Should You Buy Afren Plc For Its Bid Potential?

Shares in Afren (LSE: AFR) are among the top risers in the FTSE 250 today after speculation surrounding a bid for the company has intensified. This has taken place because Afren’s potential suitor, Seplat Petroleum Development Co, has secured a refinancing deal that includes an option to extend the facility by up to £700 million in order to take part in M&A activity.

Furthermore, the two companies have confirmed that they are now in ‘highly preliminary’ talks regarding a possible takeover of Afren by Seplat, although no information has been given on the numbers being discussed or whether any offer would be cash or cash plus shares in the new entity.

A Challenging Period

The potential for a deal seems to have come about at least partly because of the considerable fall in Afren’s share price in recent months. For example, it has declined by 79% over the last year, thereby making the company more attractively priced to potential suitors, such as Seplat. Clearly, a key reason for this has been the fall in the price of oil, but a payments scandal involving Afren’s former CEO and COO also caused investor sentiment to weaken considerably.

In addition, just this week Afren’s share price was dealt a further blow when it announced that there had been a significant downgrade to the reserve estimate at the Barda Rash field in Kazakhstan. As a result of this, Afren is said to be considering its options in regard to the future of the project.

Bid Potential

Clearly, a bid for Afren is a distinct possibility and, for investors in the company, it could prove to be a good thing. Although it may not recoup losses felt over the last year, it may provide an exit at a share price that Afren is perhaps unlikely to achieve without being taken over – especially while the price of oil keeps on falling.

However, buying shares in any company just because a bid seems likely is a high-risk strategy. Clearly, if no bid materialises (which is still a possible outcome of the talks) then Afren’s share price is likely to fall considerably, since a takeover premium is already starting to be baked into its valuation. For example, Afren is now trading on a price to earnings (P/E) ratio of 18.9, which appears to be rather generous given the challenges it is facing. Of course, if a bid does come in from Seplat, then a further share price rise is almost inevitable.

So, the outcome appears to be somewhat binary and depends on the outcome of an event that none of us can accurately predict. Due to this being the case, it may be prudent to sit on the sidelines and seek out other companies that appear to have more appealing long-term prospects than Afren.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has recommended Afren. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.