As well as disregarding risk, investors are starting to ignore actual disappointment too, observes Lex. “In the current private equity frenzy, when bids fail, the share prices of the target companies barely budge,” the column says, noting that Qantas, the Australian airline, is only 2 per cent off its recent high following the collapse of a bid from a Macquarie Bank-led consortium, and “ditto for the overvalued UK retailer J Sainsbury – its shares are 6 per cent below their level just before CVC Capital Partners walked away from bidding.”
In the US, however, this pattern is less apparent, “since lighter regulation and less suspicion about private equity mean that fewer deals fall through,” Lex notes.
There are three possible reasons for the trend elsewhere. “One is that the bid opens analysts’ and shareholders’ eyes to hitherto unidentified value.” A second reason is that private equity approaches, even if unsuccessful, “can jerk management into life, which ultimately raises the market’s expectations for future returns”.
There may be some truth in both these claims, says Lex. “But it is unlikely that these factors explain the entire gap between the share price prior to an announcement and the level it settles at after a bid fails”, it adds, noting that Qantas’s stock is up 180 per cent since the first rumblings of an approach were heard.
This leaves the third and most likely explanation: markets are expecting follow-up approaches.
“Unlike the old days, when trade buyers were few on the ground, the weight of private equity money that needs to be put to work means that investors have visions of queues of dealmakers stretching round the block.”
“No doubt there will be subsequent bids in many cases. But higher share prices may help management teams to justify their independence or simply deter other bidders. In this market, investors should be wary of basing an investment case on bid hopes alone,” concludes Lex.