Take care in assessing a takeover bid ::

BUYER BEWARE

Date: October 21, 2006
Publication: The Australian
Author: Bina Brown

DO you stay, or do you go? That question is probably being asked by the thousands of investors whose companies are the target of a takeover bid.

Given that any offer should be at a premium to the recent share price, the quick answer is: take the money and run.

Actually, it depends on a number of factors, including the price being paid, what value you put on the business being acquired, whether it is a scrip or cash bid, the reasons for the takeover and the expected benefits.

But just because a company thinks it has what it takes to successfully assess, acquire and integrate a business, doesn't mean shareholders have to go along for the ride.

According to the analysts at the independent stock newsletter, The Intelligent Investor, companies on the lookout for potential acquisitions usually want to fulfil growth ambitions that can't be fuelled by internal growth -- it's often cheaper to buy a new product range, than develop one themselves.

It is a lazy approach and the probability of increasing shareholder wealth through external growth has been found to be low, the newsletter says.

Benefits such as reducing costs are known in the game as "synergistic" benefits, the belief that the whole is worth more than the individual parts.

Other reasons for takeovers include better exploitation of assets, realising the value of under-performing assets, benefits of changed market perception from an expanded group, expansion without duplication or start-up costs, and diversification of operations.

But there is plenty of evidence that acquisitions rarely deliver the benefits promised.

Reports show that cash bids are better for investors in the target company and what happens after the merger is a disaster for the acquirer's shareholders.

A summary of several academic studies outlined by consultants McKinsey and Co show that shareholders of acquired companies are the big winners, receiving an average premium of 20 per cent for friendly mergers and 35 per cent for a hostile takeover.

Shareholders of acquiring companies (those parting with the cash) earn very small returns by comparison.

A report into takeovers, mergers and spin-offs among ASX200 companies over the past 10 years, released last year by JP Morgan, found that about 80 per cent of takeovers reduce the value of the acquiring company.

Research conducted by fund manager Clime Capital found that almost every acquisition in Australia where the offer price was greater than the equity of the acquirer resulted in a drop in the share price over the subsequent two years of up to 80 per cent. Examples include Aristocrat, Brambles, Paperlinx and Lend Lease.

Clime chairman Roger Montgomery says that, while acquisitions should be motivated by a desire to maximise real economic benefits, they are often aimed at "expanding the dominion over which management presides".

Running a bigger company, with greater potential to grow shareholder wealth often means more money -- even if they fail to deliver.

He believes too many "corporate chieftains" over-rate their ability to identify and then turn under-performing companies into gold. "It was US investment guru Warren Buffet who first said, 'They think their kisses pack such a punch that it can turn any toad into a princess'," says Montgomery.

"But they end up with a backyard full of toads that have to be written off. What has happened is they have bought something for reasons other than the good of the company and have paid too much for it," he says.

Montgomery's advice to shareholders of companies being acquired is: "If the price being offered seems absurd, then take the money and run."

Montgomery calculates that the current price being offered by Suncorp for Promina is 50 per cent higher than what the business is worth.

While Clime doesn't hold shares in Promina, if it did and the bid is successful, it would be selling. Clime doesn't want to be holding shares in Suncorp if it is prepared to pay so much for Promina.

Holders of Promina shares should be delighted at the Suncorp offer -- and the current rumours of a possible counter-bid.

On the day of Suncorp's offer of 0.2618 Suncorp shares plus $1.80 cash for each Promina share, the bid was valued at $7.65 -- a 15.3 per cent premium on the previous day's close of $6.48.

The chief investment officer of specialist Australian equities manager Platypus Asset Management, Donald Williams, says that, more often than not, they sell into a bid, rather than "punt on the expectation that a valuation gap may improve".

He also never buys anything for its takeover potential because it is just too hard to predict the timing. Really, any listed company is a potential target.

Of course, if you could successfully pick the companies that are going to be taken over, you would not need any other investment strategy. The risk is being left with a whole lot of toads.

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