Corporate Finance - Bid survivors continue to feel the heat

Is there any point trying to fight off a hostile takeover bid? If the aim is to maximise value for shareholders, then it would seem not.

Or at least that is the conclusion of research produced by Scottish Amicable Investment Managers. Shareholders in companies targeted by hostile predators should, as a general rule, take the money and run, they say.

Scottish Amicable make their claim after discovering that companies which successfully fight off hostile bids tend to under-perform the market afterwards.

An analysis of all hostile bids over #250m since 1986 found that on average companies which had clung on to their independence under-performed the market by 12% over one year, 21% over two years and 25% over three years following the failure of the bid.

Some companies did particularly badly. Building materials group Norcros under-performed by 56% in the three years after fighting off a 1987 bid from Williams Holdings. Retailer Storehouse under-performed by 66% after fighting off a 1987 approach from a takeover vehicle called Benlox. And financial services and tobacco combine BAT under-performed by 46% after escaping the grasp of James Goldsmith and Jacob Rothschild, bidding in 1990 in the form of Hoylake.

Douglas Ferrans, chief executive of Scottish Amicable Investment Managers, says the idea for the research came to him earlier this year when Granada bid #3.9bn for control of Forte. Faced with the question of whether to back the forecasts and plans of Granada’s Gerry Robinson rather than Sir Rocco Forte, Ferrans decided to delve into the archives and look at how good incumbent directors are at delivering promises made in the heat of battle. The answer was, not very good.

“If management had delivered in terms of unlocking shareholder value which hitherto hadn’t been there, the share price from the time of the failed takeover attempt would have grown, and grown better than the market,” says Ferrans. “That is the judgement you are being asked to make as an institutional shareholder – should I accept this bid and get X pounds now or leave it with the incumbent management in the expectation that their promise of delivering X plus Y over the next few years will be achieved.

“The overwhelming conclusion was that companies had failed to deliver the promises made at the time of the bid battle and the share prices had performed very badly,” he added.

“By managing to persuade a relatively small number of high profile institutions, they can often retain their jobs and save their company from an unwelcome predator. But they are fighting for their lives,” he says.

“You shouldn’t believe what management tell you because when anyone is under threat they will make rash promises – the ability of individuals and corporations to deliver these rash promises is very limited.”

But shareholders continue to believe it. “They have to put up some defence rather than rolling over and just accepting the bid. (But) shareholders have rather naively believed managers will change their spots and deliver a new strategy.”

Ferrans says most of the companies in his research had weak pre-bid share prices because management had failed to deliver a coherent business strategy, manage the business risk and deliver shareholder value. “That was why they were bid for in the first place. Yet as soon as they were put into play shareholders foolishly believed the management and allowed them to escape.”

Industrial conglomerate BTR’s 1987 bid for glass maker Pilkington is a prime example, says Ferrans. In its defence document, the company predicted “performance delivering the benefits of changes that will endure for years to come”. It also predicted “higher margins for our products”.

But that didn’t happen, according to Ferrans. “Analysts say that margins went to near lows, the “geographical and product diversity” proved disastrous and had to be exited many years later when a new management team came on board”.

When Norcros came into play in 1987 it forecast earnings up 30% in the first year and 14% in the second. It managed to keep its independence and the first year came in on target. But second year results were achieved with the help of a substantial property disposal. “The results revealed a decline in margins in all areas and were received with some dismay by the market,” says Ferrans.

But if the results of the research are so clear, why were so many of the bids looked at by Ferrans turned down by institutional investors?

He believes, traditionally, many institutions have adopted the approach that when they buy a share in a company they are backing the management of that company come hell or high water. “It takes an overwhelming argument to convince an institutional shareholder, particularly a large one, that a predator is going to make better use of a company’s assets than the incumbent management, irrespective of how badly the incumbent management has performed,” he says.

“It is not a case of why are shareholders so gullible. When you are buying shares in Pilkington, for example, you are backing the Pilkington story, you are backing the Pilkington strategy and you are backing the Pilkington management. If BTR come along and have a swipe at Pilkington, you tell BTR to where to get off.”

But that is starting to change. “For years and years Forte had not achieved occupancy rates in their hotels, they had low capital expenditure, they hadn’t managed their portfolio efficiently and for five years they had destroyed value. But as soon as there is a bid on the table, all of a sudden there is a new corporate strategy, there is new management being brought in,” says Ferrans.

He believes that in the 80s, institutions would have backed Forte and it would have fought off the bid. But not this time. He says there is now more pressure on investment managers to deliver short-term performance for their clients, which forces them into making short-term value judgements.

