SHARE PRICE

The simple answer to the question of what affects the prices of shares is that prices are set by supply and demand. Many of the factors that influence the supply/demand balance are discussed in some detail below and it should be noted that many of these factors are interconnected.

These factors have an influence over markets, but their effects are difficult to quantify and their influence will vary depending on a multitude of other factors. The infinite number of variables mix together on a daily basis to create the net effect that influences the market. All we can do is try to understand the major influences and how they may combine to affect the prices of shares. We can very simply summarise the two major effects on stock market prices, one being sentiment (which affects short-term market prices) and the other being earnings (which affects long-term market prices).

INTERPLAY OF FACTORS

The reality is that markets today are global and capital flows between them. Therefore, factors both in Australia and around the world affect the Australian stock market. Overseas stock markets and economies, the Australian economy, government policy, interest rates, exchange rates, commodity prices, inflation, current trends, politics and miscellaneous factors all interplay and have an influence upon the profitability of many companies on the stock market, thus affecting share prices.

Overseas stock markets

The globalisation of the world economy has led to what is effectively an internationalisation and inter-relation of world financial markets. As a result of this, the Australian stock market is not at all isolated from the rest of the world. Overseas influences play a significant role in domestic market trends.

 Large fluctuations on major overseas share markets affect the ASX considerably, in particular, the Dow Jones in New York. As Australasian markets are the first to open after the North American markets close, there has always been this strong focus on US market developments. The movements overseas affect sentiment here and Australia often gets a follow-on effect.

Australian economy

The local economy certainly affects the activity of the ASX, by virtue of the underlying company earnings. In a recession, for example, many companies' profitability will be down, liquidity will tighten and sentiment will turn negative.

Government policy

Government monetary and fiscal policies influence the stock market, and the market can fluctuate sharply, particularly around budget time. Through monetary policy, governments influence interest rates and this has a major influence on both the economy and the stock market.

Government fiscal policy has less effect on the stock market than monetary policy, but government spending in certain industries can affect companies with exposure to this expenditure.

Obviously, tax policy has a major impact on the profitability of companies and therefore influences their market value. A reduction in the corporate tax rate, for example, will increase company profitability.

Interest rates

Rising interest rates generally have a negative effect on the stock market, with investment funds being attracted away from the stock market in times of high interest rates.

Company profitability is also affected by fluctuations in interest rates, as the cost of capital increases with higher interest rates.

An obvious example of interest rates affecting the prices of shares is when either the Reserve Bank of Australia or the US Federal Reserve announces, for example, a 75 basis point cut in interest rates. The stock market generally rises on the back of this news, and this rule applies on the flip side as well-when they announce a rise in interest rates, the stock market generally falls.

It is important to note that the stock market will usually rise on expectations of an imminent interest rate drop, and upon realisation of this fact, the market may not move at all, as the positive news was already factored into the stock market when the expectation was going around.

Once again, this holds true for the reverse-when the market first suspects an imminent interest rate hike, it generally falls.

Exchange rates

As you may well know, the value of the Australian dollar affects individual companies (which make up the stock market) and hence, the prices of shares. As a simple rule, companies that import fare better when the Australian dollar is strong, as the purchasing power of the Australian dollar is stronger, and companies that export fare better when the Australian dollar is weak, as their products are cheaper and hence, more attractive to foreign buyers.

Commodity prices

Commodity prices obviously affect the share price of companies involved in the exploration, production and sale of a given commodity. For example, when oil prices go up, this is a negative for the Qantas share price, as oil is the company's largest cost and so if this increases, the company's costs dramatically increase.

Inflation

Inflation can have mixed effects on markets. What are probably most important are the changes that inflation causes in an economy, and how those changes affect market prices.

For example, during the late 1980s and early 1990s, a period of high inflation in Australia, interest rates were increased dramatically. This ultimately led to a recession, a large number of companies and individuals going broke, a fall in consumer sentiment and lower company earnings. All this had a very negative effect upon the market at that time.

Historically, high inflation on its own has not always been a bad thing for markets. With inflation, companies that have high NTAs are holding assets that are increasing in value, and so these types of companies have at times fared well during periods of high inflation.

