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Questor: we’ll stand by our aversion to ‘transformational’ deals and avoid Rentokil

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·4 min read
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Rentokil van from 1964 - Rentokil
Rentokil van from 1964 - Rentokil

It’s fair to say that we timed our purchase of Rentokil better than its sale. We tipped its shares at 293.3p in September 2017 and had we held on until now, with the shares at 512.6p, we would have banked a profit of almost 75pc. Unfortunately we contented ourselves with a gain of just 20pc by selling in February 2019.

A month ago the shares were even higher, at 635.4p, but they have taken quite a battering since then. The reason? The company announced the acquisition of a rival firm for many billions of pounds and, as shareholders in Unilever have seen in recent days, investors don’t always react well to such plans.

In Questor’s view, the market is generally right to be sceptical. The bigger the takeover, the more scope there is for it to go wrong, and Rentokil’s planned takeover of Terminix is certainly big: it is paying $6.7bn, about £5bn at the current exchange rate, slightly more than half of Rentokil’s own market value of £9.5bn.

If Rentokil is in fact overpaying, at least it will be doing so largely in its own shares rather than in cash. This avoids too heavy an impact on its balance sheet but also offers the consolation that its own shares rose very strongly in the months before the deal was announced, so if Rentokil is overvaluing Terminix it is at least paying for it in an overvalued currency.

Or to put it another way, to meet the purchase price in dollars Rentokil needs to create fewer new shares, and hence dilute existing shareholders less, than if it had done the deal when its share price was lower.

This does not magically make everything fine, however: if the people who receive all those new shares, the existing owners of Terminix, also decide that they are overvalued, they are likely to turn them into cash at the earliest opportunity. They may also not want shares in a British company. Either way a torrid time for Rentokil’s share price looks likely.

The final straw is that Rentokil described the deal as “transformational”. As we warned on Jan 4, “calling a deal transformational is usually an admission that management is overpaying for an asset they feel they must have”.

Steering clear of companies that strike such deals was one of the 10 ways “to avoid the stock market’s turkeys” we listed in that column. We’ll avoid Rentokil.

Questor says: avoid

Ticker: RTO

Share price at close: 512.6p

Update: Unilever

What then of Unilever, which has offered GlaxoSmithKline £50bn for its consumer health unit? The key difference is that GSK has rejected the offer. Unilever will therefore have to raise its bid or walk away.

The dangers of overpaying, and therefore being forced either to take on too much debt or to sell some of its crown jewels, are obvious, as are the risks of management distraction during a lengthy bidding war or later battles for regulatory clearance.

And of course there is the risk that, even if the deal is done, it turns out not to be the brilliant idea it seemed. Questor suspects that Unilever won’t manage to persuade either its own shareholders or GSK’s bosses of the merits of this deal.

We’ll reassess things if the purchase does go ahead but for now we’ll stand by our hold rating on Unilever.

Questor says: hold

Ticker: ULVR

Share price at close: £35.17

Lord Myners

Questor was sad to read on Monday of the death of a former contributor to this column, Paul Myners, who went on to a distinguished career in the City and served in government as Lord Myners during the financial crisis.

A look back through The Telegraph’s archives shows that many of the companies he tipped are no longer around, at least under the names they went by then.

Lord Myners' first stock tip, in a Questor column from 1973 - The Telegraph Historical Archive
Lord Myners' first stock tip, in a Questor column from 1973 - The Telegraph Historical Archive

Questor has not been able to track down anything he wrote on Rentokil or Unilever, unfortunately, although we have found what we think was his first tip: advice on June 18 1973 to avoid the City “stockjobbing” firm of Smith Brothers.

We have not been able to establish whether the advice was sound; Smith Brothers became Smith New Court, at one time Britain’s biggest stockbroking firm, which was bought by Merrill Lynch, now part of Bank of America, in 1995.

Certainly Myners had an attractive writing style – that column began: “Anyone who has the temerity to criticise the jobbing system is usually charged with tampering in a field where the mysteries are best left to the initiated.”

Read the latest Questor column via every Sunday, Tuesday, Wednesday, Thursday and Friday from 5am.

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