Interactive Investor

Stockwatch: intriguing takeover speculation make this one to watch

1st March 2022 11:01

Edmond Jackson from interactive investor

Our companies specialist has had recent successes in identifying interesting takeover opportunities – could this tech-focused potential deal be another?

A takeover arbitrage’ opportunity is evolving at the £1.5 billion Oxford Instruments (LSE:OXIG), amid advanced negotiations with £3.1 billion Spectris (LSE:SXS) over a possible cash and shares-based offer.  

Traditionally, takeover arbitrage relates to identified valuation discrepancies in a declared offer with agreed terms. The gains for specialist arbitrageurs are only incremental but add up when annualised. Yet nowadays, hedge funds appear to have dispensed with their disciplines merely to speculate on whether a bid might happen. 

Attractive risk/reward if the odds favour a deal 

What intrigues me about this Oxford/Spectris situation is a circa 16% discount in Oxfords share price to Spectriss terms, which themselves appear acceptable and in with a good chance of a deal being agreed. 

Yesterday, a rising share price prompted Oxford Instruments to make an 11.58am announcement that it has been in talks with Spectris since 11 February, and that a possible offer would be at a price level the board would be minded to recommend”. 

Oxford holders would get £31.00 a share, split between £19.50 in cash and £11.50 in new Spectris shares to be issued on the basis of an exchange ratio which will be determined at the time of any announcement of a firm intention to make an offer…”  

The question is whether a 15% discount, as reflected in Oxfords market price of £26.25, is a fair appraisal of the risks here, which appear chiefly to be that some kind of hitch occurs in the course of due diligence. The stated caveat – about altering terms should Oxford make a distribution to shareholders – seems to be an attempt at covering all legal bases, and would not affect net value to Oxford holders. 

In terms of assessing probability here: I note the parties have been in discussions for 18 days and Oxfords board is amenable. 

Spectris followed up with its own announcement, saying it welcomes the confirmation” by Oxfords board that it is minded to recommend the possible offer price, subject to agreement of customary terms and conditions. It referred to a compelling strategic combination, bringing together complementary strengths of Oxford and Spectris…creating significant value for all stakeholders…establishing a UK champion in the high-technology instrumentation sector.” 

Synergies could help bolster sluggish revenue profiles 

The get-together may also reflect a macro feature behind the current takeover trend in UK plc, that it is not all about cheap share prices. Organic growth – of an extent to make investors pay attention – has become harder to achieve, partly reflecting the challenges of Covid, supply constraints and now inflation. 

Looking at the six-year financial summary tables, Spectris has an overall sluggish revenue trend. Even if it achieves consensus for £1.34 billion of revenue this year and £1.4 billion in 2023, this would only resume its median performance between 2016 and 2019.  

True, the 2022 EPS is targeted to achieve 2019 levels and a record 174p is expected for 2023 – amounting to a near two-year forward PE of 15.8x at the current share price of around £27.50. 

I am not a long-term follower of Spectris, partly because for over 20 years I recall the difficulty of calling prospects for Oxford Instruments. It has had various bouts of analyst/investor enthusiasm, yet its chart shows a flat trend from 2002 to 2010, then a roller-coaster to 2016.   

Yes, from early 2019 to last September, Oxfords price rose from near 900p to the current high of around £26, but as of a week ago both stocks had been down significantly since last September. Spectris is down well over 30%, although it did fall 9% yesterday. 

My point is that advanced engineering technology is complex even for industry specialists to predict, which increases the chance that investors will convey to a board they are content to accept terms that represent an all-time high. 

I therefore see very roughly an 80% chance this potential deal will happen. Yes, it is speculative – rather than a strict takeover arbitrage – but investment anyway often involves weighing the odds. You decide your risk appetite. 

Oxford Instruments - financial summary
Year-end 31 Mar

  2016 2017 2018 2019 2020 2021
Turnover (£ million) 320 300 297 314 317 319
Operating margin (%) 6.5 -6.5 12.9 11.6 12.5 16.6
Operating profit (£m) 20.8 -19.5 38.4 36.5 39.8 53.0
Net profit (£m) 7.0 -20.3 65.5 30.0 33.8 41.8
Reported earnings/share (p) 12.2 -44.7 34.1 48.2 55.3 71.9
Normalised earnings/share (p) 56.6 51.1 32.4 55.6 61.3 75.6
Operating cashflow/share (p) 68.7 58.7 53.1 76.4 95.3 71.9
Capital expenditure/share (p) 18.5 15.8 18.5 17.0 12.4 8.8
Free cashflow/share (p) 50.2 42.9 34.6 59.4 82.9 63.1
Dividend/share (p) 13.0 13.0 13.3 14.4 0.0 17.0
Covered by earnings (x) 0.9 -3.4 2.6 3.4 0.0 4.2
Return on capital (%) 6.3 -6.7 15.9 14.6 14.7 19.2
Cash (£m) 21.8 27 20.7 35 120 128
Net Debt (£m) 128 109 19.7 2.3 -58.9 -90.1
Net assets per share (p) 250 231 313 352 438 463

