Turnaround specialist Melrose’s hostile £7.4bn takeover bid for engineering giant GKN is facing increasingly difficult questions.
Over the weekend, reports emerged that the Government could evaluate whether it’s in the national interest on security grounds given the group’s interests in aerospace.
Meanwhile, GKN this morning raised the issue of its impact on the company’s deficit laden pension scheme, which is particularly apposite in the wake of the collapse of Carillon and the criticism of the way that company’s pension black hole was handled.
In a statement, GKN warned that Melrose’s plans to increase the company’s borrowing could have implications for the pension’s funding shortfall, a clear shot across the bows of the scheme’s trustees, and of the Pensions Regulator in particular. Ouch.
Amid that sort of noise, it’s not all that surprising that a Jefferies analyst note focussing on the bid’s base case, and the value of it to long term investors, got rather overlooked.
But it is still GKN shareholders who are most likely to decide the victor of this City tug of war, which is why the note was important. Those whose interests extend beyond a half hour spin of the financial roulette wheel should pay heed to it.
Melrose has been a highly successful owner of manufacturing businesses, and made its shareholders a fortune in the process. It has achieved this through taking over struggling businesses and fixing them before selling them on after three to five years, although that timetable is “flexible”.
GKN shareholders are being promised more of the same, notwithstanding that GKN is by orders of magnitude bigger than anything Melrose has done to date, and is arguably suffering from temporary weakness as opposed to more deep seated problems.
Jeffries analysts make an important point as regards its timetabling.
“We believe five years is not long in Aerospace and not long enough to capture maximum value for GKN Aerospace,” the say.
As evidence they cite the examples of both Airbus and Boeing, both of which did well last year, and are set fair, but only as a result of sustained investment that it took the market some time to wake up to.
They think the same could happen at GKN, while arguing that its automotive business is well positioned to take advantage of the change that is coming to that market through the widespread adoption of hybrids and electric vehicles “something that again cannot be accommodated within five years.”
They go on to say this: “In both markets, we regard stability as desirable and would prefer clarity as to tenure of ownership. Further, if Melrose owns GKN for five years, would it not start to morph into GKN? In short, Melrose offers a simple initial part solution to GKN shareholders, but it may then get more complex.”
No kidding. Jefferies hesitates to describe Melrose as the wrong solution, but its analysts don’t see it as the better owner while its offer – funded largely through the issue of new Melrose shares and relying on ramping up GKN’s debt – isn’t rated as compelling on valuation grounds.
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Melrose’s bid has become increasingly political. Liberal Democrat leader Sir Vince Cable got that ball rolling by describing it as “short term financial engineering” and pointing out the importance of a company like GKN to the Government’s much vaunted (and much criticised) industrial strategy.
The Jefferies note is important because it takes that out of the equation to focus instead on what matters to shareholders: valuation and what’s best for their money. In doing that, it doesn’t quite knock Melrose out of the park. But it doesn’t do the bidder any favours, presenting an argument that institutional shareholders, and especially long term institutional shareholders, should to pay close attention to.
Melrose’s bid is now looking wonky on multiple fronts.