Mining stocks, for example, have in the past been considered to be a safe investment during periods of high inflation, as their resources in the ground are increasing in value. Other tangible assets, such as property, have also been seen as somewhat safe havens.

Current trends

The market is very fashion-oriented and different sectors go through periods of being in fashion. In 1999/2000, the hi-tech boom saw internet shares become extremely fashionable. Investors rushed into internet shares and hence, many companies couldn't whack a 'dot.com' on their names fast enough. In 2004/2005, it was the resource companies' turn in the limelight. This sector went through an incredibly fashionable stage on the back of the extraordinary economic boom occurring in China. Investors couldn't get enough of stocks like BHP Billiton and Rio Tinto, sending those companies' share prices up by roughly 100% over the two years!

Politics

Politics can also affect the prices of shares, in so far as some legislation can impact upon the profitability of various companies. For example, if Congress in the US were to put an end to the occupation of Iraq by US armed forces, various companies supplying the military would see a fall in the demand for their products and hence, a decline in profitability. 

Miscellaneous factors

Acts of terrorism, natural disasters and bad press can affect share prices. The terrorist attacks of September 11, 2001 sent global stock markets into a tailspin, with the Dow Jones Industrial Average index in New York falling 7.1% in its first trading session after the tragedy, its largest ever one-day point decline!

Natural disasters can strangely have both a positive and negative effect, in the sense that the havoc wreaked causes financial hardship in general, but the rebuilding process can benefit certain companies.

The effects of bad press can be seen when, for example, an airline has safety concerns, and subsequent negative press coverage can depress the share price and affect customer numbers.

 

INVESTOR EMOTIONS

The emotional state of investors has always been a large factor in driving markets, especially in the short term.

Sentiment, which can be influenced by the state of the economy, the outlook for the future and countless other variables, will have an influence on the short-term performance of the stock market.

Optimism and greed drive share prices up, whilst pessimism, fear and panic send share prices crashing.

Roller-coaster of emotions

Upon entering the stock market, it is impossible to avoid being barraged by a range of emotions. Most investors will, at some time or another, experience fear, greed, panic, elation, anxiety and relief, to name but a few.

Elation

The 1999/2000 global boom in hi-tech and internet companies provided excellent examples of investor emotions, but none more so than elation and greed. Elation was felt due to the incredible returns that investors were seeing, returns that were often in excess of 100%. This elation, and the feeling of invincibility, took investors down a path that leads only to greed.

Greed

In any market, a 20% annual return on a share should be considered very rewarding. However, in a boom, investors succumb, much to their detriment, to greed. In past bull markets, after having made 50% overnight in many floats, investors became greedier and greedier, and solid 20% annual returns just would not do.

Anger

When the hi-tech boom eventually burst, greed turned into other emotions. The full spectrum of emotions is experienced after a boom ends, the first of which is anger.

Investors get angry when a share turns against them, and they get angry at themselves for not taking profits when the opportunity presented itself.

Fear

As the price of the shares continues to decline, fear builds. The investor is now not just lamenting the lack of realising a profit; they are now in fear of a loss that will hurt.

Frustration

The next emotion is frustration, which builds because the share price is not going up, but the investor finds it hard to sell because it's hard to realise a loss when a profit was there to be realised not long ago, and the investor is convinced that the share price will turn, and because they take it personally, they believe the share price will definitely bounce the moment they sell.

Panic

It is important to never panic, as it never helps and it inhibits rational decision-making. However, as we get towards the end of the emotion scale, the investor succumbs to panic and sells at a loss. This panic is followed by an element of relief at finally being out.

Coping with emotion

It is impossible to invest without becoming a victim to some of these emotions. However, it is important not to let this tension come between you and good decisions. You must learn to recognise these feelings, and then control the emotional impact that they have on your decision-making.

CONCLUSION

As stated, markets are generally influenced by sentiment in the short term, and underlying company earnings in the long run.

Sentiment is usually affected by the expectation or outlook based on all the basic economic fundamentals that ultimately affect earnings. These variables include such things as interest rates, inflation, commodity prices and GDP growth - all of which are impossible to predict accurately. Company-specific activities, such as takeovers or management changes, may also have a major impact on the sentiment surrounding particular shares.

