Does Betfair (LSE: BET) look overvalued after a 40% rally since early October? A similar performance has also been recorded by Tesco (LSE: TSCO) over the period, so have the shares of the UK’s largest food retailer become too risky right now?
These are legitimate questions for investors, who may also have to decide what to do with Quindell (LSE: QPP), which hasn’t fared well since October but whose shares are up 131% since early December.
So, if you had an initial capital of £5,000, which one should you choose?
Frankly, I’d be tempted to snap up both Betfair and Tesco (75%/25%) but I’d avoid Quindell at this price. All three companies are takeover targets, but I wouldn’t buy any of their shares based on that reason.
Betfair Under The Spotlight
There’s a lot to like in its business model as well as in the way Betfair is managed. The group is targeting the market for recreational punters, also know as “mug punters”, while trying to minimise regulatory risk and operating more efficiently. Its management team is doing a very good job, and prospects are truly encouraging.
Financially, Betfair is a strong company boasting hefty operating margins; it is likely to reward shareholders with rising earnings and dividends into 2017. Its shares aren’t cheap at 22x forward earnings, but if managers continue to deliver on their promises — and there are reasons to believe they will — Betfair will likely meet bullish forecasts from some brokers, according to which upside could be 30% or more. The average price target from brokers is now 5% above Betfair’s current stock price.
With a market cap of about £1.3bn, the company is an ideal candidate for a takeover by private equity. It’s the most appealing investment of the three, although upside could be greater with Tesco.
Tesco Or Quindell?
Tesco is a risky investment, although it has delivered plenty of value to shareholders in recent weeks. Revenues rose for the first time in a year, it emerged on Tuesday, but whether that is actually good news is another matter. Tesco must prove it can grow efficiently by restoring profits and gaining market share over time.
The retail market is incredibly challenging, and Tesco — whose fair value is 229p a share, in my view — has just begun a very difficult corporate restructuring in a sector where competition is fierce and may force the largest players to run their businesses at a loss to preserve their market share.
Tesco CEO Dave Lewis has invested in price cuts, which was inevitable. More importantly, Mr Lewis seems to have come to terms with the idea that Tesco must shrink to get fitter: if that’s the path to follow, then it’ll be a long road to value creation.
Of course, talk of divestments makes a lot of sense, but disposals aren’t easy to execute and, as far as investors know, Tesco has yet to announce a benchmark sale. “Look, folk out there talk about Tesco’s assets and their appeal, but Tesco’d be much more likely to get a top valuation if it received a full bid,” an M&A banker told me yesterday. “That’s been discussed for some time,” he added.
Finally, Quindell.
Well, I don’t think Quindell is investable. Is that the end of the story?
Its shares could certainly be perceived as an opportunistic bet, but at this point in time I don’t think the company can’t be trusted and there are plenty of questions that will have to be answered by management in weeks ahead, such as ‘has management cooked the books and if so, why is it taking so long for investors to learn more about the current PwC independent review?
The only way out for shareholders is a change of ownership, I believe.