“In the mid 80s the pressure on you as an investment manager to perform was not as great as it is today,” says Ferrans. “Pension fund trustees and finance directors are putting us, the investment management community under the microscope, not on a three-year basis, not on a two-year basis but a one-year basis and in many instances a quarterly basis. This pressure to deliver in the short term has changed the investment management industry into focusing on short-term business judgements, like accepting a bid whereas in the past it would have been ignored. The Williams bid for Norcros, the BTR bid for Pilkington – if these bids had been made today they would have been successful”.

In two of the 15 bids which Scottish Amicable looked at the target escaped and did go on to do well. Dixons got away from Kingfisher and outperformed by 48% over three years. Racal fought off Williams Holdings and beat the market by 61%. But Ferrans says those were opportunistic bids for cyclical companies.

He says he gets “very suspicious indeed” of companies which come up with a new corporate strategy as soon as a bid is put on the table. The message from his research is, “Once you get a final bid for a company you are well advised to take that because the laws of average suggest that if you don’t take it the value of your investment will be significantly eroded over the following three years.”

But companies supposedly exposed by the research have cried foul.

Michael Prideaux, director of public affairs at BAT, says that while the company under-performed by 46% in the three years after fighting off Hoylake, it outperformed by 22% over five years. He denies any suggestion that the management of the time made “rash promises” which they couldn’t deliver. And he points out that the company was hit by events which would have had an impact, whoever owned the business, but could not have been predicted at the time.

“We had the domestic mortgage indemnity crisis which hit our financial services business, Eagle Star, in that period, which also encompassed Marlboro Friday in 1993, when Philip Morris cut the price of their premium cigarettes in the United States – that played havoc with our US tobacco profits that year. Those are things that happened, but the notion that they had anything to do with fighting off a hostile bid looks rather like deciding what conclusion you want and going and finding the facts that support it.”

As a result of the bid, “we reshaped the group perhaps more quickly than we might otherwise have done,” says Prideaux. That involved demerging the Wiggins Teape and Argos businesses, which makes it more difficult to compare performance. But Prideaux says the market capitalisation of the 80% of the business left behind after those two deals has been as high as #17bn, compared to the #13bn valuation put on all of the old BAT by the Hoylake bid.

The Scottish Amicable research shows Storehouse under-performed by 66% in the three years after fighting off a bid from Benlox, but Richard Dixon, director of corporate affairs at Storehouse, says the share price performance “had nothing to do with takeover bids”.

“It was structural and related very much to unrealistic market ratings for the whole retail sector,” he says. “The massive boom for the sector came rapidly off the boil at the end of the 80s. Storehouse and others like Next and Burton were extremely exposed. It was exposed whether there had been a bid or not. Following the reconstruction of Storehouse, which was completed around 1992, the share price has actual performed extremely strongly.”

Richard Hughes, managing director of M&G Investment Management, says: “If you change the period from three years to ten years it might totally change the nature of the study.” The question of “what happened next” is very important, he says.

“With bids which have been accepted, you can never know what they might have done had they not been taken over,” he says citing the example of Westland, the helicopter business taken over by engineer GKN which subsequently benefited from orders completed prior to the takeover. And shareholders in companies targeted by Polly Peck, British & Commonwealth or Coloroll might wish they had looked more closely at the bidder’s sparkling track record before taking the money and running. “There were people who accepted paper offers and lost everything,” says Hughes.

He says “share ownership is a two, way relationship – there are responsibilities as well as privileges and they should be balanced. We don’t want a short-term climate where investors are breathing down management’s neck demanding short-term financial performance all the time.”

M&G doesn’t have any general rules on hostile bids. But Hughes says: “We look at each bid carefully on its merits, but tend to take the view that the board know more about it than we do and if the board recommend us not accepting and if we are satisfied we will tend to go along with them.” Sometimes that support will be conditional.

Ferrans says Scottish Amicable is equally willing to back incumbent management.

“If management have delivered what they set out to, if their corporate strategy is intact, they have delivered value to us, they will have nothing to fear at all and we will be loyal to them,” he says.

But he warns: “If we are invested in a company that is bid for, first and foremost we will examine the reasons for the bid. If the reason is that management have failed to deliver on their past promises, and they have failed to deliver, we will show absolutely no loyalty whatsoever.”

Neil Baker is a freelance journalist.

In the last issue of Financial Director we published an article by Richard Halstead highlighting the advice being given to leading British companies by their financial advisers. In the article we implied that confidential papers prepared for Guinness plc by Lazard Brothers & Co Ltd had been deliberately leaked to the press by Lazards. We now accept that the article cast grave and unwarranted aspersions on Lazards’ ability to maintain client confidentiality.

We very much regret the publication of this allegation and we apologise unreservedly to Lazards for the embarrassment and irritation suffered as a result.