UK stocks are cheap. Stop me if you’ve heard that one before. Yet I was taken aback by just how undervalued our beloved domestic companies truly are.
In the abrdn UK Smaller Companies Growth Trust’s annual results this week, managers Abby Glennie and Amanda Yeaman highlighted “around two UK quoted companies a week are being acquired either by private equity business or other corporates, as merger and acquisition (M&A) activity has increased”.
Kepler Trust Intelligence investment writer David Kimberley also provided some stats this week, noting that 56 companies were “picked off” last year at an average premium of 51% - much higher than in 2021 and 2022.
“Buyers are not typically eager to overpay and, even at these rates, some of these companies are being acquired at very low valuation levels. For example, the recent bid for Curry’s by US asset manager Elliott represented a nearly 40% premium on the prior day’s closing price,” he said – still placing the firm on an undemanding valuation of 8.4x current earnings.
Glennie and Yeaman argued this trend will continue well into the year as interest rates start to fall, which should only accelerate M&A deals – with cheaper debt, companies can afford to borrow more to consume one another.
In their own portfolio, the most recent bid they had was for Smart Metering Systems by a private equity company called KKR.
“This is a good example of an attractive long-term equity investment case, but in a listed structure it required higher debt levels to invest for future growth; something that is currently more digestible in private land than in listed,” they said.
So what are private equity firms looking for?
Alan Gauld, fund manager of the abrdn Private Equity Opportunities Trust, said most are “highly sector focused” and can take long-term views on pricing and growth where patience may sometimes be needed.
“For example, Hg Capital* took London-listed Ideagen private in 2022, a software business that they had tracked for many years. When share price declines in software occurred during 2022, this created a window of opportunity for Hg to acquire the business at a relatively attractive valuation,” he said.
Another “eye-catching” example was EWT buying veterinary specialists Dechra Pharmaceuticals, he noted.
Glennie and Yeaman said private firms like businesses with long-term sustainable cash flows and are often looking for companies where there is a turnaround story, rather than by combining with another business, as typically happens with public mergers.
However, they said that they would never buy a company based on it being a bid candidate, adding that any approaches “need to reflect the true value” of a business.
I tried asking several fund groups, stock analysts and investment platforms to find out if there were any truly undervalued companies on the radars of private equity, but none were willing to respond with names.
This is possibly for the best as, to me, it seems more like a game of chance anyway. Yes, a company could be bid for – sending the shares rocketing – but relying on this seems like a poor way to invest for the long term.
*Hg Capital is an investor in FE fundinfo.