Low share prices encouraging corporate activity

Investor: The extraordinary volatility in the prices of financial assets in recent weeks is not particularly surprising in view of the geopolitical tensions and a highly uncertain underlying global economic outlook. It is difficult to envisage anything other than very volatile stock markets for some time to come.

In such an uncertain environment it can be extremely difficult to identify any underlying trends that may be emerging. One such trend is the gradual increase in the number of companies that are buying back their own shares in the marketplace.

In Britain, Schroder Salomon Smith Barney estimates that the volume of share buybacks increased from 0.45 per cent of the FTSE All-Share market value in 2001 to 0.9 per cent in 2002.

On a single trading day last week, 15 FTSE100 companies bought back their own shares. These included large blue-chip companies such as BP, GlaxoSmithKline, Diageo and advertising agency WPP. The daily size of these buybacks is not particularly large totalling £25 million sterling (€41 million) on a typical day, which compares with daily turnover for the entire UK equity market of approximately £4 billion.

Nevertheless, share buybacks give a strong signal that companies are increasingly taking the view that investing in their own shares will provide better returns than investing in tangible assets.

In the Irish equity market, several companies have been active in buying back their own shares. Bank of Ireland has recently stepped up its repurchase programme and has been gradually buying its own shares almost on a daily basis.

Irish Life & Permanent completed a significant buyback programme last year, whilst AIB will begin to repurchase approximately $450 million (€420 million) of its stock once the Allfirst/ M&T Bank merger is competed.

As well as share buybacks, there has also been an increase in corporate activity, either through taking companies private or through outright take-overs.

In the UK, there are a number of pending take-over battles that include some large quoted companies such as supermarket chain Safeway and hotel/leisure company Six Continents.

In the Irish equity market, the past year has seen Smurfit, Green Property and Dunloe revert into private ownership. Several other Irish quoted companies such as Arnotts, Alphyra, Conduit and Riverdeep are currently the subject of corporate activity at various stages of progress.

Clearly, one of the keys to this heightened level of corporate activity is a low share price. However, it is low equity valuations combined with historically low interest rates that are improving the attractiveness of buying companies outright.

Strong cashflow and low interest rates are the key elements to taking a company private since prospective buyers will generally have to fund the purchase of outstanding shares with debt.

A recent note* issued by Merrion Stockbrokers argues that management buy-outs, management buy-ins and straight take-overs are likely to be an ongoing feature of the Irish equity market.

The broker identifies several companies that are generating cashflows that are sufficiently strong and dependable to support a buyout by either management or a group of venture capital investors. These include (amongst others) Fyffes, Heiton Holdings and Irish Continental Group (ICG).

Fyffes is one of the world's top five fresh-produce producers and has substantial cash balances on its balance sheet. While its earnings and cashflows have been variable, the firm has consistently generated cash and, with the McCann family holding 12 per cent of the shares, it would seem to be a strong take-private candidate.

Heitons operates builders' merchants, DIY and hire businesses in Ireland and the UK. While profit margins were squeezed last year, strong cashflows and moderate debt levels mean that the business could support a debt-funded buy-in.

ICG operates passenger/ roll-on roll-off ferries between Ireland and Britain and Ireland and France. ICG has a strong cashflow profile and, in the past, it has used some of its free cash flow to repurchase its own shares.

In recent years, ICG has modernised and expanded its fleet and, therefore, it will not have to incur further substantial capital expenditure for several years. This makes the company a strong contender for corporate activity.

It is notable that the companies mentioned are in businesses involving the provision of fairly basic goods and services. While these businesses are subject to the vagaries of the economic cycle, they are all businesses that should be capable of generating cash through good and bad times.

It is, of course, impossible to predict which (if any) specific companies become the subject of take-private or take-over activity. However, what the analysis highlights is that, if share prices fall to a sufficiently low level, trade buyers and/or investor groups are likely to be enticed into trying to purchase outright some of these quoted companies.

*Irish Equity Market Strategy - Continued Corporate Action Likely. March 12th 2003