GKN – Melrose and the Sage of Omaha

This blog gives you the latest topical news plus some informal comments on them from ShareSoc’s directors and other contributors. These are the personal comments of the authors and not necessarily the considered views of ShareSoc. The writers may hold shares in the companies mentioned. You can add your own comments on the blog posts, but note that ShareSoc reserves the right to remove or edit comments where they are inappropriate or defamatory.

A number of ShareSoc members have asked the ShareSoc Board for their recommendations for the GKN offer from Melrose. ShareSoc is not FCA registered and cannot give advice – and neither can I.

Why have fund managers, who should be talking a long-term view, sold 25% of GKN to short-term opportunists? Why are 11% of Melrose shares shorted? Why has the Melrose share price not dropped hugely in the face of this short selling?

The final offer is for 81p plus 1.69 Melrose shares, each worth 219.2p (25 March 2018), so the offer is worth 451p. GKN shares closed on Friday at 429p, some 22p (nearly 5%) below the offer price.

If you really like Melrose shares and think the Melrose offer will win, then owning GKN shares is a cheap way to acquire Melrose shares. But if you don’t like the idea of holding Melrose shares in the long term and you think the Melrose offer will win, then you should sell your Melrose shares when you get them, and hope that they don’t drop in price in the meantime.

If you don’t think the Melrose offer will succeed, then:

  1. If you like GKN prospects hold onto the shares.
  2. If you don’t like the GKN prospects then sell out now, taking advantage of the recent c40% price rise.

As regards voting, the outcome will be decided by the institutional shareholders. Individual shareholders are currently largely disenfranchised by the nominee system, as ShareSoc has noted on many occasions. We are actively campaigning to improve the situation, but with very little positive reaction from government to date.

I personally don’t like the Melrose business model and am very suspicious of highly acquisitive leveraged companies; their accounts become impenetrable to the average person and often to the experts as well. Time and time again we see problem cases (e.g. Enron, Carillion), so I shall avoid Melrose.

I read Warren Buffet’s annual letter yesterday which included this gem of a warning: http://www.berkshirehathaway.com/letters/2017ltr.pdf

Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase. Subordinates will be cheering, envisioning enlarged domains and the compensation levels that typically increase with corporate size. Investment bankers, smelling huge fees, will be applauding as well. (Don’t ask the barber whether you need a haircut.) If the historical performance of the target falls short of validating its acquisition, large “synergies” will be forecast. Spreadsheets never disappoint.

Other gems were

The ample availability of extraordinarily cheap debt in 2017 further fueled purchase activity. After all, even a high-priced deal will usually boost per-share earnings if it is debt-financed.

Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their “chart” patterns, the “target” prices of analysts or the opinions of media pundits. Instead, we simply believe that if the businesses of the investees are successful (as we believe most will be) our investments will be successful as well.

Stocks surge and swoon, seemingly untethered to any year-to-year buildup in their underlying value. Over time, however, Ben Graham’s oft-quoted maxim proves true: “In the short run, the market is a voting machine; in the long run, however, it becomes a weighing machine.”

And a final quote which is relevant to our RBS campaign:

While I’m on the subject of our owners’ gaining knowledge, let me remind you that Charlie and I believe all shareholders should simultaneously have access to new information that Berkshire releases and, if possible, should also have adequate time to digest and analyze that information before any trading takes place. That’s why we try to issue financial data late on Fridays or early on Saturdays and why our annual meeting is always held on a Saturday (a day that also eases traffic and parking problems).

We do not follow the common practice of talking one-on-one with large institutional investors or analysts, treating them instead as we do all other shareholders. There is no one more important to us than the shareholder of limited means who trusts us with a substantial portion of his or her savings. As I run the company day-to-day – and as I write this letter – that is the shareholder whose image is in my mind.

PS My wife is a GKN shareholder.

Cliff Weight

One comment
  1. Crusty says:

    Well I like the Melrose model and have shared in their earlier successes. As I see it they unearth basically good companies that have been badly managed for long enough to be uncompetive with poor profitability. They put in top managers, devolve responsibilities, invest more in R&D and transform performance and prospects. What is not to like about that? Perhaps if they re-floated the rejuvenated basket-cases rather than sold them off it would soothe the ‘asset-stripper’ mob, but in fact that epithet is far from the truth.

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