May 1, 2015

Super-Size Me!

Numerous studies have shown time and time again that M&A is value-destructive for the acquiring company. A study by the National Bureau of Economic Research in 2003 showed that acquisitions led by large US firms over the preceding 20 years had destroyed a total of $226bn in shareholder value. Of course this never seems to put off company management, who always believe “my acquisition will be different”.  Investment bankers encourage CEOs to pay what’s necessary and then justify it after the event. CEOS get carried away with empire building, and rarely need the extra push. This leads to synergies being over-estimated, integration costs being underestimated, and an extortionate price tag. As an analyst, you need to get a good understanding of what you’re dealing with before you can judge whether management’s estimates are reasonable. What follows is my guide to the most common types of acquisition you’re likely to come across.

The “Transformative” Deal

Be skeptical of deals that management describe as “transformative”. Often the transformation is not for the better. These usually involve mergers of two large companies, big egos, overlapping functions and competing cultures. They are justified on “strategic” grounds – with references to economies of scale, or complementary products/ technologies. In reality the cost of integration gets grossly underestimated and the revenue synergies rarely materialize. In some cases two companies are put together that have no business being integrated. What makes sense to the management makes less and less sense as you go down the hierarchy. AOL and Time Warner is a classic example of a transformative deal gone wrong.

The Technology Deal

Here a large company buys a smaller company for access to a particular technology or product. The deal is sold on significant revenue synergies – the idea being that this new technology/ product can be sold through the acquirer’s existing infrastructure. Often pharmaceutical companies will buy smaller biotech for access to a new pipeline. (For example the 2011 acquisition of Genzyme by Sanofi) There are two big risks here – firstly that the culture is not a good fit, leading to key staff departures and low morale for those who remain. Usually this happens when there is a large, bureaucratic company buying a much more entrepreneurial one. Secondly, think about whether the revenue synergies are realizable. Can the new product easily be sold through the new infrastructure? Is the sales force equipped to sell the new product and do they have access to the right people in the organizations they sell into?

The Land Grab

Here a company expands its empire into another geography. These kind of deals are often justified because growth opportunities have run dry in the domestic market (god forbid they should start giving the money back to shareholders). An example here is Walmart’s forays into multiple foreign markets. Because these deals relate to a completely new market, synergies are often thin on the ground. There might be some cost synergies (central purchasing, back office efficiencies), but these are usually small in relation to the size of the deal and can be harder to extract than initially thought. In some cases the acquiring company may bring expertise or a novel process to the new market. But what works in the US may not work so well in Europe or China. While Walmart have been relatively successful with Asda in the UK, other deals in countries like China have been much harder work.

The “Two Drunks” Deal

This is where two weak companies merge, hoping that somehow the combination will create a much robust company (not unlike two drunks holding each other up). However if a fundamental problem existed before the deal it’s not likely to magically vanish as a result of the combination. And the distraction created by the integration will usually make things worse. A classic example here is the combination of Alcatel and Lucent – both companies were struggling at the time with disruption in the industry and the combination only served to make things worse.

The Consolidator

Here a company attempts to consolidate a hitherto fragmented industry by buying up smaller companies and attempting to instill price discipline to the market. The Indian company Mittal has has attempted to do this in the Steel industry (via the acquisition of Arcelor as well as many others). However it can take decades to truly change the structure of the industry: Despite a large number of mega-deals the Steel industry remains fragmented and undisciplined to this day.

The Bolt-on

Deals are often most successful where there a dominant company buys a much smaller company that can be integrated without too much fuss. In these cases you want to look for a management team with a strong track record of successfully integrating businesses. The best strategies will involve a clear idea of how the acquisition is adding value – whether it’s improving an underperforming business, stripping out costs or accelerating development of a technology. Bolt-on acquisitions often go through below the radar, but over time are likely to be the most value-accretive.

Join the conversation! 1 Comment

  1. perfect example of bolt on acquisitions: GLUU.
    They have been acquiring smaller mobile game developers, where they use their platform to develop profitable games by using GLUU’s monetization strategy.
    Great article.

    Liked by 1 person


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