Investment Matters

Are we entering deal nirvana?

We have long thought that current market conditions bode favourably for merger and acquisition (M&A) activity (see M&A activity on the rise).

Factors influencing this include recovering earnings, strong balance sheets, a firming of the economic outlook and cheap funding (record low-interest rates).

In the past few months, private equity firms have been in a frenzy to snap up public and private companies, in a world where money is cheap.

Bids this week for two large ASX companies: Hansen Technologies and Altium were evidence of this.

An offer for a company (or “bid”) is a powerful catalyst – the market quickly reassesses the value of companies once they are on the M&A radar.

Several companies in your portfolio are strong candidates for M&A activity.

Over the week, three of these were thrust into the M&A spotlight: Intega, Cardno and Boral.

Whilst the bid for Boral had already been announced, shares in Cardno and Intega jumped on the news finishing the week +15% and +12% higher.

We take a look at announcements from the three “targets” this week and a broader look at how the potential for M&A is factored into your portfolio.

Boral to Seven: premium, please

Boral’s board issued a resounding ‘NO’ to Seven Holdings offer of $6.50 cash per share this week. This was in a font large enough to be seen by Boral shareholders on the moon:

Boral rejects your offer

Source: Boral

As discussed in a previous Investment Matters, Boral received an unsolicited off-market takeover offer from Seven Group Holdings (SGH) in mid-May.

The bid was a classic move out of the Stokes’ playbook. This is one where Seven acquires upwards of 30% of a company (currently ~23%) effectively allowing it to gain control for little to no premium to the target’s current share price.

At a current price of $6.80 – the decision to reject the Stokes bid does not require much thought.

The response, therefore, wasn’t much of a surprise.

Note, a shareholding of 25% and above in a company effectively allows a shareholder to block special resolution, in particular, it can effectively block any acquisition by a third party through a scheme of arrangement.

Some residual value

What Boral’s response did is reinforce the value we have seen in Boral.

An independent expert report released has estimated Boral’s fair market value of $8.25 to $9.13 per Boral Share.

While we take any external valuation (even an independent expert’s) with a grain of salt, the report highlighted elements of value we have long seen in Boral.

We have long thought that Boral would be a key beneficiary of an increase in fiscal stimulus and infrastructure spending. Furthermore, we have always held the belief that it had well-positioned assets that could benefit from a renewed management team.

With a new strategy, board and CEO, and Seven Holdings at its gates, we have seen some of this value reflected in its share price.

Clients have ridden the rise in Boral’s share price up along with the Stokes, with an average entry price of approximately $3.88 per share –returning more than 80% this year.

Boral to Seven: Pay a premium for the privilege

Pay a premium for the privilege

Along with highlighting elements of value we had seen in Boral, the report also highlighted some value we may have underappreciated, including the potential value of the surplus property on its balance sheet (approximately $0.72 of additional value).

M&A still in Boral’s future

Over the longer term, Boral will have to execute its strategy to prove up any further value.

The strategy has three prongs to it.

Despite rejecting Seven’s offer, M&A will be a key element to one of these prongs: through shedding some of its businesses.

Boral has already announced the sale of its USG Boral (completed in March) and Meridian Brick businesses (to be completed in FY22). This has put the company’s balance sheet on much surer footing and facilitated a mammoth buyback (~$700 million).

The company is looking to unlock more value with the sale of its North American Building product businesses and a strategic review of its fly ash business. This comes at a time where the US housing market is booming.

Another prong is the unlocking of value in its existing land holdings – which as mentioned may add further value.

The third will be operational improvements in Australia (and whatever US businesses are retained), with management targeting a Boral in the future that has sustainably higher, through-the-cycle returns (reasonable returns in both “booms” and “busts” – not just “booms).

Boral Targeting $300 million uplift in operating profit – including $200-250 million in Australia
Boral targeting uplift in profit
Source: Boral

Boral's current share price already gives it credit for a number of these initiatives. We are therefore less optimistic than the Independent Expert’s report about the remaining upside.

We are also weary in ascribing the full value of planned operational improvements, just yet.

Given Boral’s history, we would prefer to see more ‘walking’ before ascribing significant value to the strategic initiatives highlighted over the past 6 months.

Cardno and Intega: back in the crosshairs

It has been over a year since we published our piece on Cardno and Intega (see A dislocated duo).

In the article, we briefly outlined why we thought both stocks were incredibly cheap, particularly considering the prospect of increased infrastructure spending.

Their share prices have risen by 262% and 191% since then – with a noticeable reaction in recent months to President Biden’s proposed infrastructure bill.

We have subsequently trimmed our position in Cardno, while we have continued to add to our position in Intega, which has remained significantly more undervalued in our view.

This week, both companies announced they will be undertaking “strategic reviews” to maximise shareholder value.

It appears both companies have become takeover targets - as we suspected would be the case.

With respect to Cardno, the announcement specifically referenced “a number of unsolicited approaches from interested parties”.

Importantly, majority shareholder and private equity firm Crescent has indicated it is supportive of the deal (as mentioned in A dislocated duo– they are incentivised to produce a timely outcome).

While we continue to await an outcome from the process, we see that a bid for both companies is likely.

We will continue to represent clients’ interests throughout any subsequent process. In doing so we will look to see that that only a fair offer that reflects the value of either (or both) companies is accepted.

M&A and client portfolios

In addition to being an input to our valuation process, takeover bids are often simply the output of buying cheap companies: something we intend on continuing to do!

The prospect of M&A is an active consideration we make in constructing client portfolios – both in assessing the value of individual companies and the overall exposure the portfolio has to M&A.

We think there is a substantial opportunity in the near term for outperformance through owning companies that may be beneficiaries of merger and acquisition activity.

This week has been a reminder that activity is rising.

We see that client portfolios’ have further potential to benefit from M&A activity in the future in several names including Emeco and United Malt.