QD view – Bargain Britain

There’s been a surprising amount going on in markets this week, what with UK inflation, which many commentators have been suggesting is rolling over, remaining stubbornly high at 8.7% over the year to end of May 2023…by Matthew Read

 
This was unchanged from the previous month and was higher than had been expected, what with energy costs coming down. This set off alarm bells in markets and precipitated the 13th consecutive interest rate rise from the Bank of England, as the central bank tries to pull demand out of the economy and bring prices rises down to a more sustainable level.

The latest interest rate rise, at 0.5%, is not small and, while it is good news for funds that are invested in floating rate instruments, it has added to the pain that floating rate borrowers are suffering after so many interest-rate rises. Inevitably, this will weigh on funds with long duration assets (think property and infrastructure, for example, and the higher discount rates being applied) and particularly those that use floating rate debt financing.

Not surprisingly, a lot of column inches have been devoted to the interest rate rise during the past week. Chief amongst these has been the real human cost for homeowners that have mortgages that are not on a fixed rate. Many are finding themselves in an increasingly precarious financial position and some, particularly those that work in more cyclical facing industries, are increasingly worried about where this leaves them if the economy tips over into recession, which looks increasingly likely.
 

Under a cloud

 
The UK manufacturing PMI at the end of May reinforces this sense of gloom – it fell to a four-month low of 47.1 in May, down from 47.8 the month before (we are yet to see the end June PMI, but I would hazard a guess it will be down again given the size of the interest rate rise).

At the beginning of the month, the OECD published new forecasts for real growth in world output and, while the growth estimates for none of the G7 group of developed nations looked particularly strong, the UK places sixth with a piddling 0.3%, some way behind France in fifth place at 0.8% (and this was before the latest UK interest rate rise, which likely pushes us into negative territory).

Add in a political backdrop that can be best described as chaotic and ongoing challenges as we try and adjust our relationship with our biggest market, and it is not surprising that the UK market is down year-to-date and that the UK generally remains out-of-favour with international investors.
 

The UK – a fertile hunting ground for foreign investors and trade buyers

 
However, herein lies a problem. When there is a lot of background noise and when sentiment is poor, it can be easy to focus on the macro and overlook the long-term fundamentals of a business. Of course, this throws up opportunities for those that are able to look through the noise and are prepared to be patient.

We have long been saying that the UK’s ongoing malaise has created a fertile hunting ground for foreign investors and trade buyers who are prepared to take a long-term, and perhaps contrarian view. While sterling has strengthened modestly over the last 12 months, it is still very cheap when compared to its long-term history, which makes UK investment all the more attractive if there is also the prospect of some improvement in the exchange rate over the longer-term.
 

Civitas Social Housing – snapped up at a 26.7% discount

 
In the investment companies space, the latest to succumb is Civitas Social Housing (in case you missed it, there was an announcement around 8am this morning – Friday 23 June – saying that the offer from Hong Kong based CK Assets at 80p per share has become unconditional).

Regular readers might remember that we were taken aback when CSH’s board recommended the original offer, which came from a party with existing business arrangements with CSH’s manager at a 26.7% discount to the then prevailing NAV (not only does CK Assets already have a significant exposure to the UK specialist social housing sector with a substantial property portfolio that is run by CSH’s manager CIM, CKA also owns an indirect shareholding in the manager). You can click here to read what we said but, fundamentally, we thought that shareholders were being sold short and that we would have liked to have seen a bid a lot closer to NAV.

Sadly, no such bid came and quite possibly because of the cloud of uncertainty that hangs over the UK market as well as the troubles that have beset Home REIT. I should say now that HOME and CSH are radically different investments propositions and CSH has not got itself into the kind of mess that, regrettably, HOME appears to have done. Nonetheless, the social housing label seems to have stuck to both.

The lack of an alternative bidder left CSH shareholders with a simple choice – cash out a hefty discount or dig in for the longer-term. Initial anger at the bid, which some called derisory, suggested that it would flounder, which made sense because an investment in CSH should be a long-term proposition. However, when push came to shove, the majority of shareholders were not prepared to wait.
 

Delisting looks likely

 
At the time of writing, CK Assets does not yet have sufficient voting rights to delist the company – it requires 75% of the voting rights to do this and, at the last count, had 64.23%, which gives it enough to control it. Logic dictates that, with CK Assets having effectively seized control of the company, most other investors will not want to remain as a minority with such a dominant shareholder. I suspect most will now, begrudgingly, cash in their chips and the 75% percent threshold will probably be reached shortly, as will the 90% required to squeeze out any remaining minorities.
 

More opportunistic takeouts look likely

 
I have been genuinely surprised that sufficient shareholders have decided to throw the towel in at a price that seriously undervalued the company and, despite its issues, I am amazed that so many were sufficiently fed up to take the quick cash exit. Looking at the bargains to be had in the UK market, I don’t believe this is the only opportunistic take out of strategically valuable assets that we will see.

As for CK Assets, we sincerely congratulate them on the acquisition. The bidder described CSH as “one of the leading social housing providers in the UK” and we think they are right. They have been able to look through the noise and, although time will only tell, will probably have snapped themselves up a bargain. My gut feeling is that they will be very pleased with their purchase.

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