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Questor: takeover caps our Merlin gains at 18pc. But did the City sell out too early?
Questor share tip: as another of our holdings falls to a takeover bid, this column wonders whether investors should have held out for more
The hype surrounding the next Legoland park opening has already gone into overdrive.
Sixty miles north-west of New York, the new visitor extravaganza will not begin admitting young fans of plastic building bricks until next spring, but the company behind it is gushing about the 50 attractions it will offer – including Factory Street and Bricktopia – over 150 acres.
Legoland New York is the ninth and largest of its kind and joins a family of parks from Windsor to the original at Billund in Denmark close to Lego’s headquarters.
It was not cheap to build. Merlin Entertainments, the parent firm with attractions including Madame Tussauds and Thorpe Park in Surrey, has spent something like £250m on this single site. Developments such as Legoland New York help to explain why the company agreed to a £4.8bn takeover late last month that will see it go private after less than six years in the FTSE 100.
Much of Merlin’s long-term growth prospects depend on the opening of Legoland parks. Once New York is up and running, all eyes turn to the next prospect, in South Korea. But long before kids will be enjoying the Ninjago ride, the cost of construction is sitting on the group’s balance sheet.
The activist investor ValueAct, which built a 9pc stake in Merlin, believes the share price has suffered because of declining returns on invested capital in the short term.
ValueAct’s call for a takeover was answered in short order when Kirkbi, the family owner of Lego and already a 30pc owner of Merlin, teamed up with Merlin’s former investor Blackstone and the Canada Pension Plan Investment Board to mount a deal.
With plans for many more Legolands in Asia, the spending will go on. These backers will be less squeamish.
At 455p a share, the deal was trumpeted as a 37pc premium to the price just before ValueAct published its letter, or 12 times Merlin’s underlying earnings last year of £494m. That seems fine, except investors won’t really know how good this year is shaping up to be until interim results come out in August.
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There is much promise, given that the second Lego movie was released in February and should have sparked extra interest in the parks. Analysts at Peel Hunt forecast underlying earnings will leap to £616m by 2021.
But the involvement of Lego means it is all over bar the shouting, and there has been plenty of that. Merlin chairman Sir John Sunderland blamed analysts and the stock market for undervaluing his company. Aviva Investors’ chief investment officer David Cumming disagreed, labelling the comments “totally inaccurate and pretty pathetic”.
He has a point. Isn’t the investment story something the finance director Anne-Francoise Nesmes and her investor relations team should have managed? As company watchers at RBC Capital Markets point out, Merlin has grown its earnings by an average 6pc a year since coming to market. At the time of flotation, 16pc growth was expected.
The Merlin story says much about the state of the markets in 2019. Experts tell us the FTSE 100 looks cheap versus other major indices. Brexit uncertainty may have something to do with that. But there is frustration from some listed companies that their long-term investment story is not being bought into by institutional investors who want higher returns today.
At the same time a wall of private equity cash – $2 trillion or more if you believe some estimates – is looking for a home and rock-bottom interest rates mean it is easy for these buyout firms to borrow more.
When Questor recommended Merlin shares in June 2018, we were drawn to the recovery after a profit warning caused by poor weather and terror attacks in Westminster and Borough Market that were putting visitors off London.
The business was also doing the right thing by investing in new attractions themed around the adventurer Bear Grylls and Peppa Pig, plus visitor accommodation. But reaping the benefits was going to take time.
Readers do not have to wait for their handsome 18.2pc gain but would they have got more in the long term? We will never know. They should hold firm until the payout comes through and consider where next to deploy their cash.
Questor says: hold
Ticker: MERL
Share price at close: 448.6p
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