Stockwatch: what does a low bid for this firm mean for investors?

Further takeovers are likely, as the company looks to benefit from an increasingly elderly population.

This Covid-19 era gets more curiously dystopian each day. 

Now we see an opportunistic ‘recommended’ cash offer for Britain's largest retirement homes builder and operator, McCarthy & Stone (LSE:MCS).

I have been aware of McCarthy, which enjoys a circa 70% market share, for at least 30 years. It has been serially bought out by private equity and later re-floated. 

Someone must reckon on upside. Loan Star private equity has made a 115p per share cash offer valuing McCarthy at £630 million. This is despite a 10.5% discount to tangible net assets, even after a £60.4 million impairment charge at interims and accounting procedures, generally meaning the land and homes completed or being built are valued at cost. 

I write partly to draw attention to how shareholders must not assume ‘independent’ boards and advisers can be relied on. 

Also to how McCarthy now represents a classic takeover arbitrage situation: an offer is tabled, net asset value limits downside and there is the off-chance a higher offer appears. 

It may be a low probability, given any rival needs to swiftly get their act together. However, retirement homes offering a measure of independent living could now be a major growth trend.  

Older demographic is projected to soar, and wants to live well

The number of old people is expected to more than double over the years to 2050. Many people must be appalled how hospital patients with coronavirus were deployed into care homes earlier this year, causing many further cases.

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It seems likely to fuel demand for homes where you have a balance of independent space but are part of a community with integral support service. 

Forgive me for losing track of the precise details surrounding buy-outs of McCarthy in the past 30 years. 

But in 2006 it was valued at £1.1 billion and the 2015 re-flotation was priced at 180p per share. Normalised pre-tax profit was £88 million on £486 million revenue. 

Due to lockdown having disrupted building and sales, the consensus forecast for McCarthy’s year to end-October 2020 is a £66 million net loss.

This comes after an underlying interim net loss of £24.8 million in the first half year and a caution with those results that “while we have passed the peak of the crisis, the financial effect will be weighted towards the second half”. Consensus looks to be a £6.4 million loss in the next financial year. 

In line with a bullet point header on July's interim results, however, you would think this period represents a trough before a new era of prosperity. 

Management said: “Beyond Covid-19, we see exciting opportunities due to our unique proposition and our strong brand, enhanced by recent government policy announcements around stamp duty, planning and adult care reform, the evolving land market and the emergence of a new and attractive retirement living property asset class”.

Board’s justification looks unusual 

The 23 October ‘recommended cash offer’ declaration starts by citing 39% to 58% premia to recent market price trends. But even a half-witted shareholder knows that what matters in a takeover is price of offer relative to intrinsic value. Loan Star's offer is manifestly a low-ball one. 

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Section five attempts to justify that by saying that Brexit has disrupted house sales and older people have been unable to sell their homes to move into a McCarthy property. This is rubbish. 

The market in homes for old folks looking to down-size is red hot. During the last three weeks alone, I have been swiftly out-bid for cash in two situations of grandparents looking to downsize, while others seek to live and work remotely. Both these homes had offers accepted within a week of first being advertised. Locals tell me you have got to be really quick as homes are selling instantly. 

These strange justifications continue. For example, because how McCarthy’s strategic shift towards rental and multi-tenure living “introduces complexities to the business” this means McCarthy “may be required to maintain a meaningful longer-term minority equity stake… in order to align interests with a capital partner”. 

This “may have a knock-on impact on levels of capital availability and deployment within the business. Additional operational resources are required to operate the portfolio efficiently”. 

But the sense of a problem arising is absurd. Central banks continue to sustain easy-money policies and the economy is replete with capital seeking a return. Equity investors look desperately for new stories, many still heavy in cash. Analysts like me rack our wits for situations that are not grossly over-valued growth plays or businesses still at risk from Covid-19.  

McCarthy’s management should publish its rationale and projections, so its equity can be evaluated as a ‘buy’. Manifestly Loan Star rates it as such. The table shows McCarty’s operating margin declining from the high teens' per cent to mid-single-digits. Doubtless Loan Star sees potential to restore this while capitalising long-term on sales. 

In the US, an activist shareholder would intervene

Management's justifications conclude by fretting about Brexit negotiations and Covid-19 localised lockdowns, making near-term prospects and finances "difficult to plan for and predict". Are they not aware how the pandemic is affecting all of us?  

In the US, an activist shareholder – a Carl Icahn for example - would intervene to urge rejecting the offer, replacing the board and likely management too, then table a rival offer and prospectus for the future.  

It is testament to how supine UK institutions are to act as business owners in situations like this. Private equity therefore capitalises on value that properly belongs to the institutions' clients (such as pensioners). 

Perhaps the only pragmatic upshot is this latest example underlining how London’s open stock market also means takeovers will continue rolling in. 

A relatively strong balance sheet to withstand Covid-19 and Brexit

Yes, dividends are suspended, and I note that last April, Peel Hunt expressed the view that bank covenant restrictions might need to be waived if lockdown persisted past the middle of the year. 

But it hasn’t. Lockdowns are localised, the Johnson government is manifestly doing its best to keep business functioning to mitigate public debts mounting up. 

McCarthy’s balance sheet is genuinely strong versus other companies. Within £695.1 million net assets or 129.2p per share, £41.7 million goodwill has been fully written off and £25.2 million intangibles have been reduced to £4.3 million. 

The bulk of assets constitute £709 million of inventories which appear under current assets.

I calculate from note six that these are: 47% finished stock, 36% sites in the course of construction, 13% land and the residual element being part-exchange properties. It is hard to be sure of the £709 million given variation of accounting methods for “stock”, if reasonable to assume such assets are broadly valued at cost. This could represent a further margin of safety for Lone Star.

The bulk of £198.1 million long-term debt has quite recently been introduced, although there is no short-term debt, and £146.5 million cash also. Financial health and bankruptcy scores rate McCarthy well. 

Slight premium in market price reflects hope for a better offer

A merger arbitrage specialist would probably see logic in taking a small position given downside risk is thoroughly underwritten yet a chance exists for a higher offer. 

Admittedly it is an off-chance, but a current market price of 115.4p proves some investors are willing to pay a slight premium to the 115p offer price for such potential. Hence, if somewhat for illustrative purposes: ‘Buy’. 

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