A takeover approach for this UK mid-cap stock has led to a 30% jump in its share price. Edmond Jackson assesses prospects.
The mid-cap energy consulting and engineering group John Wood Group (LSE:WG.) has become a prime example of “worth to a private owner” that I discussed among principles for ISA and SIPP stock selection just recently.
I drew attention as a “buy” last October at 115p after noting directors had acquired more than £300,000 worth of equity since the August interim results. While a turnaround appeared under way under a new chief executive, the Ukraine war dealt a blow to sentiment in cyclical type stocks. In addition, a meagre 1.6% operating margin helped explain Wood’s single-figure price to earnings (PE) multiple. Yet the CEO cited a strong order book and a major disposal raised £1.5 billion that has cut net debt near £300 million.
The stock has gradually crept up, helped by markets’ recovery, although weak sentiment lingered, for example, in January when one analyst downgraded his target from 275p to 140p, and from “buy” to “hold”.
But cash says more, and late Wednesday (22 February), Wood announced that it had received takeover approaches from US private equity firm Apollo Capital Management. A potential cash offer at 230p a share, near £1.6 billion, had been rejected as significantly undervaluing the group.
The stock opened over 30% near 205p yesterday, albeit with active trading that closed just below 200p.
Apollo has disciplined form on listed plc takeovers
There are plenty of bid approaches that never get announced and come to nothing. Apollo similarly made three proposals to education group Pearson (LSE:PSON) a year ago, for a possible cash offer at 870p a share, but was likewise rejected as an undervaluation.
Having jumped from around 600p, Pearson then fell from 786p to 739p and steadily advanced to test 1,000p late last November, currently 908p.
The implication is Apollo being astute at picking recovery situations albeit disciplined not to pay full value. A limitation on a private equity relative to industrial buyer is an inability to exact “synergies” where 2+2=5 as a result of combining operations.
Wood shareholders can at least take comfort that if no actual bid materialises, then market price is unlikely to fall back to around 140p (a week ago), barring a global recession. A potential cash offer of 230p valuing Wood at £1.6 billion, says a lot more than any analyst can write.
Recent challenges to divine Wood’s prospects and value
Mind it has nowhere near as good a financial record track record over recent years, as Pearson, although a capable CEO (since last July) proclaims in a trading update on 12 January that: “This is a new Wood, led by a new team, and our strategy will enable us to deliver sustainable returns. We have attractive growth prospects in our core markets...we’re focused on designing a strong future and enter 2023 with positive momentum.”
The long-term chart conveys the stock as very much over-sold, where reversion to a mean level implies more like 300p.
Yet market prices over the decade from 2010 could have been skewed on the upside; first by high oil prices bolstering services’ demand that was unsustainable, given revenue has slipped steadily from £8.3 billion equivalent in 2018.
Second, hopes were raised in 2017 by the £2.2 billion acquisition of peer company Amec Foster Wheeler; but which arguably harmed value, affirmed by the stock falling from 700p five years ago to 115p last October. Only last November was £98 million equivalent paid to settle US litigation over Amec’s cost increases and delays on a 2013 contract.
Third, and more subtly, the de-rating may also reflect fears that revenue derives predominantly from oil & gas-related work, as if the stock is long-term ex-growth and should instead be priced for yield.
If so, then Wood is between two stools given it has not paid a dividend since a 9.4p equivalent in respect of the first half of 2019, and even if free cash flow is restored in 2024 (the CEO guides for), the 4p a share targeted by consensus implies only a 2% yield.
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While Wood is pivoting towards de-carbonisation and the hydrogen economy, “sustainable solutions” constituted 22% of 2022 group revenue.
You can, of course, take the alternative view – as might Apollo – that despite climate concerns, fossil fuels will have a significant role in global energy for decades yet.