CAPITAL AND SHARE STRUCTURES

The capital structure of listed companies often changes. It is important when investing to understand why companies change their capital structure and how it affects you as an investor.

SHARE SPLITS

If the directors of a company feel that the share price is too high, they may decide to split the shares. They may do this because many investors have a problem with purchasing a share that is trading at, for example, $50 per share. By reducing the price of the share, a share split improves the marketability of the shares. Even though there is no real logic behind it, investors prefer buying shares that trade at lower levels.

A share split means issuing more shares, which are in proportion to the shares you already own. For example, if you own 1000 shares of a stock that is trading at $20, and a 5-for-1 split is announced, the following would occur.

A 5-for-1 split means you will receive five shares for every one you have. You would now have 5000 shares, having received an additional 4000 shares. As a result of this 5-for-1 split, the market price of the stock will fall to approximately $4 ($20 ÷ $5). The value of your shareholding is generally unchanged. You still have approximately $20,000 worth of shares.

REVERSE SPLITS (CONSOLIDATIONS)

Occasionally, directors of a company feel that the share price is too low, and they don't want the company to be thought of as a 'penny dreadful', which is essentially a low-priced, speculative share. This is not a good reputation to have, as it deters institutional and private investors.

To combat this, the directors may choose to implement a reverse split. So if you have 100,000 shares of a stock that is trading at 5c, and a 1-for-10 reverse split is announced, the following would occur.

A 1-for-10 reverse split means you will receive one share for every ten that you have. So you will now have 10,000 shares. The share price will go from 5c to approximately 50c, thereby leaving the value of your shareholding at approximately $5000.

BONUS ISSUES

A bonus issue is essentially a free issue of shares that is made to a company's shareholders. This is made in proportion to the existing shareholding.

For example, in a 1-for-5 bonus issue, every shareholder will receive an additional share for every five shares they already own. If you own 10,000 shares, you will receive an additional 2000 shares (10,000 ÷ 5 = 2000), resulting in a total of 12 000 shares.

Obviously, the value of the shares does adjust accordingly, as with a share split. This must happen, as the value of the company's assets is now spread over a greater number of shares. If the stock is trading at $3 and the 1-for-5 bonus issue is made, the following would occur.

The value of five shares before the bonus issue is equal to the value of six shares after the bonus issue. Therefore, your original 10,000 shares at $3 are now equal to your 12 000 shares at $2.50 (5 shares _$3 = 6 shares _$2.50). The value of $30,000 remains the same after the bonus issue.

You might ask why the directors would decide upon a bonus issue if it actually results in no profit for shareholders. The reasons are threefold.

Firstly, it gives the illusion to some shareholders that they have actually received some shares for free and it is seen as a positive step by the company.

Secondly, a bonus issue often serves as a replacement to a cash dividend. If the company can't afford to pay a cash dividend, the bonus issue placates some shareholders who expected the dividend.

Thirdly, as a bonus issue works in a similar way to a share split, the directors may implement a bonus issue if they feel the price of the stock is too high. The bonus issue will result in a lower share price and improved marketability, as with the share split.

One potential advantage of a bonus issue, as with a share issue, is that if a dividend is announced, and it is maintained after a bonus issue, the shareholders are effectively receiving an increase in dividends, as they have more shares on which to receive dividends.

Finally, it is important to know that the drop in price (after a bonus issue occurs) is on the ex bonus date (XB) and an investor buying shares on or after the XB date is not entitled to the bonus shares.

RIGHTS ISSUES

A rights issue is like a bonus issue, in that it is an issue of new shares to shareholders, and it is made in proportion to the existing shareholding. However, unlike a bonus issue, it is not free. A rights issue is implemented to raise additional capital for the company from its shareholders. The benefit for shareholders is the option of acquiring new shares at a discount to the market price.

Shareholders are offered the right, but not the obligation, to buy new shares in the company at a certain price on a certain date. Usually, the price offered in the rights issue is at a discount to the market price. The new shares are usually offered on the basis of a certain amount of new shares for every old share held.

If it is a renounceable rights issue, the shareholder can take up the offer and buy the shares, or they can sell the rights to another investor. A non-renounceable rights issue means that the offer must either be taken up (exercised), or completely forfeited.

