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M&A: The Good, the Bad and the Ugly

Posted By Barry Ritholtz On February 18, 2004 @ 12:18 pm In Finance | Comments Disabled

With the recent spike in Merger activity, perhaps its time to look more closely at the Mergers & Acquisition issues which affect investors. Consider these 5 issues when mulling over a potential Mergers or Acquisitions:

· Why? What are the strategic advantages to the combination?
· What Sector? Some areas have a good merger history (Oil, Banks), while others (Tech, Retail) are notably poor;
· “Paper or Plastic?” How is the acquisition being paid for? Cash, Debt or Paper?
· Valuation: What metrics are valuing the purchase? Are they reasonable?
· Management: Do they have the requisite skill set to successfully integrate two disparate entities?

These questions should help investors make an intelligent appraisal regarding potential acquirors or targets. Let’s do an a quick look at various reasons for mergers, and whether they tend to be successful or not:

Operating Business Purchases
Warren Buffett and Berkshire Hathaway buy businesses. Sometimes they complement the rest of their holdings (GEICO, American RE) sometimes they are just good solid franchises at a substantial discount. (Clayton Homes, Seitel, McCLane, Fruit of the Loom, Garan).

Strategic Mergers
The GOOD: Apple bought NeXT, bringing not only the kernal of its newest Operating System, but getting innovative Steve Jobs to return as CEO in the process. Disney could pull off a “sequel” by buying Pixar, and getting Jobs as CEO.

The BAD: AT&T: Starting with NCR, and went straight downhill from there. A series of disastrous acquisitions to buy “earnings

The UGLY? Comcast/Disney: This deal raises numerous red flags: Disney is a pricey, under performing property with arguably the world’s most overpaid CEO; Comcast has no management experience in travel/media/film/TV business. Lastly, Comcast’s corporate governance is not good for shareholders. They are essentially a family run business (like Disney was) only they are public, with 2 classes of stock: CMCKA, CMCSK. The family has the voting stock, while the owners of the company are disenfranchised. It’s unclear whether that same silly arrangement would be in place if their bid for Disney succeeds.

Two other strategic serial acquirers to consider: GE and Cisco. They tend to buy – smaller, more readily digestible parts; They do a lot of these acquisitions — enough so that management actually becomes good at it.

Other players to consider: Barry Diller’s strategic purchases for Interactive Corp (IACI) have been solid, reasonably priced, and integrated well with the parent firm. IBM’s buy of Price Waterhouse Coopers Consulting seems to be working out so far also.

Competitive Threat
The HP Compaq acquisition: Faced with the potential marginalization at the hands of Dell, Carly Fiorina threw a “Hail Mary” pass via the HP Compaq merger. The only way they could stay competitive with Dell was to dramatically reduce costs, and to further expand into the enterprise and consulting businesses.

Widely despised before consumation, this has turned out to be a surprisingly successful pairing, based upon cost savings alone.

Trading Expensive Stock for Hard Assets
At the peak of the bubble, several companies traded their pricey paper (monopoly money) for hard assets:
      AOL/Time Warner
      Qwest / U.S. West
      Yahoo/Broadcast.com, Yahoo/Geocities

As widely disliked as the AOL deal was, Steve Case actually swapped monopoly paper for arguably the world’s largest collection of media properties. Who knows what AOL stock would look like today if not for that transaction.

Unlike the Yahoo deal, on the other hand, which traded dot com paper for dot com paper.


Cost Savings
Some deals are more likely than others to work out. Consider bank mergers, which invariably result in large cost savings (i.e., layoffs). More assets and accounts, lower per dollar overhead = greater profits. It’s a pretty simple formula, and it usually works.
Banks
      JPM Chase
      Citibank Travelers

On the other hand, mergers in the Broker Deal/Investment Banks are less of a sure thing.
B/Ds
      Lehman NB
      Morgan Stanley/Dean Witter
      Wachovia/Prudential
      Goldman Speer Leeds
      Merrill Herzog

Commodities
Commodity mergers often work because the valuation issue is readily determinable: What does it cost to get a barrel of oil out of the ground or out from under the seabed? What are you paying for proven reserves?

These have all been mostly successful:
      Exxon Mobile
      BP/Amoco
      Conaco Phillips

R&D Purchases
A more challenging area: There are many different practice areas of medicine, each with separate product lines. Some pharmaceutical manufacturing are drug specifc, and are not readily adaptable to other product lines.

Buying a much larger firm in a hostlile bid is quite challenging; That’s the risk in the Sanofi / Aventis deal:

Smetimes, deals take a long long time to get fully integrated: Amgen’s stock is essentially unchanged from the day before this acquisition was announced. Amgen / Immunex

Roll Up Strategies
Perhaps it’s unfair to rely on just these three notable disasters, but each ran into accounting problems. It shouldn’t be surprising given the opportunity for mischief all the acquisitions create (AOL also)
      WorldCom/MCI
      Tyco
      Cendant

Other
What can I say about Auto Mergers? They tend to large expensive and time consuming.
Which of the following were win/wins for both the hunter and the hunted?

Auto
      Daimler Chrysler
      Ford Volvo
      VW/Audi Lamborghini (Chrysler)
      Fiat / Ferrari

Retailers
      Limited
      Federated/Macy’s, et al.
Also, retailer mergers also have a very mixed track record.

Two final thoughts on M&A: First, where were all these dealmakers last Summer, when stocks were so cheap? Why do we always seem to have a spate of mergers AFTER a big run up in prices?

Lastly, consider the role of investment bankers, whispering sweet nothings into Execs ears. They tend to do well (fee wise), regardless of how well the deal works out. That suggests looking at Goldman Sachs, Merrill, UBS and Morgan Stanley as the prime beneficiary of these deals.

Sources:
The Mega-Merger Mouse Trap [1]
By DAVID HARDING and SAM ROVIT
WSJ, MANAGER’S JOURNAL, February 17, 2004

http://online.wsj.com/article/0,,SB107698270248031082,00.html

The Art of the Deal [2]
James B. Stewart
SmartMoney.com February 17, 2004

http://www.smartmoney.com/commonsense/index.cfm?story=20040217


Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2004/02/ma-the-good-the-bad-and-the-ugly/

URLs in this post:

[1] The Mega-Merger Mouse Trap: http://online.wsj.com/article/0,,SB107698270248031082,00.html

[2] The Art of the Deal: http://www.smartmoney.com/commonsense/index.cfm?story=20040217

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