Melrose to GKN: We Don't Negotiate in M&A

(Bloomberg Gadfly) -- Some bidders take as long as they can before formalizing their takeover proposals, hoping their target's shareholders will push a besieged management team to the negotiating table.

Not so Melrose Industries Plc. Within days of its interest in British engineering giant GKN Plc becoming public, the turnaround specialist has made a formal offer. The move underscores the weakness of GKN's position and how little the bidder thinks the co-operation of its target is worth.

Melrose to GKN: We Don't Negotiate in M&A

Under British takeover rules, Melrose had until early February to firm up its offer or walk away. On Wednesday, it said it would make a bid in cash and shares, setting the clock ticking. The rules give targets plenty of time to mount a defense, and it could be month before GKN -- which rejected the offer almost at once -- sets out a detailed rebuttal. Even so, GKN needs all the time it can get. It only appointed a permanent CEO on Friday.

GKN can't now threaten to leave the pitch, a tactic that could have led to talks on a recommended deal. But that matters little. A Melrose takeover probably wouldn't face major regulatory or political hurdles. The co-operation of GKN chairman Mike Turner and his board clearly isn't of much use.

Melrose to GKN: We Don't Negotiate in M&A

If the bidder is on the hook, the price it has committed to is low. Based on Melrose's stock price on Wednesday, the offer is worth 425 pence a share, less than GKN's current price of 442 pence. Melrose can dream of GKN shares falling below that, but it's unlikely. Analysts calculate that the break-up value of GKN is in line with its current share price. Melrose can afford more, and the market knows it.

Melrose's shares dipped 1.5 percent to 231 pence after it bid. That probably reflects greater certainty of a deal happening, if merger arbitrage funds are buying GKN and selling Melrose short. Investors probably expect a raised offer at a later stage.

Melrose has several options to make a better offer closer to GKN's current share price. True, it would struggle to use debt to add more cash without pushing the combined company's leverage to a level that antagonizes GKN's pension trustees. But it could yet tap its own shareholders for funds in a rights offering, as it has in previous deals. Or it could up the share component. Giving GKN shareholders 59 percent of the combined company, rather than the proposed 57 percent, would lift the value of the bid to 450 pence a share. Not too painful.

GKN argues its shareholders shouldn't agree to Melrose's offer and give up a share of the benefits they would reap from its recovery. But investors now have to run a brutal calculation: is roughly half of Melrose's management expertise worth more than 100 percent of the GKN's less-than-credible board?

So long as Melrose's share price holds, it's clear what its offer is worth. GKN needs to unpack its side of the equation.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

To contact the author of this story: Chris Hughes in London at chughes89@bloomberg.net.

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