The existence of pricing anomalies

Among the many emails that hit my screen last week there were some that disclosed the news of further takeover activity in the UK stock market.

On Thursday, the share price of Hotel Chocolat Group plc surged over 161% after the group revealed it is being taken over by US-based Mars Incorporated in a deal valued at GBP524 million. Mars Inc, which owns the Mars, Celebrations, Dove, M&M’s and Snickers food brands as well as Whiskas cat food, submitted a bid of GBP3.75 per share cash compared to the previous day’s closing price of GBP1.40.

On the same day, another company operating in a different economic sector was also taken-over as City Pub Group plc announced that it will be acquired by its rival Young & Co’s Brewery.

Several UK-based financial journalists published a number of articles on these two latest deals across the UK capital market. Most journalists cited that such developments ‘reignite concerns about a perceived undervaluation of UK-listed companies and the seemingly waning attractiveness of listing in the UK’. During the past several years, especially in the aftermath of the Brexit vote in 2016, the UK equity market strongly underperformed the US market while the value of sterling also weakened remarkably. These factors exposed a number of companies as potential takeover targets from overseas investors.

Among the various articles published last week, there were some that also included quotes from UK-based fund managers and other investment services providers mentioning the ‘absurdity of UK small cap valuations’ amid a clear warning that more UK businesses are becoming targets for takeovers by global corporations. A specific fund manager warned that UK companies can be best described as ‘sitting ducks’ for takeovers by global giants.

However, one comment in particular caught my attention. A UK-based investment manager commented that ‘it makes you wonder, once again, if the UK stock market knows how to value anything’. Along the same lines, another commentator suggested that the recent deals confirm the increased ability of certain investors to value businesses ‘where the capital markets do not’.

These particular comments caught my attention since they mirror repeated and numerous rumblings from many investors in Malta about the current state of the local equity market.  As I mentioned in one of my recent articles, I have yet to recall a time when investor sentiment across the Maltese capital market was at such a low level.

Similar to the UK market, the Maltese capital market has also been performing poorly over the past 4 years following a series of negative shocks that rocked investor sentiment. Trading activity has dropped to very anaemic levels over recent years and share prices have not recovered from the cumulative impact of the pandemic, the lack of dividends from several companies between 2020 and 2022, Malta’s grey-listing by the FATF for a 12-month period and the hike in interest rates since Q4 2022.

Several Maltese investors believe that the problem facing the Maltese capital market is due to the lack of market makers which disheartens investors from entering the market due to the difficulty in finding an exit route when required. As a result, trading activity has dwindled to very low levels indeed causing extreme nervousness among various investors.

While the presence of market makers will surely be of great help to the local market dynamics by instilling a greater degree of confidence that an exit route is indeed possible, it does not necessarily follow that such price anomalies will not exist if market makers are introduced. As is being seen in the UK and in other more sophisticated capital markets worldwide, share prices regularly differ from the perceived value by retail investors or more professional valuation models prepared by financial analysts and investment banks. It is a known fact that pricing anomalies exist across all capital markets and present opportunities for seasoned investors.

Moreover, it is also fair to say that prior to the pandemic in early 2020, when trading activity across the Maltese market was evidently much higher and there was a more active market in several equities, the same market dynamics existed without the presence of market makers. As such, the acute problems very evident today go well-beyond this issue.

It is worth pointing out that the main participants across the more developed international markets are institutional investors (asset management companies), pension funds as well as the companies themselves via share buybacks or directors/senior managers participating in the company’s equity. Unfortunately, due to various reasons, these same participants are rarely present across Malta’s capital market.

In order to place the importance of share buybacks into perspective, among the companies within the UK’s FTSE100 index, the total value of share buybacks hit a record of GBP58 billion last year while during the period from January to October 2023, this amounted to GBP46.9 million. These large volumes provide abundant liquidity to the retail and institutional investor community. Only last week for example, the London Stock Exchange Group also announced a GBP1 billion share buyback programme which represents 2% of the current market cap of the company.

If such share buybacks were to take place in Malta, I firmly believe that this will be of great help by providing a necessary exit route to many investors in this new interest rate environment that we are experiencing. This will then automatically help fresh investors to look at some companies in a more positive manner.

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