This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.
In mid-April, three London-listed companies received takeover bids in the space of 24 hours. Clearly this is not something we’re going to see happen every day. However, it was a sign of the opportunity some private buyers see in UK equities.
Since the start of the year there have been 14 bids for UK public companies from private equity firms. The combined value of those deals was around £13bn, according to Trustnet. These are similar levels to those we saw over the same period in 2021, which was a record year for M&A activity in the country.
Given the performance of smaller companies since then, many investors may look back on that year with fond memories. Invesco Perpetual UK Smaller Companies (IPU), for example, saw 8 companies in its portfolio being acquired at sizeable premiums to their share prices.
Whether we’ll see something similar happen again this year is unclear. But the dynamics that were behind those acquisitions are arguably still in play – which is why we’re probably still seeing such a large number of takeover bids.
Most notably, UK valuations are still below all major global peers. According to Yardeni Research, the UK’s forward price-to-earnings ratio was 10.7 on 17/05/2023. By comparison, the equivalent figures were 18.5 for the US, 13.6 for Japan, 12.3 for the European Economic and Monetary Union, and 11.8 for emerging markets.
A common retort to this is that the UK is a ‘legacy’ market and that its lower valuation is thus warranted. There may be a level validity to this claim but if you look at individual sectors versus the US, valuations are still substantially lower.
As Schroders’ head of strategic research Duncan Lamont noted this week, if you look at the UK market on a sectoral basis versus the US, the former is trading at a sizeable discount to the latter in almost every instance.
Out of 22 sectors, the UK was only trading at a higher valuation relative to the US in two instances – telecom services and tech hardware – at the end of April. In both cases the premium was marginal, whereas the median discount for UK sectors versus their US peers was 26%. For example, UK pharma was trading at a forward P/E of 15.6, compared to 21.4 for the US. Even energy was trading at a nearly 35% discount.
Beyond the bids by private equity firms we’ve seen in 2023, one other sign that the UK does offer more than just a value trap is the fact that the managers of Aberforth Smaller Companies (ASL) have used their gearing facilities, with the trust holding a net gearing position of 5.6% at the end of April.
This may not be unusual for the investment trust sector as a whole, but ASL has only used gearing four times since its launch in 1990, another sign that some investors are positive about the UK’s prospects.
As the trust’s name suggests, ASL invests in smaller UK companies, which are more likely to be subject to takeovers. However, this is also an area of the market that has seen major sell offs over the past 18 months. Indeed, as at 17/05/2023, the average three year discount for trusts in the AIC’s UK Smaller Companies sector was -0.3%, but the average discounts for trusts on the same day were -14.0%.
Discounts may tighten if we see performance start to pick up again. Whether or not the M&A we’re seeing, or other actions like ASL’s use of gearing, will make more investors start to believe in UK companies again remains to be seen.
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