U.K. roadside assistance and insurance group AA plc has updated the market on its ongoing discussions with possible suitors. There’s the possibility of a bid being announced in the next month or so, which could lead to a short-term jump in the battered share price. However, there’s a real risk that either no bid materializes, or if it does that it has no premium over the share price, or such a small premium not to merit the risk of getting involved in the stock speculatively at this point. I continue to avoid.
AA and the Dates that Walked Away
The company has been on the block for some time and had announced several months back that there were multiple prospective suitors looking into the feasibility and attractiveness of bidding for the company. It was announced recently that two possible suitors had decided not to make a bid, the details of which I outlined in my piece AA Plc: Breaking Down.
There could have been all sorts of reasons why those suitors decided not to make a bid, which may reflect on their own business and objectives, not necessarily those of AA, so although it’s easy to infer that they did not like what they saw when they looked more closely into AA as a prospective purchase, we don’t know whether that has any truth to it. It’s pure speculation.
What’s clear, however, is that with two of three possible bidders gone from the process, the prospect of a bidding war falls away. If the remaining prospective bidder did decide to make a bid, shareholders wouldn’t be able to play it off against others.
The Process Has Been Extended
The U.K. takeover code has a “put up or shut up” provision designed to reduce the impact of long stretched out takeover auctions and the uncertainty that they can engender. A deadline is set by which a prospective bidder has to mount an offer or walk away, with a proviso that they are then barred from coming back and making an offer within a set period of time.
That deadline was on 29 September.
On that day, the company announced that it had requested an extension to the deadline. This had been granted and the new deadline is set at 27 October, four weeks after the original one.
The reason for this extension is that the remaining prospective bidder, a consortium formed of TowerBrook Capital Partners (U.K.) LLP and Warburg Pincus International LLC, was exploring the possibility of an offer for the entire issued and to be issued share capital of AA. By way of background to this, the company noted that “Discussions with the Consortium have continued positively and due diligence is ongoing.”
There’s a Potential Short-Term Trade in This
If the market expects a bid to be made, or if a bid is announced as it may be in the coming weeks before the deadline expires, there could be a short-term boost to the AA share price. That opens up the possibility of a quick return on shares bought now, should a bid materialize at a level which is at a premium to the current share price.
The Risk Makes the Trade Unattractive
However, I would be very wary of such a trade.
First, there’s no guarantee that a bid will materialize. It’s perfectly possible that, even after staying in the process this far, the consortium decides to walk away and not make a bid. While that doesn’t preclude other bids from alternative possible suitors down the line, it could mean that getting into AA shares in anticipation of a bid turns out not to be a short-term trade one can flip in coming weeks.
More concerning, there’s no guarantee that there will be a bid premium. AA looks desperate. This week it published its most recent interim results, to the end of July.
Source: company interim results
Take your pick between profit before tax and free cash flow, the point is the same: Net debt was reported at £2.628 billion. That was a fall across the period of £17 million. It’s a huge number: With six monthly free cash flow of £21m, how will a company ever service its debt of £2.628 billion? This is not an academic question: £900 m of debt needs to be refinanced by 2022. Even if the company can persuade lenders to agree to that, it will essentially have to use almost all available profit and cash flow for years to come simply to service debt.
That cuts to the heart of the issue of bid premium. Why should a suitor offer a premium? Indeed, why not make a bid below today’s market price? After all, if no bid emerges, the alternatives for AA shareholders look grim. In one scenario, the company runs out of cash when it needs to refinance in 2022, cannot borrow more money, and shareholders get wiped out. In an alternative scenario, it’s able to roll over the 2022 debt, but with its enormous leverage, there’s little realistic upside in the shares for years to come. Neither scenario presages short-term share price upside.
Making an offer below current share price sounds odd: Why wouldn’t shareholders just sell into the market at market price? The answer is that they can’t all do that at once, or the price will collapse. Making an offer at or marginally above the current share price would allow for a smoother bid process. However, given the AA’s dire balance sheet, a very small, essentially token, premium may be sufficient. Shareholders have few or no alternatives in the short to medium term. So, the upside of buying in now anticipating a possible bid premium is in my view outweighed by the limited return weighted for the real risk that no bid and/or bid premium will materialize.
Conclusion: AA Could Still Go South
I’m by nature an investor, not a trader, but I expect that the news that a potential bidder for AA has an extension in which to make a bid made some readers wonder whether a short-term trade could provide a handy return. In theory it could but in practice I’m wary. The AA share price could collapse yet further if no viable bid emerges, which essentially makes it a buyer’s market for a would-be bidder. That is not necessarily good news for the share price. Continue to avoid.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.