It’s been a few years since the LSE has seen a good ol’ fashioned hostile takeover the size of Melrose Industries’ (LSE: MRO) proposed acquisition of GKN (LSE: GKN). And although it’s far from clear as to whether GKN’s thus-far-recalcitrant management team will eventually accept any improved offer, I think shareholders of both groups could benefit significantly from the deal.
For GKN, there are a few upsides. On one side, if it goes through its shareholders would own 57% of the enlarged Melrose, which has proposed paying a large chunk of the purchase price in its own equity. Considering private equity-like Melrose’s repeated success in buying, improving and selling on a series of industrial firms, becoming shareholders would be a great thing if past performances can be repeated.
On the flip side, even if the takeover offer falls through, GKN’s board and new CEO will be extra motivated to repair the group’s recently dented reputation, move forward with much-needed plans to improve margins and recover from the series of recent profit warnings from mis-accounted inventories.
And GKN is in a good position to achieve these goals as the company is a market leader in critical-but-niche areas of automotive and aerospace design where barriers to entry for competitors are high. This gives the new management team a solid base from which to begin cranking up margins in the coming years if it remains a standalone firm.
A history of success
For Melrose’s current shareholders, the main reward from the deal going through would be the possibility of supercharged returns due to the sheer size of it, which at £7.4bn is by far the largest attempted by the company.
In its presentation supporting the takeover, Melrose’s management team has laid out a plan for improving operating margins above GKN’s internal 8%-10% target that it has repeatedly failed to achieve, with consensus analyst forecasts for 2017 margins coming in well below that at 7.7%.
This would be achieved through head office simplification, exiting lower margin and non-core business lines and investments in higher return areas. Judging by the firm’s success with its current and past purchases, where margins have improved between 500 and 900 basis points at each company, this plan comes across as very realistic, even if Melrose has never attempted to turn around such a large company before.
Just as important as making internal improvements at the companies it purchases, Melrose has been largely successful with the timing and price for disposals it’s made. Between improving margins, reaping the benefits of increased cash flow and striking attractive sale prices for its firms, it has delivered over a 3,000% return to its shareholders since first listing in 2003.
If I were a GKN shareholder, I’d be looking at this index-walloping return with a fair bit of envy and hoping both companies’ boards can find a suitably attractive price at which to make a deal.