Let's look at an example. Assume National Australia Bank is trading at $25 and it implements a 2 for 15 rights issue at $20. Therefore, it is an issue of an additional 2 shares for every 15 shares you already own. So if you own 1500 shares, you would be able to purchase an additional 200 shares (1500 divided by 15, then multiplied by 2) at the set price of $20.

If this rights issue is renounceable, then if you choose not to buy new shares, you can sell the rights to these shares to other investors. To do this, you simply sell them on market during the period in which they trade. The rights will usually be listed by the placing of an R after the ASX stock code. And if the stock is trading at $25 and the rights issue is at $20, one would expect the rights to be trading at around $5.

It is important to remember with a renounceable rights issue that you should either exercise or sell the rights. If you do neither, the rights will be forfeited and you will have given up money for jam.

If this rights issue is non-renounceable, then the rights must be exercised or forfeited entirely; the rights cannot be sold. A non-renounceable rights issue is effectively the same as an 'entitlement offer'.

SHARE PURCHASE PLANS

A share purchase plan is essentially the same as a rights issue, in that it is an issue of new shares to shareholders and is implemented to raise additional capital for the company from its shareholders. However, the difference is that rather than the issue being made in proportion to the existing shareholding, it is instead a fixed dollar value that is offered to every shareholder regardless of the size of their shareholding. The maximum dollar value companies are permitted to offer is $15000 in new shares to each existing shareholder.

As with rights issues, share purchase plans are offered at a discount to the prevailing market price (if they weren't, why would anyone bother buying shares in a share purchase plan!) and so a benefit to smaller shareholders is that they are offered the same opportunity as institutional shareholders. For the company, the benefits are clear; a cost effective, fast and simple way to raise additional capital.

BUYBACKS

A buyback is essentially when a company buys back its own shares from shareholders and cancels them (they disappear altogether). The benefit of a share buyback to shareholders is simply that this effectively reduces the number of shares on issue (as less of the company is now listed on the stock market). This means that each shareholder's holding after the buyback essentially represents a greater percentage of the company, which in turn entitles shareholders to a greater percentage of company profits.

Looking at this concept from a supply and demand point of view, assuming demand for the shares remains the same, the smaller supply of shares tends to result in higher prices for the shares.

The main reason for a company to buy back its shares is that it has surplus capital and believes that its own shares represent the best value and most appropriate investment at that time.

Warren Buffett, arguably the world's most successful investor, is of the belief that when a company's shares are trading at less than their intrinsic value, one of the best investments the company can make is to buy back its own shares - unless there are other companies that are cheaper, and then they are better investments.

TAKEOVERS

Takeovers can provide excellent trading opportunities, as The Rivkin Report has demonstrated time and time again.

INTRODUCTION

Put simply, a takeover occurs when one company attempts to buy another company in order to expand. This may be a hostile bid, which is unwelcome by the target company, or a welcome bid, which has already been agreed to by the respective boards of directors. When two companies decide to join together, it is often called a merger, but basically it is the same as a friendly takeover bid.

WHY LAUNCH A TAKEOVER FOR ANOTHER COMPANY?

There are a few reasons why one company would want to take another company over. The bottom line for most of them is growth. Companies aim to grow sales, earnings, dividends, etc., all to increase the value of the shares and, therefore, the return to shareholders.

Takeovers sometimes happen for other reasons that don't always make sense to market observers. Sometimes a company may buy another in order to get access to certain intellectual property or to eliminate a potential competitor before they become too powerful.

Although these other reasons for takeover bids exist, most bids are launched in order to grow a company the quickest and easiest way possible.

Time has shown that the long-term result of takeovers on the share price of the bidding company depends enormously on the quality of the deal and the ability of management to blend the two organisations and derive synergies. Some bids are ultimately positive for shareholders and some are not.

TYPES OF BIDS

It is important to understand that a buyer is prohibited from acquiring more than 20% of a public company without making an official takeover bid. This is why you often see entities holding 19.9% of a given company.

There are some small exceptions to this, but basically a company must make a takeover bid if it wishes to buy more than 20% of a company.

