“Don’t try to catch a falling knife” is an old stock market axiom. But what if you want to catch it?
Take Carillion’s recommended offer for Alfred McAlpine, struck at a level lower than that agreed barely a month ago.
Having been rebuffed twice by the rival construction and support services group earlier this year, Carillion’s indicative bid in November valued McAlpine at 585p a share, with 75 per cent of the consideration payable in shares.
But while Carillion was conducting due diligence, the shares of both companies started to slide. Now the two sides have renegotiated at a lower level – 558p based on Monday’s opening prices – which still represents a premium to McAlpine’s market value. To help win the obligatory recommendation for an ostensibly lower bid, Carillion also sweetened the offer by lifting the proportion of cash from 25 to 30 per cent.
All-share bids provide the best insurance against overpayment in volatile markets, because their appeal is based on relative rather than absolute value. Yet they have their drawbacks. If the bidder fixes the share exchange ratio and its price falls in relation to the target’s, the offer can suddenly look less attractive. If the value of the offer is fixed, however, the bidder risks having to dilute its own investors by issuing more shares.
In any case, most sellers hold out for at least some cash. But, as Royal Bank of Scotland and its allies discovered in bidding for ABN Amro, if the target’s price falls, a bid composed mainly of cash can end up looking expensive. What is more, raising the money in treacherous credit markets can be tricky.
Carillion and McAlpine have found a way to square the circle. But optimism about the pipeline for forthcoming deals still looks misplaced. Buyers reliant on leverage will be hamstrung by their inability to borrow money. Strategic corporate bidders or better-endowed buy-out houses have fewer constraints. But they may prefer to wait – perhaps because they hope to get a bargain in six months, if and when markets quieten down. Result: stasis.