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Takeover talk – What happens when CEOs snub a bid? Ask FirstGroup’s Tim O’Toole

Naturally, most deals ultimately boil down to valuation - this is capitalism after all

FirstGroup boss Tim O’Toole was shown the exit door after rejecting two bids

What do FirstGroup PLC (LON:FGP), Shire PLC (LON:SHP), Hammerson PLC (LON:HMSO), Flybe Group PLC (LON:FLYB), Norwegian Air Shuttle, Santos Ltd (ASX:STO), and Broadcom Inc (NASDAQ:AVGO) all have in common?

The answer is they have all rejected takeover approaches at one point or another in the first half of 2018.

For some, it was a good call - Shire and Hammerson for example, subsequently secured improved offers - but, for others, like FirstGroup’s now departing chief executive, there’ll be regret.

So why do takeover offers get rejected?

Naturally, it more often or not boils down to valuation - this is capitalism after all. The problem for the executives at opposite ends of negotiations is that valuations are unsurprisingly subjective.

For the boss whose company is in the takeover crosshairs, their point of view is underpinned by potential - confidence and ego put a premium on unrealised assets, as well as the projects in development and the sales of the future.

There’s also the not-so-insignificant matter of career trajectory. What if the cheques for shareholders arrive with a P45?

Plainly, there are personal reasons for management to snub a deal, though it won’t necessarily secure their boardroom seat either.

FirstGroup boss sees exit door

FirstGroup shares slumped 12% on the news that chief executive Tim O’Toole would be replaced with immediate effect.

It came after the UK transport group rejected two takeover approaches from a private equity buyer and coincided with the news of a £326mln loss for 2017.

As one analyst eluded, the sale of the company would have given shareholders an exit whilst offering the company a fresh start.

“Just weeks after rejecting two bids from Apollo Global Management, chief executive Tim O'Toole has paid the price for failing to revive the business in his eight years at the top,” said Lee Wild, Head of Equity Strategy at Interactive Investor.

He added: “The share price is less than half what it was when he joined, and management wants a ‘new approach’. Grim annual results were the final nail in the coffin.”

“With no chance of a resumption of dividend payments anytime soon, FirstGroup shares offer little of interest to long-suffering shareholders. The new CEO will have their work cut out convincing them otherwise.”

High risk bluff and barter

M&A is a high stakes game of bluff and barter. Sometimes rejection invites an improved offer, solicited or otherwise.

Shire was the subject of multiple takeover tilts even before knocking back Takeda’s £42bn offer in April, but, weeks later management were suitably happy to recommend a better £45bn bid.

Holding out for an improved deal is, frankly, negotiation 101.

There’s always the chance that it will also flush out any other interested parties and spark a competitive bidding war, and, that’s arguably the holy grail for the speculative traders that jump into these special situations.

It sounds like such a simple strategy but it doesn’t always work, of course.

Airline industry is full of M&A

Norwegian Air earlier this month looked down its nose at a second offer from British Airways owner IAG, whilst claiming the proposal undervalued the company and its prospects. 

At that time, the Scandinavian budget airline said it had received "several inquiries" though about three weeks later, the market has yet to see a competing bid.

IAG, which had built a 4.61% stake in Norwegian, had said it would now consider its options and at the time of writing, it has not yet ‘gone hostile’ – which happens as its stake rises to the point where it is legally compelled to make an offer directly to shareholders, independent of the takeover target’s view of the proposals.

Ultimately, the company is owned by its shareholders and when those shareholders are sufficiently united and organised, the position of management is quickly reduced to that of any regular employee. It simply becomes irrelevant.

In the airline industry, takeovers and consolidation are rather commonplace, particularly in recent years as tough underlying trading conditions have left operators seeking strength in scale and numbers.

Indeed, IAG itself is the result of the 2011 marriage of BA and Iberia, and the group has continued to pick up brands such as Aer Lingus and Vueling.

Elsewhere in the sector, on a somewhat smaller scale, a possible combination of Flybe and Stobart Group (which runs Southend Airport operations as well as regional Flybe branded routes out of the ‘London’ hub) failed to get across the line back this spring.

An agreement could not be reached on satisfactory terms, the aviation businesses revealed in March.

That deal was proposed as a ‘reverse takeover’, a mechanism whereby a smaller company with a typically cleaner corporate structure and access to funding, agrees to acquire the larger company in exchange for new equity. In a practical sense, such cases are often closer to a merger or even a full reboot for both companies.

Timing is everything

By the nature, all negotiations are contingent. They’re fixed at a certain moment in time, and, the dynamics of any piece of M&A are always liable to change with the prevailing trading condition. It can be a case of landing a shot on a moving target.

Prior to the failed deal in March, the most recent investor communication from Flybe was the October 2017 profit warning.

Just a few weeks after the talks, however, Flybe shareholders shrugged off final results which included the anticipated negative impacts, but, also a positive outlook for this summer’s trading.

All other things being equal (i.e. ignoring the temporary takeover drive spike through late February into March), the Flybe share price is now some 12% higher than it was before Stobart made its move.

Devilish details can derail deals

Questions also arise over the who’s and how’s of a takeover approach, not least if the deal involves any form of private equity investor.

The leveraged buy-outs popularised through the nineties may be rarer in the post financial crisis decade, nonetheless, the practive isn’t entirely extinct.

Capital may be harder to come by and it may be at a higher cost, but, it is still possible to weaponise a company’s own asset base. Well-connected private equity backed investment groups are still able to build the framework of a deal based on the assets that it has yet to acquire.

Sydney-listed liquefied natural gas group Santos in mid-May rejected a US$14bn takeover proposal from America’s Harbour Energy. The offer was pitched as being at a US$4bn premium.

Santos, which is developing a huge project in Queensland, said in its rebuttal that the deal on offer was based on a "highly leveraged private equity-backed structure" requiring Santos support in debt raising and the pre-sale of production.

Santos chief executive Kevin Gallagher was quoted in the Australian media claiming the offer “wasn’t clean” and there was said to be friction with Chinese shareholders, owning 15% of Santos, which opposed the deal.

Outside forces can conspire to squash deal

Problems and obstacles are especially common for mature, highly consolidated sectors like telecoms, technology, broadcasting and retail – all of which have seen tremendous levels of activity over the past two decades.

Here, regulation is the likely stumbling block. It can make negotiation and execution protracted and complex especially if the issue of competition (‘anti-trust’ or consumer protection) is a factor.

Deal structures become increasingly complex and fragmented, sometimes it sees different brands and subsidiaries spun out or sold in separate transactions so that the larger business can get past industry watchdogs.

Even the most avid market watchers would, for example, have to stop and think for a moment if asked who is currently in the process of buying Fox or Qualcomm.

Plainly the landscape for M&A is extremely fast moving and dynamic, with vast sums of money changing hands at the top end of the market.

For senior executives, the pressure to make the right call is high, fortunately for investors they get to speculate, scrutinise and ultimately judge from a position of hindsight.

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