Off-market bid

There are two basic types of takeovers in the Australian stock market. An off-market bid occurs when a company announces its offer to buy shares in the target company. The bidding company (making the takeover) will lodge a Bidder's Statement with ASIC (the Australian Securities and Investments Commission), then send it to all shareholders of the target company. This document sets out the terms and conditions of the offer and how shareholders should go about accepting it.

The target company then sends a Target Statement to all its shareholders, recommending acceptance or rejection of the offer. The Target Statement is designed to contain all of the information known by the target directors that is material to the bid.

If the bid is hostile, the target company will often include an independent expert's report, which will include a recommendation as to whether or not the bid is fair and reasonable, together with a valuation for the target's shares.

An off-market bid usually has conditions attached to it.

These conditions allow the bidder to withdraw its bid if it does not get exactly what it wants. One of the most common conditions is for 90% shareholder acceptance. This guarantees the bidder the option to withdraw its bid unless it is able to buy the entire company and consolidate it into its existing operations.

Shareholders who accept an off-market bid can do so through their broker if they are CHESS sponsored. Brokerage and GST don't apply when accepting this bid.

Market bid

The other kind of takeover bid is a market bid. This is where the acquiring company stands in the market and buys shares in the target company at a certain price, free of conditions. The company sets an expiry date on the bid and buys in the market until that date.

The bidding company prepares a Bidder's Statement and lodges it with ASIC. The Bidder's Statement is then sent to shareholders of the target company. If shareholders wish to accept this type of bid, they sell through a broker and pay brokerage and GST.

The target company issues a Target Statement in response to the Bidder's Statement, which outlines the directors' opinion about acceptance or rejection of the offer.

Substantial holdings

While a shareholder can buy up to 20% of a public company without launching a bid, if the company is listed on the ASX, there are several disclosure requirements you should understand.

Any party that buys more than 5% of a public company must disclose the holding to the market. This is known as a substantial shareholding. If this shareholding is changed by 1%, the ASX must be informed within 48 hrs of the change.

Regulatory bodies

Apart from ASIC and the ASX, there are other regulatory bodies that monitor takeover activity.

• FIRB The Foreign Investment and Review Board, via the Treasurer, must authorise any takeover of an Australian company by a foreign party. A purchase of more than 15% of a company by a foreign party requires approval. A high profile example of the FIRB's involvement in a takeover bid was when the Federal Treasurer rejected Shell's takeover bid for Woodside Petroleum (WPL) in 2001.
• ACCC The Australian Competition and Consumer Commission has the job of policing issues such as unfair trading practices, monopolies etc. The ACCC has broad powers and can prohibit a takeover bid based on the fact that it would reduce competition and not be in the best interests of Australia and its citizens. The ACCC generally investigates most major takeover bids in Australia, but has only prohibited a few. Some examples of the ACCC's involvement in takeovers include when the regulatory body rejected Boral's proposed acquisition of Adelaide Brighton, fearing a detrimental effect on competition.

TAKEOVER STRATEGIES

To trade takeovers The Rivkin Report way, it is critical to understand how takeover bids work, to know as much as possible about the different players in the game, and to understand the specific details (incl. conditions) of the bid.

There are three main strategies to consider when investing in takeover scenarios.

1. Buying before a (potential) takeover bid

Although trading on potential takeovers does not strictly fall into the realm of takeovers, this is the most appropriate place to discuss the subject.

The Rivkin Report firstly scours the market, looking for suspicious price activity. This is not easily defined, as it is a skill that The Rivkin Report investment team has developed over many years of stock market experience.

Put simply, we look for what appears to be a strong accumulation of shares by a single party. Sometimes this is made easier by significant shareholders having to disclose their change of shareholdings. At other times, we will just identify a particular accumulation pattern occurring in the market.

Next, we consider the fundamental value of the shares. This involves examining the company's fundamentals, such as NTA, P/E ratio, dividend yield and earnings.

The next issue we consider is the company's strategic value. Certain companies have strategic value, which competitors within a particular sector will fight for and, subsequently, often pay a high price for in the interests of securing a strategic asset and denying a competitor the chance to buy it.

So first of all, we endeavour to identify price action that suggests some corporate activity may emerge. Then, to protect our downside, we consider the fundamental value of the company and the strategic value. Armed with an understanding of these variables, we try to calculate a risk/reward ratio. This allows us to decide if a share is good to buy, and if so, how much capital we should allocate to it.