A high valuation and quite problematic net assets
While 25 times price to earnings (PE) looks plenty high enough at 200p a share, based on consensus for 2023 earnings per share (EPS) around 8p equivalent, near £5 billion group revenues make its profits sensitive to margins.
If the CEO knows what he is doing, and his January words were fair, a high PE is currently rational as the Chinese economy opening up from Covid should help energy demand – again I stress, assuming no recession.
Last June’s balance sheet had net assets near £3.5 billion equivalent or 507p a share; albeit constituted 117% by goodwill and other intangibles (the premium paid to net tangible assets in past acquisitions).
This was followed last September by net proceeds around £1.4 billion from the sale of the built environment consulting side, which has reduced net debt from around £1.5 billion equivalent to around £300 million excluding leases. While tricky to fathom the upshot for Wood’s interest bill, it should escape the effect of higher rates.
Quite some dynamics are therefore involved, to discern a fair value for Wood, meaning Apollo (or any other potential bidder) may not have finalised on a 230p a share.
John Wood Group - financial summary
Year end 31 Dec
|Turnover - $ million||5,001||4,121||5,394||10,014||9,890||7,564||6,426|
|Operating margin - %||3.2||2.2||0.5||1.7||3.1||-0.4||0.5|
|Operating profit - $m||159||89.4||27.9||165||303||-32.9||32.3|
|Net profit - $m||79.0||27.8||-32.4||-8.9||72.0||-229||-139|
|Return on capital - %||5.0||3.0||0.3||2.1||4.1||0.5||-0.1|
|Reported EPS - cents||17.3||7.3||-7.4||-1.3||10.5||-34.1||-20.6|
|Normalised EPS - c||67.5||51.3||38.7||28.7||22.2||-0.3||1.1|
|Operating cash flow/share - c||123||49.5||34.2||80.9||96.4||45.1||-8.8|
|Capital expenditure/share - c||21.8||22.7||18.0||13.8||21.3||13.1||17.0|
|Free cash flow/share - c||101||26.8||16.2||67.1||75.0||31.9||-25.8|
|Ordinary dividend/share - c||30.3||10.8||34.0||35.0||11.4||0.0||0.0|
|Covered by earnings - x||0.6||0.7||0.0||0.0||2.0||0.0||0.0|
|Cash - $m||851||580||1,257||1,353||1,857||585||491|
|Net debt - $m||320||349||1,641||1,559||2,052||1,568||1,855|
|Net assets/share - c||633||576||732||674||645||606||590|
Source: historic company REFS and company accounts.
Effectively, a ‘put up or shut up’ declaration by Wood
Wednesday’s announcement closed by saying it had been made without the consent of Apollo, which under the Takeover Code has until 5pm on 22 March to make an offer or concede not.
For Wood, this deals cleanly with a possible ongoing distraction; albeit has been well worth engaging to make clear to the market, an opening cash offer of 230p is judged an under-valuation.
While there has not yet been any comment by Apollo, it took 19 days last March from the initial declaration to say it had been unable to agree with the board on terms, hence did not intend to make an offer.
Arguably, that process has gone on for more than a month with Wood, given its announcement cited 26 January as “the most recent” proposal of 230p a share. Although if Apollo’s intent is serious, its advisers will now be sounding out institutional holders – as to what they might be prepared to accept.
Possibly a week or more, to flush out a verdict
I would be surprised if 230p is the end of it; the behavioural economics of takeovers normally involve an initial rejection where fair value is controversial. After Wood’s long and extensive share price decline, Apollo is naturally being opportunistic.
The chief risk is this potential offeror declining to match what enough institutional holders would sell for. A private equity buyer needs to figure its margin of safety besides potential value years hence.
Woods’ operations also do not appear the kind where debt can be employed to leverage gains on (acquired) equity, squeezing the business for higher margins and cash. A debt burden has only just been removed.
Given Apollo has already devoted some resource, I would expect it to continue exploring options, although would not hold breath for a bid seriously north of 230p. Hold.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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