Stockwatch: This share confirms the bull is very much alive

Is it better to sell in the market when a stock price trades above possible takeover terms? What of the reported intervention of Elliott Capital Advisors - an American hedge fund group - buying 5% of this mid-cap financial software group in the hope of a higher offer?

As yet, there is no confirmation in Fidessa's Regulatory News Service, although media reports the "offer" has been "accepted". The last such RNS was 20 February declaring "advanced discussions regarding a possible all-cash offer".

Meanwhile, the shares have risen above potential offer terms of 3,646.7p per share (inclusive of final/special dividends) - to an all-time high of 3,830p, currently about 3,750p.

Reflecting hopeful spirits of the times

The approach is by Temenos, a Swiss financial software group and an industry leader, representing 40 times historic earnings and four times sales, although, as the table shows, Fidessa shares have long enjoyed a high rating (annual average price/earnings (PE) multiples towards 30, versus slack earnings growth) due to perceived strategic value in its operations.

Apparently, at least three-quarters of all securities transactions in London are handled by Fidessa systems. I've been aware of the group since it floated in 1997 as Royalblue, and the long-term context includes Temenos losing out to a private equity bid for Misys (another FTSE 250 financial software group) in 2012. Thus, Temenos has bided its time but kept watching.

Interestingly, this potential deal involves £1.4 billion cash, twice Temenos's $1 billion (£712 million) reserves for acquisitions - a sign that animal spirits are running high after years of low interest rates. It might not be a classic "deal too far" - i.e. high-profile takeover that marks the top of an economic cycle - but reflects bullish management, likewise Elliott's circa £65 million intervention.

This is a gamble in the sense that takeover arbitrage properly limits itself to confirmed takeover terms, exploiting market price trading at the slightest discount. Event-driven hedge funds such as Gruss & Co used to shave a series of takeover situations to compound returns at say 5% to 10% annually, albeit with very low risk.

A few such plays might result in higher offers, enhancing returns. But with loose monetary policy having encouraged risk-taking, hedge funds have proliferated and tended more to speculate. Mind also how Elliott has - reportedly - trimmed its stake to 4% after Fidessa's rise over 3,800p, though again there is yet to be any confirmation in the RNS.

Cash flow strengths may mitigate risks

I drew attention to Fidessa at 2,450p exactly a year ago after 2016 prelims beat expectations - showing a 25% advance in pre-tax profit to £48.8 million on revenue up 12% to £331.9 million, albeit up just 1% and 3% respectively, at constant currencies.

With 43% of 2016 revenues deriving from the Americas, 36% from UK/Europe and 21% from Asia, sterling's volatility post the EU referendum, also US dollar strength, had provided a boost.

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Yet underlying performance was still ahead of expectations and likely upgrades to forecasts implied a PE in the low twenties. That, together with a prospective yield near 4%, looked good value in Fidessa's long-term context, the share price relatively low in its range. The group was also positioning itself well in its main US market, to capture medium-term benefits of financial deregulation there, which has likely caught Temenos's attention.

See from the table how cash flow per share has trended at least twice earnings per share; so, despite capital expenditure absorbing around half of cash, this has offered a higher benchmark for value than earnings. Cash flow strengths have probably influenced Temenos's offer terms, and appraisal of risk.

Temenos is confident of synergies arising

While analysts have questioned what scope there is for cross-selling, Temenos's chief executive proclaims: "quick wins on revenue synergies and overlapping geographies on top of the synergy numbers we have talked about."

He believes a merger is not mainly about cross-selling to each other's clients, but their wanting to work with fewer vendors in future; also that Temenos's sales model, evidenced by 28% top-line growth, can be extended to improve Fidessa's - whose latest 2017 results show 7% growth, or 3% at constant currencies.

"They have a huge sales organisation in the US and Japan where we are not that present, while we are strong in Europe and the Middle East." The merger rationale also hopes to capitalise on banks increasing their software spend on "cloud" systems, again likely to favour one key vendor.

Yet Fidessa's sub-15% operating margins are less than half those for Temenos, suggesting a lack of efficiency despite global reach. Thus, understandably, Fidessa's board are attuned to Temenos's apprach a means to deliver shareholder value much sooner than a stand-alone Fidessa could achieve.

Current price is 2.8% above possible offer

According to Fidessa's 20 February RNS, the timetable for Temenos to make a firm offer runs to 20 March. Most likely they will and soon, subject to due diligence, enabling Fidessa shareholders to exit at a big premium to the last few years', volatile-sideways trend.

Although my 'buy' stance at 2,450p a year ago was followed by an 8% rise, the stock was 17% down on this by late summer, before recovering to about 2,500p. Temenos's potential offer would represent a 43% premium for control, excluding dividends, 46% all-inclusive, thus likely to convince shareholders.

Fidessa hasn't disclosed any other bid approaches in recent history, and a private equity bid would not derive synergies, so, unless Elliott is hawking Fidessa around US software industry circles, it's hard to envisage a competitive rival offer.

Mind the aspect of dividend taxation versus capital gains, which may vary for some individuals, but all-considered the best stance is to sell in the market while a premium pertains - which amounts to call option value, based on an off-chance.

More widely it's all a notable sign how animal spirits remain strong: Temenos appears to be quite stretching itself. This hedge fund has weighed in speculatively, and the market anticipates a higher offer before a first is even properly tabled. The US market might have briefly dropped 10% this month but, according to this, bullish sentiment is well-intact.

Even so, a discipline approach would recall birds and the bush. Take profits.

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