Investing In Small & Mid-Cap Equities: The M&A effect
The M&A theme tends to be big in small-caps: these companies are growing, often via their own acquisitions; and becoming assets coveted by both LBO from below and large-caps from above. Our featured strategies feel its effects as both a blessing and a curse.
Luiz Sauerbronn at Brandes Investment Partners says that his portfolio probably feels fewer effects than average because it focuses on well-established names that already own large market shares.
Hamish Galpin at Hermes says that 2014 was a surprisingly quiet year in his portfolio, which would usually see four or five take-outs annually.
“We don’t position for M&A, but our quality bias means our stocks are juicy morsels for the big guys,” he says. The most recent ‘loss’ was Dresser-Rand, bought by Siemens for a 25% premium in Q3 2014.
That quarter saw two bids for businesses in F&C’s portfolio. The first was a welcome one for Nutreco, the Dutch animal-feed manufacturer: its shares had fallen to attractive levels because a big customer, Marine Harvest, decided to produce its own salmon feed; they popped up when family office SHV Holdings made a bid, and again when Cargill and Permira joined the fray. The other was Jazztel, whose strategic deal with Telefónica to roll out fibre optic cable to millions of Spanish households left Vodafone and Orange scrambling to stay relevant: Vodafone bought cable operator Ono; Orange is bidding for Jazztel itself.
“While quality can remain cheap for a long time we always retain faith that, even if the market doesn’t recognise it, other corporate buyers eventually will,” as director of European equities Sam Cosh puts it.
On the other side of the equation, Galpin says that growth-by-acquisition can be risky, but “valid” as a strategy. In his portfolio, he cites an “unusually big” acquisition of unmanned petrol stations in France by Irish distribution company DCC, which has an explicit and so far successful growth-by-acquisition strategy, and Jarden Corporation’s purchase of Yankee Candle to gain more European exposure. These are his two biggest holdings.
But small companies can be just as prone to the temptations of ill-considered empire-building as large-caps. F&C has spent recent weeks reviewing its position in Irish drinks firm C&C Group after it announced a potential bid for an English pub chain. It also sold down its position in Germany’s KUKA when it bought Swisslog, a systems integration business. F&C invested because management had dismantled a conglomerate and made it into a focused robotics business, and to Cosh the new acquisition felt like a return to dilution of that core strategy. Still, some relief came in the form of CTT-Correios de Portugal shelving its bid for Portugal Telecom.
“That was something we were trying to get to speak to them about, to find out why they felt they needed to do it,” says Cosh.
When the animal spirits take hold, sometimes small-cap shareholders have to save their portfolio companies from themselves.