Why predators can be poor investments

By:Tim Bennett
This week, Tim Bennett warns investors not to get carried away by “M&A” hype and looks at why acquisitive CEOs often fail to deliver shareholder value.

Why predators can be poor investments

Mergers and acquisitions are big business – in 2017 the value of deals done globally has passed the $2.5trillion mark to beat the level set in 2016.

However, popular as mega-deals are amongst corporate CEOs and their advisers, investors should be careful: predators are not always great investments and here’s why.

A curious anomaly

S&P Global Market Intelligence looked at the Russell 3000 index between 2001 and 2017 and came to the following conclusions;

·         A $1,000 investment in the broad index would have tripled

·         A $1,000 investment in their M&A Universe – stocks where deals represented more than 5% of Enterprise Value – would have only doubled

This suggests that whilst some mergers and acquisitions add value to the acquirer, plenty don’t or are not worth the effort and money that is sunk into making them happen.

The basics of M&A

Mergers and acquisitions produce a similar end-result to the outside world but are subtly different in nature;

Why CEOs love them

There are only two ways to grow a business. “Organic growth” is achieved where a CEO expands a firm using its own profits and cash flows. This is worthy but can be slow. Acquisitions offer a faster route to the same end-goal. And that’s not all;

What can go wrong for investors?

Despite all the fireworks and excitement that M&A generates (not to mention fees for professional advisers) S&P’s review suggests that following many deals, debt-related expenses increase for the newly expanded firm, net profit margins fall and earnings per share growth decelerates. In short, there is a gap between what an acquisitive CEO promises and the subsequent results delivered by the combined firm.

Warning signs

Clearly some transactions are more successful than others in terms of generating post-deal performance. It seems that a deal is more likely to disappoint when certain conditions hold true;

What should an investor do about this?

Experienced investors often focus on buying potential targets before they are snapped up by a bigger predator – this is easier said than done, however. Really savvy investors may even try to bet two ways, on a rise in the share price of a target and a decline in that of a predator.
For everyone else, the advice is simple and twofold – first, don’t get lulled into chasing the latest hot deal by media headlines and second, keep an eye on overall deal volumes. Why? Sellers tend to try to sell when the market is buoyant, so a flurry of deal activity can suggest insiders are trying to exit ahead of a dip. If this is the case, be doubly wary!