Edgar Degas

In recent weeks, several holdings in the portfolio have found themselves the subject of opportunistic bids from industrial competitors (seven outstanding at last count). Takeovers tend to leave us feeling both frustrated and resigned. Frustration because, as long-term shareholders, the premiums offered are rarely commensurate with the underlying value. Resigned because consolidation is an inherent part of the capital cycle. As the market’s attention is diverted to shinier things, there are ever more anti-bubble casualties: undervalued businesses in consolidating industries, ignored by investors, but not, it turns out, by those who know them best.

Tate & Lyle, a manufacturer of specialty food ingredients, has been approached by Ingredion of the US with a £2.7bn offer at a 63% premium to the pre-bid price. Tate & Lyle was a relatively new holding in the portfolio. It is transitioning from commodity, standalone food ingredients to more complex specialty ingredients requiring “solutions”. For the best part of five years, its food and beverage customers had been sacrificing volumes and underinvesting in product development and innovation, preferring to use an inflationary period to push price hard to generate revenue growth. We believed this was unsustainable, and that focus would eventually need to return to volume growth.

The volume pressures resulted in substantial in-market consolidation, as companies sought to maintain scale and pricing power. Nonetheless, the depressed backdrop meant the shares were cheap.

We believed that the work Tate & Lyle had been doing on its business model would benefit it when volumes returned and the innovation cycle resumed. With fewer competitors, growth would accrue across a smaller number of companies with better business models and greater pricing power.

Ingredion has clearly had similar thoughts. While the premium is optically impressive, long-term shareholders, which we intended to be, could view the timing as opportunistic, taking advantage of investor apathy. But what is investing if not opportunistic? We are constantly scouring the market for mispriced companies, so why should we feel aggrieved when an industrial buyer follows the same logic? If investors are not willing to assign an appropriate value to an asset, then more fool us. That said, we have not yet made a decision on whether to support the bid, should it be finalised this month.

AkzoNobel, having just successfully deterred Nippon Paint and Sherwin-Williams from acquiring the company after a recent bid, exhibits remarkably similar underlying characteristics to Tate & Lyle, providing insight into the types of attributes industrial buyers are currently seeking. Paint volumes have been depressed for the better part of five years, as consumers and industrial customers pushed out the re-painting cycle (now beyond the point where assets begin to degrade). As a result of volume weakness, industry consolidation has been a consistent feature in recent years, allowing participants to lean on price as the primary means to grow revenue. Again, the less-than-rosy backdrop meant the shares were trading cheaply.

AkzoNobel has not been idle, restructuring the business to focus on its most dominant market positions, and proposing a merger with Axalta to increase its presence in North America.

Paint is an attractive industry: consolidation is ongoing; distribution and brand matter; scale benefits accrue to the larger participants; and there is, through cycles, underlying volume and price growth. As is our way, we have expressed this by building a handful of positions in the sector. TOA Paint of Thailand (4.5x EV/EBIT), SK Kaken of Japan (3.7x EV/EBIT) and Masco in the US (12x EV/EBIT) all have compelling valuations and market positions. They have largely suffered from the same volume lethargy since the pandemic. This has been going on long enough that the market is screeching ‘structural demand weakness’, whereas we would argue the case for fundamental supply-side improvements. Any volume recovery will be met with a more attractive industry structure than in previous cycles.

The nature of the, now abandoned, bid itself illustrates the inherent attractiveness of the market structure. Nippon Paint of Japan and Sherwin-Williams of the US appeared to be trying to get ahead of those pesky competition authorities by proposing a consortium bid for AkzoNobel. Nippon Paint would have taken the decorative paints business (including the Dulux brand) and industrial coatings, while Sherwin-Williams would receive powder coatings, marine, automotive and specialty. This was the Molotov-Ribbentrop Pact of the coatings world.

This is where we, as shareholders, can begin to feel aggrieved. Yes, AkzoNobel had been roundly ignored by investors, and we should not be surprised that Nippon Paint and Sherwin-Williams would seize the opportunity to acquire a highly attractive asset at a bargain-basement price. However, the joint bid structure was clearly designed to avoid a competitive bidding process.

This is where the endgame of the capital cycle can come and bite one in the proverbial backside. Coatings has seemingly consolidated to the point where competitors are moving in packs, to the detriment of one of our holdings. AkzoNobel management has been rightly sceptical. They rejected the bid on the basis that the valuation was not appropriate (“the indicative offer price did not come close to adequately reflecting the value of AkzoNobel”), that regulatory hurdles would likely be significant, and that they see greater strategic merit in the proposed Axalta merger. They have their wish – and we now have a management team even more incentivised.

If nothing else, the bid reinforces elements of our original investment case and highlights the attractiveness of the other coatings companies in the portfolio. But the more interesting observation is broader - the characteristics drawing in industrial buyers (industry consolidation, depressed volumes, attractive valuations) are not confined to food ingredients and paint. We see the same qualities across a number of our holdings, particularly in areas such as specialty chemicals and consumer products.

We try to guard against the quiet satisfaction that comes from seeing a premium land. These recent bids are not frothy, late-cycle acquisitions driven by bankers and private equity, allowing us to happily offload our shares at stretched valuations. These are opportunistic consolidation moves, enabled by a market that is looking elsewhere. We live to fight another day with AkzoNobel, but we suspect these will not be isolated cases.