Source: historic company REFS and company accounts

Potentially a useful price entry level into Spectris 

A 30% plus drop must be frustrating for existing holders, but essentially marks a mean-reversion to the long-term bull trend from around 400p in March 2009 to a circa £40 peak last September.   

There was a strong rally from around £22 in March 2020, a point when many tech-related stocks can be regarded as benefiting from momentum buying amid huge monetary stimulus in response to Covid.  

I also like the way the precise number of Spectris shares – as part of any offer – has yet to be struck, but that they will respect a value of £11.50 up to that time. 

This lends a comparable advantage to (potential) Oxford holders in the near term, as it has cut downside risk in the Spectris equity element, given that the potential offer has been declared before equity terms are struck. Spectris has been marked down but I would not necessarily regard that as a thumbs-down on this potential takeover, which could actually work out well.  

Spectris - financial summary
Year-end 31 Dec

  2016 2017 2018 2019 2020 2021
Turnover (£ million) 1,346 1,526 1,604 1,632 1,336 1,292
Operating margin (%) 2.9 18.5 14.5 17.7 -1.4 29.5
Operating profit (£m) 38.3 283 233 289 -18.9 381
Net profit (£m) 10.3 235 185 234 -17.0 347
Reported earnings/share (p) 8.6 189 156 202 -14.6 304
Normalised earnings/share (p) 131 119 145 164 142 138
Operating cashflow/share (p) 181 159 151 207 195 140
Capital expenditure/share (p) 24.0 62.1 82.2 74.6 37.1 30.9
Free cashflow/share (p) 157 97.2 68.7 133 158 109
Dividend/share (p) 52.0 56.5 61.0 65.1 68.4 71.8
Covered by earnings (x) 0.2 3.4 2.6 3.1 -0.2 4.2
Return on capital (%) 2.7 19.2 13.9 18.9 -1.3 27.8
Cash (£m) 83.5 138 73.1 213 222 168
Net Debt (£m) 151 50.6 297 27.0 -65.7 -102
Net assets per share (p) 896 1,010 1,067 1,139 1,065 1,138

Source: historic company REFS and company accounts

20% to 25% near-term downside risk if Spectris walks 

You could say the current market pricing of Oxford at £26.25 is fair, because if no offer materialises the price would drop back to roughly where it stood pre-approach. The risk/reward profile is therefore not attractive if you are playing – in the short to medium term – only for around 15% upside.  

That argument is true if the odds of a successful offer are 50:50. But the market is justifiably, and in my opinion still cautiously, weighted towards the likelihood of a deal. 

Decide for yourself if I am overconfident due to recent successes in pointing out Air Partner (LSE:AIR) and Menzies (John) (LSE:MNZS) as takeover targets. But when updating Menzies on 11 February in response to an approach, I discussed the 510p offer (versus stock at 295p last November) being modest, given 510p was only a median price in the long-term chart context. The stock was then trading at 470p and the market remained cautious. The offeror has subsequently raised its price to 608p, which Menziesboard recommended. My point is that there is scope to take a view on the market pricing of takeover stocks.  

Without an offer, Oxfords six-year financial summary table shows top-line consolidation similar to that of Spectris, with earnings likewise rescued by an improvement in the operating margin. Cost-cutting and reorganisation initiatives – doubtless spurred by Covid in the last two years – can only go so far.  

Yet sales prospects are looking up  

At last Novembers interims, Oxford did deliver a 27% jump in revenue and pre-tax profit, with EPS up 26% – although at least one acquisition has helped. Orders grew at over 18%, or by 26% when using 2019 as a comparator, with double-digit growth across Europe, the US and Asia. 

The CEO said: We have emerged from the pandemic a stronger, more focused and efficient business… we are increasing our investment to take advantage of… the foundation for good growth and medium-term margin expansion.”

So yes, Spectriss timing looks right, and Oxfords improved narrative lends comfort should an offer not materialise.  

As a speculation according to your risk appetite: Buy. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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