What To Do When A Takeover Fizzles

The Motley FoolThere are few things more exhilarating in investing than to own shares in a company that receives a takeover approach. It invariably means instant profits are on offer.

But just as a takeover approach can be massively uplifting, a failed or scotched buyout can be deeply disheartening as the share price could collapse almost as quickly as it inflated.

Easy peasy

On the face of it, a takeover should be a relatively simple business transaction. If Company A wants to buy Company B, then all it should need to do is to make an approach.

However, that is not quite how it works in practice. Instead, a suitor might surreptitiously buy shares in the target company and slowly build up a position over a period of time until it triggers a level of ownership that obliges it to launch a mandatory bid.

Some predators may choose to avoid the stake-building exercise altogether and move in with an offer straight away.  Sometimes, this could happen when managers of both companies agree that a takeover might be in the best interest of the shareholders of both companies. The agreed bid in this case could even be at a knock-out premium to deter other bidders from launching a rival offer.

Hard and fast

There are, unfortunately, no hard and fast rules when dealing with takeovers. That is because each situation is likely to be different. What matter, though, is whether you believe any bid – be it real or imaginary, firm or tentative – reflects the true value of the company.

In the recent case of CapitaMalls Asia (SGX: JS8), the management reckoned that the bid by major shareholder CapitaLand (SGX: C31) was fair. Others reckoned it wasn’t.

They are both right. It really depends on how you define “fair”.

At the current price of S$2.36, CapitaMalls Asia is valued at around 30% above its tangible book value. That is a premium over its tangible assets. In fact, we could even say that it is bordering on being overly generous.

From a dividend discount model, though, the offer might not seem quite as lavish. But that hinges on how quickly the annual payout could grow, if it grows at all.

Here is something else to consider. At the current market price, the historic yield is 1.5%. So ask yourself this: Would you consider buying a REIT that only offers a yield of 1.5%?

Standing firm  

As an investor, if you believe that an offer is inadequate then standing firm could be a good strategy to adopt. It is likely that if you believe that the offer undervalues the company, then other investors might think likewise.

But if you reckon the offer sufficiently exceeds the underlying value of the business then selling your shares and reinvesting the proceeds into something else could be a sensible strategy.

Takeovers could be a significant feature in the coming years, so it could be a good idea to be prepared. According to a recent report, global companies are reckoned to be sitting on about US$7 trillion of cash. That is greater than the economic output of Japan.

Think private-equity company KKR and Goodpack (SGX: G05); think Pfizer (NYSE: PFE) and AstraZeneca (LSE: AZN); think General Electric (NYSE: GE) and the energy assets of France’s Alstom and think Temasek’s bid for Olam International (SGX: O32). These takeovers could be just the tip of the iceberg.

Meanwhile, many global stock markets are flirting with all-time highs. Have you ever asked yourself why?

What matters is that a combination of high stock prices and mountains of cash could tempt some companies to consider acquisitions to spur growth, especially when global economic expansion is expected to be slow.

Ripe for plucking

From an investors’ perspective, looking for vulnerable companies that may be ripe for a takeover could be an easy way to make some quick profits.

However, it is worth noting that just because a business might look like a possible takeover target doesn’t necessarily mean a bid will happen. Consequently, it is important to only buy shares in companies that you are prepared to hold for the long term.

The old rules about investing still apply.

Look for companies that do not properly reflect their intrinsic values. That way you won’t be too disappointed if a takeover approach doesn’t materialise or just fizzles out. Simply saying that this baby looks ripe for a takeover doesn’t really count as an investing strategy.

This article first appeared in The Independent on Sunday.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.