Is the Costa takeover a 'great outcome' for shareholders or not?

Experts are mixed on whether the offer is strong or not.

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Key points

  • Costa has received a takeover offer of $3.50 cash per share
  • It’s not a binding offer yet but there has been speculation that a deal is close
  • If earnings rebound as they’re expected to, one expert thinks the offer may undervalue Costa

The Costa Group Holdings Ltd (ASX: CGC) share price climbed 12% yesterday after news broke of a confirmed takeover offer.

For readers who aren't sure about what the company does, it describes itself as Australia's "leading grower, packer and marketer of fresh fruit and vegetables". Costa grows food in five categories: berries, mushrooms, glasshouse tomatoes, citrus, and avocados.

Let's check what sent the Costa share price higher on Tuesday.

Takeover offer

Yesterday, the company acknowledged there had been media speculation about a proposal from private equity group Paine Schwartz Partners (PSP) to acquire Costa.

PSP actually made the offer on 31 May 2023, which was a confidential, non-binding offer of $3.50 cash per share. Costa shareholders would also be entitled to an interim dividend of up to 4 cents per share. After a four-week period of initial due diligence, PSP has reconfirmed its indicative offer.

In October 2022, PSP bought a 13.78% stake in Costa for $2.60 per share. Costa and PSP talked in April about a potential approach at a range of between $3.20 to $3.30 per share.

There was media speculation that Costa and PSP were "hopeful of an agreed deal in coming days" but further due diligence and negotiations about an agreement are expected to continue through July, according to Costa.

What to make of this deal?

The offer is close to a 30% premium of where the Costa share price was on 30 June 2023, so it's a solid price compared to recent levels.

However, it's more than 25% lower than where the company's share price was in May 2021, as we can see on the chart below.

For investors who have been around for a while, that would represent a sizeable decline. Though, there's no 'rule' that says that PSP has to offer a price as high as where it was a couple of years ago.

According to reporting by The Australian, there has been a suggestion that the offer undervalues Costa. Still, Wilson analyst James Ferrier thinks that PSP's offer will be supported:

While Costa has invested in significant expansion of its productive asset base over the past five years, incremental return on capital has disappointed.

If one assumed that return on capital can and will improve to target levels, then PSP's indicative bid price arguably undervalues Costa.

Meantime, Belinda Moore from Morgans said in a research note:

We view Paine Schwartz's $3.50 indicative takeover proposal as a great outcome for Costa shareholders, given the execution risk involved in delivering its growth projects and targeted returns over the next few years. Also, Costa's earnings are just too volatile for the listed market.

Foolish takeaway

Despite the huge jump in the Costa share price in the past week, at its current share price, the company is valued at 18x FY25's estimated earnings. As well, the company's earnings are expected to increase. Time will tell whether the takeover offer is acceptable to shareholders or not.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Costa Group. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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