2. Buying after the first takeover bid and then selling into a higher bid

One of The Rivkin Report's most important rules is that 'it is very rare that the first price in a takeover bid is the last takeover price.' This means that if you are selective, you can buy into a company that is under takeover and eventually sell into the final bid, higher than the initial bid.

Something to consider here is our rule, which is to buy at, or close to, the first takeover price. This is a simple rule, but there is a bit more to it than just that. There are two aspects to consider.

Quality or status of bidder

Make sure the bidder is a bona fide bidder! You should only get involved in a situation where the bidder is credible. The bigger the bidder is, the better their ability to pay up will be.

A good example of this is when Air New Zealand, through its wholly-owned subsidiary Ansett, bid for Hazelton Airlines (HZA) in 2000. Qantas (QAN) then entered the game and a bidding war started between the two companies.

Air New Zealand was capitalised at approximately $600m and Qantas was capitalised at approximately $4.5bn, whilst Hazelton, before any takeover bid, was capitalised at approximately $11m (Qantas was over 400 times bigger than Hazelton).

It was clear that Air New Zealand and Qantas were quality bidders, and that there wasn't much chance that they would not be able to proceed with a bid to take over a company capitalised at $11m.

Furthermore, this scenario was begging for a higher bid. At the time Air New Zealand launched its first bid of 90c a share, Hazelton was trading at 66c a share. Qantas then came in with a bid of $1.20 a share. This substantial 30c-a-share raised bid only cost Qantas approximately $5m more than the Air New Zealand bid, which is peanuts for Qantas.

Air New Zealand then came back with a $1.35-a-share bid, which cost Air New Zealand only another $2.5m than the Qantas bid. Qantas came back again with a higher bid of $1.50, and Air New Zealand eventually won it with a bid price of $1.60!

This bid goes to show that Hazelton, had you examined it closely, had assets that were strategically desirable to several large, potential bidders, and the quality and size of these bidders was unquestionable. Hence, the bid would not fall over and further bids were definitely on the cards.

How many potential bidders could there be for the target?

As with the strategy of buying before a potential takeover bid, it is important to assess how many potential bidders there might be. Certain target companies have monopolistic characteristics that strategically may be very important to a number of companies. The downside risk of buying after the first takeover bid is the downside to the bid price. This bid price underpins the downside. The upside is up to you to assess. At this point, it is important to highlight one of Rivkin's Rules: 'Look at the downside of any transaction first. If acceptable, then examine the upside.'

The lesson is that when you see a takeover bid launched, examine the situation to assess the downside/upside risk profile. If the ratio is acceptable, the bidder is bona fide, and the capital is available, go for it.

There are two potential downsides to consider in regards to trading during this kind of takeover process. The first involves the likely downside risk if no other bids, beyond the first one, are launched. If one buys shares above the bid price in the hope that a higher bid will emerge, then the 'likely' downside is the gap between the price paid and the current bid. For example, if shares are bought at $1.03 when the current bid is set at $1, then the likely risk is 3c (plus transaction and holding costs).

The other type of risk to consider is 'the worst-case scenario risk'. This is the downside likely to eventuate in the unlikely event that the current bid fails and no other bid is launched. This downside is not as easily predicted, but the share price levels in the period before the bid was launched are a reasonable guide.

3. Buying below the existing takeover price and making a guaranteed return

As mentioned, when the market believes another bid is unlikely, shares will often trade below the takeover price. This situation will often provide a low-risk, solid-return situation. It is somewhere safe to put your money when you're not using it, and the annualised returns are far better than those you'll get at the bank.

The risk profile of buying shares that are under (unconditional) takeover is low, so this return is attractive.

Three things to consider here are:

• Never forget that even though the return provided by the bid at the time may be small in nominal terms, its annualised return is often much higher.

• The chance of a higher bid can never be ruled out until the whole process is over, even if it seems unlikely. Often, when a friendly bid is launched, which the market expects to be successful, the bid will attract more corporate interest and a higher bid may appear. The stock is often in play once a bid is launched. This has occurred on many occasions. This 'free option' over a higher bid should not be disregarded.

