Takeovers are arguably the most exciting aspect of stock market investing because it is one way that investors can make substantial profits in a short space of time. Newspapers love takeovers because they often involve companies with colourful personalities as chief executive – so there is generally plenty of press coverage, which means shareholders can easily keep themselves aware of any developments.
It is quite likely that at some stage you will invest in a company that is subsequently involved in a takeover or a merger (a merger is when two companies join together as equals to become one). This activity is referred to as mergers and acquisitions, more often than not abbreviated to M&A.
Takeovers may be:
· Friendly: a friendly bid is where the two sides agree on a price and the target company recommends its shareholders to accept.
· Hostile: in a hostile bid, the target company tries to fight off the bidder and advises its shareholders to reject the offer.
Takeovers and share prices
In takeovers, the share price of the target company tends to rise, sometimes even before the bid is announced. This may happen because news of an approach leaks out or because investors sense that a particular company is susceptible to an offer. Since investors privy to inside information can make large profits from buying shares before a bid is announced, the procedure is governed by a strict Takeover Code. Bidders believe that takeovers create the opportunity to increase sales or cut costs, which is why they are usually willing to pay a bid premium – that is, they offer more than the prevailing market price. The share price of a bidding company often falls as its shareholders fret over whether it is paying too high a premium.
Although takeovers can happen at any time, they are understandably more prevalent when shares are comparatively cheap. A surge of takeover activity can be a sign that the stock market is rising again after a fall; similarly, the sudden drying up of takeovers can signal that the stock market has peaked.
Do takeovers work?
Opinions vary on whether takeovers really work. Among the most spectacular successes was Hanson, built into a transatlantic conglomerate giant in the 1980s by an astute strategy of buying undervalued companies.
On the other hand, some boards seem merely to want to flex their muscles in a show of strength, or they have run out of ideas for growing the businesses they already have. Takeovers can end up destroying rather than creating value, although that is all too often forgotten when the next wave of takeovers comes along.
One group of people always gain in a takeover situation, whatever the outcome. An army of highly paid advisers drawn from each company’s lawyers, stockbrokers, financial advisers and PR experts pore over all the details at great and expensive length.
Takeovers
In a takeover, one company buys another. We shall refer to the company making the bid as the bidder and the company on the receiving end as the target company. The bidder is also referred to as the offeror and, less formally in the press, as a predator or a suitor.
The majority of takeovers and mergers involve companies in the same line of business. This is known as a trade deal. These deals are popular because there are advantages in putting two companies with complementary businesses together.
It may be possible to grow the combined businesses by selling goods and services to each other’s customers or by creating a nationwide business instead of two regional ones. Working together to boost sales is known as synergy.
There could also be cost savings, for example from combining the sales staffs or from putting manufacturing facilities under one roof. This is cost cutting – although companies will often incorrectly refer to it as synergy because this sounds better than saying staff will be fired to save money.
If the bid is from a company outside the sector it is referred to as a financial bid. In this case there are no synergies to be achieved as the businesses cannot be combined, although it may be possible to boost sales through more dynamic management. The bidder will probably be hoping to make the operations more profitable by cutting costs.
Takeover Panel
Where one company buys, or attempts to buy, another company, the procedure is governed by a strict set of rules called the Takeover Code and is supervised by the Takeover Panel, an independent body established in 1968.
Takeover rules have been tightened considerably over the years for the good of all investors.
The Takeover Panel has 36 members representing a spread of expertise in takeovers, securities markets, industry and commerce. Members include representatives of professional bodies such as the Association of British Insurers, the Association of Investment Companies, the Confederation of British Industry and the Institute of Chartered Accountants in England and Wales.
This is not a cosy Old Boys’ club, nor is it a protection racket to preserve the rights of City bigwigs. It has developed a justified reputation for fairness and even handedness. It does not flinch from bringing large quoted companies and their City advisers to book in order to ensure fairness for all, including small shareholders. The Takeover Panel expects the spirit of the Code to be followed as well as the letter of the law.
The Takeover Code has been developed since 1968, not only to promote fairness but also to ensure that takeovers and takeover battles are conducted in an orderly fashion. Its rules apply even before a bid is formally launched and it governs not only the companies involved in the bid but all their advisers.
The Code does not rule on whether a takeover is set at a fair price or makes commercial sense. That is a matter for the shareholders to decide.
You can read the full details of the extensive and thorough Code by logging on to the Takeover Panel’s website (www.thetakeoverpanel.org.uk) – the relevant web page is: www.thetakeoverpanel.org.uk/wp-content/uploads/2008/11/code.pdf. In the next two chapters we shall pick out the main points that affect small shareholders.
Mergers
In a merger, two companies agree to come together to form a new group. A new company will be set up and shareholders in both existing companies will receive new shares in the new group in place of their existing holdings.
The size of the allocations will depend on the sizes of the respective companies that are merging. Assuming that both companies are quoted on the stock exchange, the ratio will be broadly in line with their market capitalisations.