Jupiter: Can the UK's M&A frenzy continue?

We are not yet halfway through 2018 and already five of the holdings in the Jupiter UK Growth Fund have been taken over or received formal bid approaches: GKN, Zoopla, CityFibre, Virgin Money and Inmarsat. Given the fund only holds 37 positions, that is an unusually high hit rate, certainly the highest in any of the eleven years I have been working on the fund. Why has this happened, and can it continue?

The UK is still unfashionable

The first point to make is that the UK is still deeply unloved by global investors. Sentiment, as measured by BAML’s Global Fund Manager Survey, is the worst it has been since 2008, when the UK’s banking system was on the verge of collapsing. In one sense, that attitude is perfectly understandable given the political and economic uncertainty affecting the UK, but it also means that there are some very lowly-valued stocks on the market. Almost 45% of the holdings in the UK Growth Fund now trade on a p/e multiple of less than 10x¹, and it is not just distressed or structurally challenged businesses that are on such low valuations. Other examples from the fund include names like Lloyds, International Airlines Group and Taylor Wimpey which, in my view at least, are well-run businesses with sensible balance sheets and decent prospects over the long term.

On top of this, I believe the UK stock market has become very myopic, focusing on current-year earnings and heavily punishing those companies that are investing now to drive growth and profits over the medium term. My investment time horizon is longer than this, usually 2-3 years and often further, and so I see plenty of valuation anomalies at present. Other investors, such as private equity or corporates will also tend to operate on longer timelines and this is why they are willing to pay higher prices than the market in M&A deals. This was certainly the case for CityFibre, where the bidder paid a 90% premium to the prevailing share price, and also for the likes of Zoopla and Virgin Money.

The role of luck should not to be overlooked in all this. James Moir (who joined the team as an Equity Analyst at the end of 2017) and I do lots of work trying to identify companies which we think the market is undervaluing, but it still requires a real bidder to make an actual approach and that is much harder P/E to predict. At the start of this year I had my own list of M&A candidates in the fund and, while GKN and Inmarsat were near the top of that list, Zoopla and CityFibre would have been much lower down. Equally, there were a number of names high up the list where, so far, no bidder has emerged at all – so potentially that gives us more to look forward to in the second half of the year.

Engagement is key to our process

I talk a lot with our clients about how actively I engage with the companies we are invested in. That engagement becomes particularly acute in these M&A situations. In the case of GKN, I was asking them to consider splitting the company in two long before Melrose appeared on the scene and, once the bid process was underway, I had several meetings with GKN’s new CEO and CFO to explore and understand the ways in which they could deliver value to shareholders.

With CityFibre and Zoopla, I spoke with the Chairmen of both companies on the day of the bid announcements. The main focus there was to understand how they had assessed the value of their companies relative to the prices being offered by the respective bidders. With Zoopla, the offer price was very close to my own target price, so it was easy to accept Silver Lake’s offer for the fund’s shares and move on. In the case of CityFibre, my valuation aspirations were a fair bit higher than the bid, but might have taken five years to materialise and with plenty of execution risk along the way.

The bid for Virgin Money by CYBG is still ongoing at the time of writing. The first important governance point for me with this deal is to ensure that the board is assessing any offer independently of the Virgin Group, as the latter also receives a royalty for the use of the Virgin brand as well as being a shareholder, so their interests may not exactly align with those of minority shareholders like us. In addition to this, I will be focusing on the IT integration risks arising from any combination with CYBG (particularly in the light of TSB’s recent travails) and the role of the existing Virgin Money management team (for whom I have very high regard) in a combined entity.

If, as seems likely, the UK remains out of favour among global investors for some time to come, then the UK market may see plenty more M&A activity in the second half of the year. We believe our strength in individual stock-picking and our focus on companies with strong cashflows leaves the Jupiter UK Growth Fund well placed to benefit, but, as noted above, there is also an element of luck involved too.

The fund has outperformed so far in 2018, rising 5.5% to the end of May against 1.9% for the FTSE All-Share Index, despite the macro headwinds of rising oil prices, weaker sterling and lacklustre performance by financial stocks around the world. In the meantime, the CityFibre and Zoopla deals should complete over the coming weeks and that is effectively almost 8% of the fund that will soon turn into cash, allowing us to reinvest elsewhere. That will mainly be used to raise the weightings of some of the newer positions that have entered the portfolio in recent months, but James and I have also been exploring a few new ideas which may make their debuts too. 

Performance

Past performance is no guide to the future.
Fund performance data is calculated on a NAV to NAV or bid to NAV basis dependent on the period of reporting; all performance is net of fees with net income reinvested. Source: FE, Jupiter UK Growth Fund I Acc, in GBP, to 31/05/2018. 

¹Source: Jupiter, as at 30/04/2018

Steve Davies is Head of Strategy, UK Growth for Jupiter Asset Management.

Risks

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