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What makes a company a takeover target?

We take a closer look at how to identify if a company might be bought out, and why investors should care.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The UK could be in for an increased number of buyouts, which is when one company, private or public, buys another. Supermarket chain Morrisons is set to accept such an offer at the time of writing, valuing the company at £6.3bn.

This could act as a catalyst for other takeovers in the UK grocery market, and other sectors. Private equity firms have announced over 120 takeovers and minority stakes for UK companies so far this year – that’s faster than at any time since 2007.

Often a buyout can benefit existing shareholders. The firm buying a company needs to incentivise shareholders to agree to the deal, so they usually offer significantly more than the existing share price.

But what makes a company more likely to be bought? And is it always good news? Remember, this is a nuanced science, and nothing is guaranteed.

This article isn’t personal advice. Investments can fall as well as rise in value, so you could get back less than you invest. If you’re unsure if an investment is right for you, ask for advice.

It can pay to be an underdog

Being a weaker member of the pack can make a company more likely to be bought. Large sectors sometimes have a handful of dominant companies but, as with any pecking order, someone must be at the bottom.

A struggling company is more likely to accept a lower price, which is an obvious reason someone might try to buy it. In situations where a company is viewed as unviable, or simply unlikely to prosper, a private equity firm might want to snap it up and make money from selling parts of the business. This is also known as asset stripping.

But a company doesn’t have to be in terminal decline to be taken over. A lot of the time a relative underdog in a sector, like Morrisons, might be attractive. Not only because it will cost less, but because its size means there’s room for more growth, compared to the industry titans. It might not have the necessary funding on its own to fulfil its potential, and that’s where a buyer can come in.

Another thing prospective buyers are looking for is a niche. If they’re looking to expand and nurture a business, rather than simply asset-strip, then they’ll be after a company with a unique selling point. This could be a business that has a technical speciality, or a retailer with a good reputation for something specific (Morrison’s bakery anyone?).

Another factor that could help secure a friendly takeover is an established management team. Management can be kept on board, even after a buyout, because the buyers admire the strategic direction of their target, and believe existing management has the right tools to continue directing the company.

We’re not saying that if a company is smaller or commercially weaker than its peers, then it’s definitely a takeover target. But it can increase the chances. Some key things that signal a company might be an underdog are:

  • Smaller market share and/ or market cap than rivals
  • Track record (five years plus) of slower sales growth than peers
  • A history of needing extra funding
  • It’s in an industry that looks like it’s in terminal decline

If the shoe fits

Another way to approach this is by thinking about how a company could slot into a bigger company’s existing operations. It’s not just private equity firms that go shopping.

It’s often cheaper for a company to buy a business that provides a product or service it wants, rather than starting from scratch. This is a particularly common theme in large Fast Moving Consumer Goods (FMCG) companies, like Unilever, who rely on constant product innovation to keep their competitive edge. Especially when technology has disrupted the sector – selling makeup or soap is a lot less old school than it used to be. It can save a lot of time and money bringing an already established technology in-house.

A bit like the underdogs, offering an attractive product doesn’t guarantee a takeover bid. But it’s worth asking whether a company offers a service or product that a bigger player could easily absorb. One way to go about that is to take a look at the annual report of some of the big FMCG or tech names. Read about their recent acquisitions, and/or which areas of their business they’re trying to grow.

Our team of equity analysts provide research on some of the biggest stocks in the UK and overseas. So if you don’t want to do all the digging yourself, sign up to our share research emails.

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Movers and shakers

A takeover or minority stake isn’t always commercially motivated.

An activist shareholder is a shareholder who buys shares in a company to try to influence how the company’s run. It could be an individual or a group. The bigger their stake in the company, the more influence they can have.

This can be triggered by a number of things, but is increasingly related to Environmental, Social and Governance (ESG) issues. ESG ideas have become more prominent in recent times, and companies that score poorly could be more at risk of this kind of activism. There’s no hard and fast rule, but companies like oil & gas majors, fast fashion chains or miners could be more likely to trigger activism.

What does all this mean for investors?

Increased private equity activity could be a positive sign for the UK and we think more takeovers of listed UK companies are likely. This could bring opportunities for shareholders and you can use the information in this article to help identify potential targets.

But it’s really important not to invest only on the hopes of a potential takeover. A struggling business can just be a struggling business, and it doesn’t mean a buyout will happen. It’s best to look at companies you’re prepared to hold over the long term, buyout or no buyout.

A takeover isn’t always good news either. While it can mean shareholders receive a premium for their shares, a takeover usually ends a company’s journey on the stock market. That means shareholders could miss out on the benefits of a recovery. It’s important you understand your own preferences and needs before deciding if a potential buyout stock is right for you.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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