Melrose: a better bet than most fund managers

Investment firm Melrose has a simple strategy: buy, improve, sell. It's delivered handsomely for its investors in the past, says Phil Oakley. But can its success continue?

Investors are waking up to the fact that entrusting your savings to most fund managers is not a good idea. High fees and a focus on asset gathering rather than investment too often leads to poor returns.

What can you do instead? You could put your money in investment trusts these tend to offer lower fees and better performance.

Or you could buy shares in Melrose (LSE: MRO).

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

A great investment

Melrose's investment strategy is summed up in three words: 'buy', 'improve', 'sell'. It buys underperforming industrial businesses, turns them around and then sells them.

The numbers don't lie. The fact is, Melrose has been very good at doing this, and its shareholders have made lots of money.

The company was set up in 2003, with equity of £13m. It raised a further £244m to buy Dynacast McKechnie Aerospace in 2005 and £528m to buy FKI in 2008.

Out of a total equity investment of £785m, shareholders have had £593m paid back to them when businesses were sold, as well as a further £178m in dividends. When the final dividend for 2011 has been paid, all the money raised from shareholders will have been repaid to them.

This is a tremendous performance. On top of that, the market value of the company has increased from £13m to £1,478m (based on a share price of 378p).

What's even more commendable is that these returns have been achieved without taking on excessive levels of debt. So unlike lots of hedge funds, returns have not been artificially juiced up and investors have not been exposed to big risks.

Nor can the management be accused of underinvesting and running the business for cash. Since 2005, cumulative investment has comfortably exceeded the depreciation expense (this is a good approximation of replacement expenditure on fixed assets).

This has allowed its portfolio of businesses to grow and become more efficient. It also means that when the time comes to sell a business, the prospective buyer knows that the business has been looked after rather than stripped for cash. This can only be helpful in achieving better selling prices and better returns for shareholders.

What about management pay?

Most fund managers get paid too much. So what about Melrose's managers?

2012 earnings per share(eps) forecasts factor in an issue of around 30 million bonus shares to company management. This equated to £99m at 31December 2011. These shares relate to an incentive plan set up in 2007 that allows management to receive 10% of the growth in the company's market value (adjusted for share issues, dividends and other cash returns) between July 2007 and May 2012. The payment can also be taken as a cash dividend.

There is no doubt that this is a large amount of money and something we'd rather not see. That said, unlike lots of fund managers, Melrose's management actually run proper businesses. They have also delivered handsomely for their investors.

Should you buy now?

So can the good times continue? The good news is that it looks like they can. Melrose's remaining portfolio of businesses have high exposure to the buoyant power generation, oil & gas and mining industries. Order books remain healthy while further efficiency gains should see profits grow again in 2012.

Melrose's finances look in good shape. It has £290m of debt with its gross interest payments covered more than six times. It has said it is ready for its next acquisition, which means that it will probably ask shareholders for more money soon. Given the company's track record this is something to be welcomed rather than feared.

When any company buys another, the biggest risk is that it pays too much and lowers investment returns. Melrose has a good track record here. Last year it tried to buy UK engineer Charter but walked away when other bidders pushed the price too high.

And even without another acquisition, Melrose's shares look reasonable value. At 378p with City analysts forecasting 2012 earnings per share of 30p, the shares trade on a p/e of 12.6 times and a prospective dividend yield of 3.7%.

Given the potential for Melrose to create more value on top of this by buying companies, we think the shares are worth buying.

Phil spent 13 years as an investment analyst for both stockbroking and fund management companies.


After graduating with a MSc in International Banking, Economics & Finance from Liverpool Business School in 1996, Phil went to work for BWD Rensburg, a Liverpool based investment manager. In 2001, he joined ABN AMRO as a transport analyst. After a brief spell as a food retail analyst, he spent five years with ABN's very successful UK Smaller Companies team where he covered engineering, transport and support services stocks.


In 2007, Phil joined Halbis Capital Management as a European equities analyst. He began writing for MoneyWeek in 2010.