year stock chart of Brambles (BXB.ASX).
Transport and logistics group Brambles looks a prime takeover target for private funds. Media reports speculate that KKR has started crunching the numbers on Brambles.
That does not surprise. As the world’s largest pallet-pool provider, Brambles has a sustainable competitive advantage through its scale. Pallet shortages and rising timber prices have caused plenty of headaches for Brambles during Covid, but it is an obvious beneficiary of a recovering global economy after the pandemic.
At $9.71, Brambles is trading well below the consensus share-price target of $11.58. The stock looks undervalued, with or without takeover. Brambles has fallen from a 52-week high of $12.70, even though its outlook is improving as the global economy recovers and supply-chain disruptions in pallet pooling are slowly resolved.
In its FY22 interim result, Brambles upgraded its underlying profit growth to 8-10%, from previous guidance of 6-7% (excluding restructuring costs), due to expected moderating lumber costs and improving supply-chain dynamics.
The market gave Brambles shares a small lift on the news, but it deserved more. A global predator might see greater value in Brambles than the market does at the current price. Brambles is too good a company to trade near four-year lows.
5 year stock chart of Insurance Group Australia (IAG.ASX).
The general insurance company has been a depressing stock to own over the past five years: the total annual return (including dividends) in the period is -0.2%.
Like other insurers, IAG suffered from macro trends (falling interest rates) and micro threats (commoditised products, rising competition and shrinking margins). Large, unexpected natural disasters – and the resulting insurance claims – added to IAG’s woes. The Queensland and NSW floods are yet another example of the increasing frequency and severity of disasters. Almost everything that could go wrong for IAG did.
For all the headwinds, IAG has a valuable market position as the largest domestic general insurer in Australia and New Zealand. A cycle of rising interest rates will benefit insurance stocks by improving returns on their debt-market investments. Policy premium increases should aid insurance margins, although the outlook is challenging.
At $4.40, IAG looks undervalued. Morningstar, for example, values it at $5.60. The outlook for insurance stocks is improving and there’s a lot to like about the potential for insurance technology (insuretech) to improve margins and distribution.
IAG must look interesting to a larger global insurer or private equity firm at this point in the business cycle, given its valuation and share price are at near multi-year lows.
5 year stock chart of Star Entertainment Group (SGR.ASX)
It wasn’t so long ago that The Star was predator rather than prey. In July 2021, it lobbed an opportunistic, unsuccessful takeover bid for arch-rival Crown Resorts.
Blackstone’s successful pursuit of Crown highlights two things. First, the latent value in integrated resorts (casino/hotels), which is supported by rising property values over time. Second, the opportunistic timing of Blackstone’s offer.
Regulatory probes into money laundering and the effects of the pandemic (governments shuttered casinos during the lockdowns) were headwinds for the sector. If private equity was ever going to make a play in Australian casinos, the time is now as the sector battles depressed tourism conditions and poor investor sentiment.
There’s been far less talk about The Star as a takeover play for offshore private equity, compared to Crown, in the lead-up to its takeover approaches. But like Crown, The Star has valuable casino assets in Sydney. It also has renovated casino assets/hotels on the Gold Coast and the landmark Queen’s Wharf Brisbane project in construction.
The first stage of the Brisbane project is expected to open in 2023, with a phased opening after that. With almost two-thirds of the gross floor space of the project built, construction and implementation risks for The Star are falling.
At $3.35, The Star looks undervalued. The consensus analyst share-price target of $4.18 implies The Star is trading 25% below its fair value. The consensus looks a touch too optimistic, but The Star must look attractive to private equity at the current price, particularly given the company’s falling construction and implementation risks.
Casinos in prime capital cities are terrific long-term assets, and The Star will have one of the best of them in Brisbane. Acquiring The Star when its share price is depressed (the three-year total return is -7.3%) and sentiment is poor makes sense.
5 year stock chart of Monash IVF (MVF.ASX)
I have written positively about the market’s two main in-vitro fertilisation (IVF) providers – Monash IVG Group and Virtus Health (VRT) – over the past year.
Monash’s total return over one year is 35%. Virtus is up 23% and last week received a revised takeover proposal from BGH Capital. As expected, private equity’s bid for Virtus encouraged market speculation that Monash would be the next target.
Both stocks would arguably be better off privately owned than publicly listed. IVF is a tricky business to run as a listed company. The main risk is that leading IVF specialists leave the company, taking their patients with them, as happened to Monash a few years ago.
Even without takeover, Monash has interesting prospects. IVF demand is strengthening, notwithstanding uncertainty due to elective-surgery delays during the pandemic.
Monash and Virtus both reported a change in attitudes during the pandemic as more patients put greater emphasis on starting and extending families. So far, that’s reflected in sharply higher demand for IVF services and fertility cycles.
5 year stock chart of Lark Distilling Company (LRK.ASX).
The market could not get enough of Tasmanian whiskey star Lark last year. Its shares soared more than threefold to $5.18 at the close of 2021. Investors loved the outlook for premium spirits, Lark’s swag of awards, and the future value of its barrelled whiskey.
That was, until the surprise resignation last month of Lark CEO Geoff Bainbridge after a compromising video that appeared to show him allegedly smoking recreational drugs was leaked to the press. The drug scandal, still ongoing, wiped $70 million off Lark’s value.
Lark has tumbled from a 52-week high of $5.60 to $3.43. Operationally, Lark is going gangbusters, judging by the 78% rise in net sales in its recent half-year result. Its whiskey bank of 1.8 million litres has increased by 483,000 litres.
The company’s fundamentals do not change with Bainbridge’s resignation. Losing a CEO unexpectedly is never good for any company, let alone a fast-growing small-cap. But the market has overreacted to the news, even though Lark shares were due for a pullback after such strong gains last year. There was too much hype about Lark late last year.
The global alcohol industry is undergoing consolidation as large beer and spirit manufacturers snap up boutique producers. Lark would be a good fit for a global spirit company that wants to expand in premium whiskies – and turn Lark into the Penfolds of the global whiskey sector.
Management instability and the recent fall in Lark’s valuation might provide an opportunity for a predator to do that. It’s a quality company, at the right price.
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. All prices and analysis at 02 March 2022. This information was produced by Switzer Financial Group Pty Ltd (ABN 24 112 294 649), which is an Australian Financial Services Licensee (Licence No. 286 531This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of WealthHub Securities Limited.