With M&A activity showing no signs of abating, shareholders in UK takeover targets have received significant premiums in return for agreeing to sell their shares. US private equity firms scooped up a number of UK companies in 2021, including Morrisons and John Laing. As the New York Times put it, “Private equity firms all want the same thing: British companies.”
According to Refinitiv, global M&A hit $364 billion (£270 billion) in January 2022, the third-highest on record, while European deals were at their highest for 20 years. Refinitiv reports that the UK was the second “most-targeted nation”, accounting for 13% of cross-border M&A deals. Technology was the leading sector by value, accounting for a third of global M&A.
Let’s explore how shareholders can make money from M&A, why UK companies are attractive takeover targets and how to identify possible takeover targets.
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What is M&A?
The term ‘M&A’ refers to mergers and acquisitions of companies. Although often used interchangeably, they’re actually different processes:
- In a merger, two companies (usually of a similar size) join together. For example, 2021 saw the £31 billion merger of O2 and Virgin Media.
- In an acquisition, one company ‘buys’ the other company. Meggitt plc (a UK defence and aerospace company) is in the process of being acquired by its US rival, Parker-Hannifin.
How do shareholders make money from M&A takeovers?
Shareholders of takeover targets are usually offered an attractive premium in return for selling their shares. The ‘bid premium’ measures the offer price against the share price immediately before the acquisition is announced.
According to Ashurst, the average bid premium was 42% for UK companies in 2021. Meggitt shareholders were offered an impressive 71% premium to sell their shares. And US private equity firm KKR recently offered shareholders in John Laing (a UK infrastructure company) a 27% bid premium.
Morrisons was the target of a bidding war last year, with the eventual winner, CD&R (another US private equity firm), paying shareholders 287 pence per share. This represented a 61% premium to the pre-announcement share price of 178 pence. Shareholders would have received even more for their shares had they sold at their peak of 297 pence during the bidding process.
However, bid premiums can sometimes flatter shareholder returns. Companies typically become takeover targets when they’re considered to be undervalued. In the case of Morrisons, the offer price was only at a 6% premium to its share price of 270 pence in 2018, before the share price halved in value.
If you’re a shareholder in the acquirer, or in a merged company, you’ll receive shares in the new, enlarged group. In principle, this should boost shareholder value by delivering higher growth and reducing costs. However, according to a study by the Harvard Business Review, 60% of M&A deals destroy shareholder value.
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Why are UK companies attractive targets?
British companies are currently trading at relatively low valuations compared to their US rivals. The FTSE All-Share index has a current price-earnings ratio (a measure of underlying value) of 15.6, compared to 25.8 for the S&P 500 (the 500 largest US companies).
PWC reports that 2021 was a record year for private equity fund-raising, with firms sitting on over $2 trillion (£1.5 trillion) of funds to invest. Pinsent Masons commented that the “mismatch between the perceived underlying value of a company and its prevailing share price will continue to attract private equity funds to the UK” in 2022.
How do you identify potential takeover targets?
Unfortunately, there’s no magic formula, and it’s not advisable to buy shares in a company solely in the hope that it becomes a takeover target.
However, stockbroker Jefferies suggests that targets tend to have a market value of under $10 billion and profit margins of over 15%. Jefferies identified three categories of possible targets:
- Subject of speculation (e.g. BT, DS Smith and Smith & Nephew)
- Industry consolidation (e.g. Just Eat, Brewin Dolphin and Burberry)
- Previously-failed bids (e.g. Qiagen and Spire Healthcare)
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How can you invest in shares?
If you’re looking for a tax-efficient way of investing in shares, you might consider a stocks and shares ISA. You can contribute up to £20,000 per tax year, and if you do manage to buy shares in a takeover target, gains are free of capital gains tax.
We’ve compared some of the top stocks and shares ISA providers on criteria such as fees, ease of use and choice of investments. IG offers low commissions on US and UK shares for active traders within its stocks and shares ISA.
If you’re investing in shares for the first time, it’s worth reading our beginner’s guide to picking the best trading platforms. One of our top-rated platforms, Interactive Investor, provides regular share tips and ideas to customers.
If you’re looking for a low-cost share dealing account, we’ve also got a list of top-rated providers for you. FinecoBank’s Multi-Currency Trading Account charges £2.95 for trades in UK shares and might be an attractive option for active traders.
