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Saturday, 20th April 2024 |
| Survival tips for Irish second line stocks |
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| An article last year in the influential New-York Barrons magazine suggested that Irish shares represent exceptional value. Under the headline "Celtic Tiger Burning Bright, Ireland Won't Follow Asia's Script", the article drew attention to second liners such as Irish Continental Group, Abbey and Jury Doyle Hotel Group as examples of companies with good growth potential Owen Purcell takes up the baton and offers some advice. |
Traditionally a publicly quoted company enjoys certain advantages; expanded access to capital, facilitated mergers and acquisitions activity, and increased recruiting power, amongst others. But what happens when the proposed advantages do not transpire; a company is powerless over market sentiment; institutional investors turn their backs; and the once ambitious share price falls dramatically?
While companies with market capitalisation of less than £600m may outperform bigger companies in terms of profit, they are typically undervalued on the stock market. Examples of Irish second line stocks currently experiencing low evaluation by the marketplace include Unidare, Ardagh, Silvermines, Barlo, Heiton, and IWP.
Why are Irish second line stocks experiencing negative market sentiment?
The euro
As Irish fund managers, currently the biggest investors in Irish stocks, rebalance to a European portfolio other European fund managers will do the same. However whilst the total value of Irish stocks held by Irish fund managers would be replaced by an average investment of 2% of all European funds, the European fund managers will focus mainly on the top 4 or 5 stocks.
Merger mania has hit many sectors, most notably the financial services. Irish fund managers feel they can no longer afford not to be represented in these big stocks and second line stocks are suffering a reduced demand as a result.
"Hot" sectors
There has been a renewed focus on fast growth sectors like technology and pharmaceuticals at the expense of industries, such as manufacturing, which previously dominated the Irish second line stocks sector.
Liquidity
Many second line stocks do not have the necessary liquidity to attract bigger institutions and there is reluctance to invest, resulting in insufficient investor interest to provide a ready market for the shares as was recently demonstrated with the recent sale of a number of shares in the Marlborough Group.
Index tracker funds
The demand for index tracker funds has led to an overvaluation of some of the blue chip stocks, and has caused many of the second line stocks to be shunned.
What fate awaits the Irish second liners?
Second line stocks will continue to feel the pressures of the market, thus affecting their attractiveness and performance. In view of this, it may be prudent to consider alternative options, to realise the organisation's growth strategy.
• Remain publicly quoted and develop a strategy to improve stock performance.
• Withdraw from the stock market and attract capital from other sources.
• Remain publicly quoted
For those organisations determined to remain public, size and scale will become increasingly important. The following options should be considered:
Be daring
What differentiates organisations in the technology sector is that they are quick to try new ideas and new business models, with each new megastock telling a unique story. But technology organisations do not have the monopoly on these strategies. Re-energising the business to exploit opportunities in the information age is an option open to all businesses. Traditional companies must look beyond their traditional boundaries.
Mergers and acquisitions
If the markets continue to undervalue the small cap companies, then they become attractive targets for mergers and acquisitions. The liquidity offered by large-scale operations will be favourably reflected in the markets, encouraging medium to large companies to grow further, organically or by acquisition.
This strategy offers two choices for second line stocks: acquire or be acquired. The "acquirer" approach will appeal to those who wish to retain control. Apart from greater liquidity and lower risk in the stock market, mergers and acquisitions offer other operational and resource efficiencies to the merged companies, such as economies of scale, etc. Obviously this should be undertaken as part of an overall clear acquisition strategy, and should include a clear understanding of the strategic fit of the target company with the existing operations.
Organisations who do not merge/acquire to grow, could find themselves the subject of take-over interest from abroad, especially considering the low ratings that are accorded many of the second liners at present and the strong growth prospects of the Irish economy.
Divestments
It may seem contrary to suggest that a sale of some assets or subsidiaries, may be an effective strategy for a second line stock that is currently undervalued but the divestiture of a subsidiary or assets may be advisable when:
• The parent company is no longer in
the best position to create the
greatest value from its business
through skills, systems, or synergies
• Analysts seldom mention the
subsidiary's future growth and
earnings prospects
• The strategic interests of parent and
subsidiary conflict.
2. Public to private moves
For companies wishing to withdraw from the stock market and reprivatise, there are a number of options.
Management buyout
An MBO usually occurs when managers believe that the share price is being grossly undervalued and can be an attractive option for both the vendor and the management team. Market value can be determined, and a deal with management completed, with less risk to the business than attempting to sell to a competitor.
There are currently virtually no limits to the amounts of capital, which can be raised for an MBO, as demonstrated by Irish Venture Capitalists Apax Partners who have a European fund of £2bn.
A management buy in
This process instigates a change in ownership as well as a change in management. Attracting an additional senior manager(s) to the buy out team can enhance the skill and experience of the new management team and encourage current investors to view the transaction more favourably. However, while perhaps saving money in the long run, going private can be a difficult and costly process.
Share buy backs
The belief that the market undervalues the company's shares may be a popular justification offered for buybacks. If the stock does prove to be undervalued, then a stock buyback would, of course represent a good investment for the company's remaining stockholders.
Stock repurchases are also thought to be a way of sending a credible sign to investors that management is optimistic about the company's prospects. The fact that they are willing to repurchase shares at a premium to market value can be an effective means of communicating the confidence of insiders. This alone could lead to higher stock prices.
The future
If second line stocks remain undervalued, then merger and acquisitions, and MBO activity is likely to continue. The Irish stock market will become bigger in value but the number of companies that are listed is likely to shrink.
Encouragingly there are tentative signs that outside investors have recognised the market was mispricing smaller stocks. Some overseas investors are interested in exposing themselves to the Celtic Tiger through small and well-managed companies. |
Owen Purcell is an Associate Director with Prospectus Strategy Consultants (www.prospectus.ie).
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| Article appeared in the December 1999 issue.
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