Melrose/GKN: come to order
Buyout specialist should try offering more stock, not cash
Business meetings are overrated. Harvard Business Review points out that the modern executive is forever in meetings, many of which are useless. Well, not the one that occurred between UK buyout specialist Melrose Industries and engineering company GKN earlier this month. That confab has added £2.1bn, over a third, to the market value of GKN.
Melrose made a formal hostile bid this week. On Thursday GKN raised its own points of order to back up its argument that Melrose has offered too little. No matter. GKN shareholders have had their heads turned.
Melrose thinks its price of roughly £4.30 per share, worth £7bn in shares and cash, provides a substantial 32 per cent premium on an undisturbed price. That values GKN’s debt and equity at over seven times expected 2018 earnings before interest, tax, depreciation and amortisation, the high end of its historical range. GKN points out that more than half of the cash portion, 81 pence per share, is effectively the cash on its own balance sheet (though overall, it has net debt). It will still own 57 per cent of the combined group. The market has added to the intrigue by lifting GKN’s shares to £4.46.
Melrose’s plans to lift operating margins by at least 3 percentage points, which equates to about £300m of operating profit annually. Taxed and capitalised, that should cover the premium. GKN has appointed a new chief executive and talked up its own plan, called Boost, to separate its various divisions. But hastily promoting a non-executive to interim chief and promising to lift profitability will not impress GKN investors. They have spent five years listening to promises of 10 per cent margins.
Melrose could likely pay more. Yet GKN cannot argue that Melrose’s buyout strategy differs much from what private equity might do, possibly using even more debt. And Melrose has bought businesses larger than its own market value before, like Nortek in 2016. More cash, if that is what GKN really wants, would not necessarily please GKN’s long-suffering shareholders. They will have more faith in Melrose’s record. A packet of Melrose shares would offer a call option on GKN’s future intrinsic value.
GKN’s objections to the Melrose bid have been minuted. Melrose can win over GKN’s shareholders next month by offering more stock, not more cash.