An occasional if persistent bugbear – in small-cap investing especially – is agreed takeovers happening when stock prices are out of favour and the business is doing pretty well.
Hardened investors are realistic to know it happens, and they move on, taking heart that at least equities may be at a discount to fair value more widely.
Right now, and despite recession risks, small-cap fund managers argue the sector has been through a big de-rating since expectations shifted from September 2021 towards interest rates rising. Despite the index improving gradually in the last six months, managers say it is exceptionally low in a long-term context, hence there are buying opportunities.
And so came 20 September news of the acquisition of Finsbury Food Group (LSE:FIF), a leading UK and European manufacturer of cake and bread – supplying grocery retail and out-of-home foodservice providers. The group is very well established, going back to 1925, and more recently has involved small-scale acquisitions such as healthier breads and gluten-free.
Terms of 110p a share value Finsbury at £143 million relative to highs of 115p as long ago as 2007 and 131p in September 2016, with no material dilution along the way. The Covid-related market sell-off was responsible for a low near 50p in October 2020.
Buyer’s modus operandi encapsulates frustration
The acquirer is DBAY Advisors – an Isle of Man-based investment company I previously noted, which acquired Eddie Stobart Logistics when out-of-favour at end-2019. This private equity operator has a shrewd eye for sound companies providing essential goods and services.
Its website declares: “Our goal is to provide our investors with superior risk-adjusted returns while prioritising preservation of capital by focusing on investments with a high margin of safety.”
Therein lies the dilemma: a high margin of safety for the buyer does not square with terms being “fair and reasonable” for existing shareholders – unless big ones who are effectively locked in, take the view we should be grateful to be offered liquidity.
DBAY’s timing is spot-on in the sense of an unexciting earnings outlook and a modest yield versus plenty of stocks offering over 5%. The exit price/earnings (PE) multiple would be 11 times consensus for a slight slip in earnings per share (EPS) this financial year to 10p, then 10.4 times assuming 10.6p in July 2025. A prospective yield of 2.5%, assuming a 2.7p dividend this year, slightly rises.
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The table shows modest mid-single-digit operating margins – to be expected when supplying supermarkets – although a mere 0.1% slip this last financial year to 4.2% versus inflation is commendable. Return on total capital entertains double digits.
Finsbury’s dilemma is not meeting investor expectations for “exciting prospects,” hence the stock being rated modestly. DBAY hopes to enliven prospects with “strategic transformational takeovers” and makes a specific accusation about how a stock listing compromises growth by acquisition.
Yet even within the 20 September offer announcement, four acquisitions were cited from 2015 to 2023 – the last being Lees Foods last January for near £6 million pounds. This is the UK’s leading manufacturer of meringues, plus some sweet treats adjacent to Finsbury’s markets. You do not want to see rapid-fire acquisitions - stock market history has plenty examples of those falling apart in the food sector. Albert Fisher was one of the hottest stocks around, but after a decade-long struggle for survival, entered receivership in 2002 and is nowadays privately held.
Finsbury Food Group - financial summary
Year end 1 July
|Revenue (£ million)||314||304||315||306||313||357||414|
|Operating margin (%)||4.3||1.7||4.9||1.6||5.8||4.4||4.2|
|Operating profit (£m)||13.6||5.2||15.3||4.7||18.2||15.5||17.5|
|Net profit (£m)||9.1||2.2||9.3||-0.8||12.3||11.6||11.4|
|Reported EPS (p)||6.9||1.7||7.0||-0.6||9.3||7.9||8.2|
|Normalised EPS (p)||10.5||13.4||7.9||7.1||8.4||9.2||10.5|
|Operating cashflow/share (p)||14.4||13.9||10.2||15.0||18.7||16.1||15.4|
|Capital expenditure/share (p)||9.6||9.5||8.4||3.7||4.7||9.5||6.6|
|Free cashflow/share (p)||4.8||4.4||1.8||11.3||14.0||6.6||8.8|
|Earnings cover (x)||2.3||0.5||2.0||0.0||3.9||3.2||3.2|
|Return on total capital (%)||9.6||4.3||8.7||2.9||11.2||9.4||9.6|
|Net debt (£m)||17.4||15.3||35.4||38.1||23.5||29.6||33.6|
|Net asset value (£m)||103||103||107||98.4||110||119||126|
|Net asset value/share (p)||79.1||78.6||82.4||75.5||84.7||91.0||96.7|
Source: company accounts.
Roll-over option for shareholders into private equity
The deal has the support of Finsbury’s board, although they have no effective choice when the CEO owns 63% of the company and DBAY has been a shareholder since August 2022 – now owning nearly 14%.
He is electing for an “alternative offer” by way of “consideration shares” – also available to small shareholders – which means people would be holding private equity. At least DBAY has offered individuals this chance, but it’s unclear quite what liquidity it would entail, possibly occasional match-bargain trading.
Not surprisingly, fund manager Invesco - holding 10% - has agreed to sell, probably because its funds holding Finsbury are restricted to listed equity.
Private shareholders are thus in a hardly-unusual dilemma with “controlled” companies: how the best overall option is to cash out, but you do so with a sense you are ceding value.
Problem is, each time this happens it impairs the stock market’s reputation – the source of funding to make companies exciting is increasingly private equity. Companies depart and fewer take their place via flotations.
Implicitly, Finsbury’s CEO reckons he has better prospects to develop the group over five to 10 years then sell it on rather than stay listed.
It is a sad indictment versus say the 1980s and later 1990s when the stock market was truly a focus of small, exciting companies, although plenty of companies appealing for public cash were proven to be flaky over time, and were businesses which private equity would have dismissed at a first meeting (indeed it was how enough tech stocks came to float).
Respectable annual results to 1 July
Last Wednesday’s numbers showed an 11% rise in operating profit to near £20 million, with overseas growth contributing £1.4 million and an acquisition just £0.5 million.
This was on revenue up 16% near £414 million, helped by price rises and volumes – with foodservice up 25%, retail up 12% and overseas up 25%. Gross margins eased slightly, over 2% to 30% due to cost inflation.
With a more normal tax charge, however, net profit eased 2% to £11.4 million.
Operationally then, the CEO and his new backers have reasons to be cheerful, while stock market investors relying on data screening might brush Finsbury aside. The net financial result alone is not even matching inflation.
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Financial debt rose 21% to near £45 million versus £11 million cash, hence, and with interest rates rising, the finance cost has doubled to £2.4 million. Yet £1.1 million finance income (curiously none cited for 2022) meant only an 8% rise in the net finance cost to £1.3 million. There are no leases involved.
Intangibles constitute 70% of £127 million net assets, although Finsbury owns respectable brands such as Vogel’s and Cranks, licences for Disney, Mattel and plenty more – hence there is substance behind an acquisitions history that has accumulated £88 million of intangibles. Say you write that down to around £50 million to be conservative, net assets would be more like £90 million and DBAY is paying over 1.5 times – but probably getting the company quite near its net asset value.
A current ratio of 1.3 (of such assets to liabilities) is satisfactory, and it’s not as if the balance sheet needs discounting for risk – or DBAY needs to mend any financial issues.
A salutary lesson on the modern stock market
Pragmatically, and unless you feel frustrated with a large stake, it is better to accept cash and move on. Look for the next value situation in a market where the approach for Finsbury implies there will be further takeover approaches, especially if a UK slowdown triggers profit warnings.
For those of us reared on listed company investing (not in elite private equity circles) the stated rationale for this deal is quite damning on the modern UK market. Take heart though, private equity is prowling it.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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