There’s a message here for all companies trying to maintain strong balance sheets in preparation for possible recession.
Tuil’s fund, London-based Sparta Capital Management, is targeting John Wood Group Plc, the UK oil-services firm. Wood overextended itself doing M&A in 2017. The subsequent repair job involved selling off a chunk of the business to cut borrowings, and the firm is now more focused on consulting which should — hopefully — offer steadier revenue.
As a result, Sparta reckons Wood could afford to return about a quarter of its £890 million ($1.1 billion) market value to shareholders via a share buyback by the end of 2024. The hedge fund has also attacked management for failing to draw more attention to the re-jigged business’s cash-generation power.
Spare debt capacity and poor communication are red rags to any activist. So too is a new chief executive (whose agenda an investor may be able to influence) and a share price languishing around 40% below the average 12-month analyst target. Sparta sets out how Wood could afford the mooted buyback while still keeping net debt at a relatively modest 1.5 times earnings before interest, tax, depreciation and amortization. That’s the top of the company’s stated leverage range, although Tuil also implies Wood’s targets here may be “too strict.”
Even if the math of a buyback stacks up, the reality is that this is a business that has struggled to turn a profit in recent years, and these are uncertain times. Returning cash now — even if affordable on paper — seems premature. The key issue is this: Disburse only if you believe the business will still be able to withstand a severe economic shock.
Wood should, however, be much more committal about cash returns when recessionary threats abate. The signaling effect may be as powerful as actually buying back shares in the short term.
This won’t be the last company to come under pressure to use debt capacity to fund goodies for shareholders at a time when equity markets are weak. Boards need to tread a fine line. There is a premium on balance-sheet strength right now. But managers also need to be crystal clear that cautious cash conservation isn’t a veil for building up war chests for ill-disciplined investment or dealmaking. Vodafone Group Plc has likewise clumsily sent mixed messages about how much shareholders will benefit from deleveraging following a recently agreed asset sale.
The Sparta attack is also evidence that targets that won’t move the needle for the Elliotts and Cevians of this world are still vulnerable to activist campaigns from smaller funds. Indeed, those with a sub-$10 billion market value may be especially susceptible.
The increasing power of passive money in the stock market, the rise of algorithmic trading and the withering of broker research on small and medium-sized companies leaves them more prone to drifting into a funk with no real committed shareholder following.
UK companies in the FTSE 250 index have been on tenterhooks for takeover bids this year, in particular from US buyers funds with highly valued dollars to spend. Now they can add activists to their list of threats going into 2023.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Chris Hughes is a Bloomberg Opinion columnist covering deals. Previously, he worked for Reuters Breakingviews, the Financial Times and the Independent newspaper.
More stories like this are available on bloomberg.com/opinion
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