• When trading this kind of takeover, where a further bid is unlikely and the nominal return is minimal, it is important to buy enough shares to make it worthwhile.

SOME COMMON QUESTIONS ANSWERED

Why is the first bid price rarely the last bid price?

There is a great deal of logic to this. Why wouldn't a company offer a lower price than it is ultimately prepared to pay?! If the offer is accepted, it gets the target cheaper than it was prepared to pay, and if it is required to pay more, at least it has more up its sleeve. A suitable analogy is the process of bidding on a house. Why wouldn't you start lower than you are prepared to pay when negotiating with the vendor?! You never know, they just might accept your offer and if not, at least you've got more to play with, you have room to move. Well, it's the same with takeover bids; companies rarely show their best hand first.

Be aware that if the bid is friendly or agreed to by the target company's directors, it is less likely to be raised.

What about scrip bids?

When a company launches an off-market takeover bid, they don't always offer cash in return for shares (a market bid must offer cash only in return for shares). They either offer cash or scrip (shares), or a combination of these.

It is important to understand the variable value issues involved in a scrip bid. If the bid currency is not cash but scrip in a public company, it becomes difficult to value the bid accurately, since the share price is changing all the time and, therefore, the value of the bid is also changing.

When trying to trade a scrip bid, The Rivkin Report generally looks for a better margin to reflect the higher risk involved in taking scrip, instead of cash, as currency for the bid. A scrip bid is often raised, but it does pose another variable in the equation, which must be considered.

When should you exit?

Like any trade, there must be a decision at some stage to exit. While there may be exceptions, the best rule to follow when trading takeovers is to stay long and accept the last and highest bid just before expiry.

The major exception is when a bid is made unconditional, and its success is pretty much guaranteed. Generally speaking though, it's best to hold back on accepting until the process is over. You never know when a new bid will appear and, if you have already accepted a lower bid or sold in the market, you may miss out on the higher price.

Why accept just before expiry?

This is a critical point. If a bid is launched for your shares in a company, it is, as mentioned already, important to stay long and accept the last and highest bid just before expiry.

If you sell on the market, then you won't benefit from a higher bid. If you accept a bid prematurely, you may miss out on the higher bid (if there is one), but it depends. If the same bidder makes a higher bid, you will get the higher bid. However, if another player has entered the game, and you have prematurely accepted the original company's offer, that company is free to take your shares at the lower price and on-sell them to the higher bidder, leaving you without the highest bid. This is why it is essential not to accept a bid prematurely. It limits your options and flexibility and can result in you missing out on profits.

How do you accept takeovers?

To accept a takeover bid, all you need to do is inform your CHESS sponsoring broker that you wish to accept. Your broker can then accept on your behalf, without you having to do anything else (other than send in your signed authorisation). This does not incur any brokerage or GST. Be sure to be specific about details of the bid. If you are not CHESS sponsored, you must fill out the acceptance form that is sent to all shareholders of the target company and return it to the bidder.

Also, often you can sell in the market if you want to get access to your funds immediately. Just remember that this will incur a brokerage charge and GST.

What is compulsory acquisition?

One question often asked is what happens to one's shares if the shareholder doesn't accept the takeover bid. If a company buys 90% of another company, it has the option to compulsorily acquire the remaining 10% of outstanding shares. This means that the bidder sends out payment to the remaining shareholders and acquires their shares at the bid price. Those shareholders have no choice in whether or not they sell their shares.

This is related to the 90% acceptance condition that is often used. It is a very common condition of bids because if the bidder gets to 90%, it knows it can acquire the rest of the shares by compulsory acquisition and consolidate the company.

Be aware that when a company reaches 90% acceptance and goes unconditional, it is wiser to accept the bid before the expiry date, as you will then get paid in 5 business days. If you don't accept and your shares are compulsorily acquired, it may take months to get paid. So, for the sake of expedience, accept the bid in this situation.

CONCLUSION

The Rivkin Report's conclusion on takeovers is fairly simple. If you can buy a stock with a serious bidder at below the bid price, you buy it. If you can buy a stock at the bid price, you still buy it. If you can buy it at a fraction above the bid price, you still buy it. It works nine times out of ten.