AFIC clarifies shareholder concerns on takeover
Australian Foundation Investment Company (AFIC) has responded to shareholder’s concerns about increasing levels of merger and acquisition activity and private equity offers for companies in the market by releasing a statement to clarify its position towards the recent surge in takeovers and to explain the issues it faces as a long term investor.
According to AFIC, the share market is close to record levels and has just completed four years of 20% plus per annum growth. It has been a feature of the current market that large amounts of money available for investment have been chasing scarce assets. In addition to the normal funds flowing to the market from the retail, institutional and overseas sectors there has been the tremendous growth in superannuation funds and a high level of takeovers.
One aspect of this has been the recent surge of private equity offers to acquire listed companies. AFIC understanding of the objective of private equity is that they identify medium term value in situations which are unrecognised by the stock market because of the short term value focus of many institutions. If the private equity entrepreneurs can secure control they seek to take listed companies private and therefore out of the public eye. They are then able to capture the hidden value by re-engineering the business, including the option of changing strategy and management, often injecting higher levels of debt, reducing costs over short timeframes and selling under-performing and non-core parts of the business. Their objective is to make substantial returns from their initial investment when the businesses are refloated and sold back into the market, with a timeframe of 3-5 years.
As shareholders would be aware, AFIC is a long term investor which seeks to buy investments in companies with high quality assets, good cash flow and valuable business foot prints. It holds these investments for the long term to generate increasing dividends for shareholders through the dividends which are derived from its investments. It does not invest in companies in its investment portfolio with the objective of making a short term profit from selling them.
However, as a result of the developments noted above AFIC has had to consider actual and prospective takeovers for many companies in its portfolio. Over the last 12 months it estimates that this has affected up to 20 of its investments. This provides a challenge for it, as a long term investor. It needs to decide whether to accept takeover offers or to continue with its investment.
There is no general rule to apply in these matters. If a bid is made for one of its investments it needs to consider:
Whether it thinks the price represents fair and reasonable value for the long term prospects of the business and assets of the company;
The dividend stream that it will be foregoing in surrendering its investment;
What capital gains tax it will be required to pay if it accepts the offer;
The availability of alternative investments with a return profile equivalent to the pre tax profile of the investment it would be selling. Given the current state of the market it is not easy to find alternative investments for large tranches of funds;
What may happen to the company afterwards if the bid fails or is only partially successful? One of the strong arguments often given for accepting a bid is that the share price will fall if the bid goes away. From a long term investor’s point of view this it is not a persuasive argument. In fact, if that occurs it can be a good opportunity to buy more stock.
AFIC do not have an invariable rule that it resist all takeovers. If the takeover consideration allows it to obtain part or full rollover relief of capital gains tax by receiving scrip in the acquirer company, then it might consider the bid. This also gives it an ongoing interest in the underlying assets that it is selling.
Quite a number of its shareholders choose to be exposed to the stock market through their investment in AFIC and other pooled investment vehicles. For those shareholders who do not need to make decisions on whether to accept takeovers or not as these decisions are made by the managers of the funds. AFIC believes it was important to communicate how it is responding to these offers on behalf of its shareholders.
However there are another group of its shareholders who also have their own direct investments in many of the same companies in which it invest. AFIC cannot give investment advice, but it would encourage such shareholders as they seek their own advice, to consider the same issues that it has faced.
Listed Investment Company Capital Gains:
Recently there has been some press coverage of an approach to the Australian Treasury/Tax Office by some of the newer Listed Investment Companies for clarification on the use of legislative tax provisions relating to capital gains made by Listed Investment Companies.
A number of AFIC shareholders have asked whether or not this affects its situation. The fundamental issue is whether or not one’s investment activities are of a revenue or capital nature. Its investment intentions, time horizons and the low portfolio turnover, reflect its position that holdings in its investment portfolio are held as capital assets. Therefore the special LIC capital gains provisions are applicable to its investment holdings.
Independent professional tax advice supports AFIC approach. This means that on the few occasions it sells investments from its investment portfolio or have them compulsorily acquired it is able to pass onto its Australian shareholders a special tax deduction in respect of the capital gains on which it has been taxed. The result for those shareholders who are able to claim the tax deduction is that they should have a similar after tax position as if they held those investments directly or through an investment trust.
1-Jun-2007