Lessons from rejected takeovers

Investors in the Canadian stock market have been dealt a few surprises lately, especially from the Canadian government and some of its organizations.

In particular, the federal government, just minutes before the stroke of midnight this past Friday, decided it was time to end Cinderella’s ball and reject Petronas’s offer to acquire Progress Energy Resources Corp. A few days earlier, the CRTC killed BCE Inc.’s bid to acquire Astral Media Inc.

Many fund managers have shared their discontent in varying degrees of severity, however we have to wonder if there is some underlying motivation backstopping their sour grapes. More importantly, we find that during such times it is better to be proactive than reactive. A great first step is asking: What is there to be learned from such developments?

In our view, there are four key takeaways for the both professional and retail investors alike.

First, greed is not good. Greed necessitates taking excessive risk. Whenever there is a deal announcement and the stock moves too close to the premium being offered, it’s important to take profit and move on. In the case of Progress, investors have seen an approximate doubling of the share price to within 1.6% of the $22 offer as of Friday’s close. We have to ask, why hold on for an additional 1.6%?

In the case of Nexen Inc., its share price was hedged a bit more, but it was trading within 8.5% of CNOOC’s offer price as of Friday’s close. That said, those investors in the stock before the deal’s announcement were still up an impressive 45%. More troubling is that over the past few weeks we have heard a number of industry professionals recommend using Nexen as a great place to park one’s cash in order to leverage off the discount to the offer, which has varied from 5% to 8.5%.

Secondly, we never recommend buying a stock solely on it being a take-out candidate, because there can be a lot of downside if an offer never materializes. It is rather amusing to see the immediate runup in share prices of companies similar to those that have received an offer to be acquired. This has occurred to EnCana Corp. following the announced deal for Celtic Exploration Ltd., Talisman Energy Inc. following the Nexen’s takeover announcement, and a number of junior gas producers following the Progress Energy announcement.

Instead, we always recommend owning companies with strong fundamentals, which includes having a core strategic value.

Thirdly, don’t play the trade ahead of a government ruling. The decisions being made are based on politics rather than economic merit and, therefore, they can at times prove to be quite costly.

Aside from the recent Progress Energy and BCE rulings, there are three great examples of this: 1) On Halloween 2006, the federal government decided to end the income trust model by taxing those receiving distributions; 2) A year later, the Alberta government decided to dramatically increase royalty rates; 3) The federal government rejected BHP’s offer to acquire Potash Corp. of Saskatchewan in 2010.

Finally, for the contrarians in the crowd, there is an opportunity in every situation. The conversion of energy income trusts into dividendpaying companies has been successful; the Alberta government eventually came to its senses and unwound its royalty changes; and Potash’s stock is within 6% of the BHP offer.