Why Most Large Mergers Are Failures

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Why Most Large Mergers Are Failures

Why Most Large Mergers Are Failures

Hubris:  “We can do it better than [the target company].  With additional scale, we will be able to gain operating efficiencies and marketing opportunities. We will be a big company in our industry, and we will control our own destiny.”

So some CEOs think.  It is easy to propose large mergers, wave your hands at the details, and the deal takes on a life of its own.  But large deals:

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  • Attract competition.  If a large piece of market share is up for grabs, many will try to grab it.  Premiums to get a large deal are often uneconomic, akin to the guy who shows of a jar of nickels  in a crowded room, and invites people to bid for it.  He never clears less than a 20% profit on the jar.
  • Have to meld two different cultures.  This is not trivial.
  • Have to meld two different information technology departments.  Also not trivial.
  • Have synergies and cost savings that are often overestimated.
  • Face greater scrutiny from the government, which slows things down, and results in greater restrictions on the combined enterprise.
  • Have a CEO that will be severed, and he will require handsome compensation to go. Sadly, the remaining CEO will get a pay boost, after all, he is running a bigger company.
  • Run into the problem of Too Big To Manage.  This may not apply to large energy companies, because they are relatively simple, but with most other companies with market caps over $100 billion, performance deteriorates.  It is difficult to keep incentives sharp for employees and managers.
  • Have a buyer who may not appreciate some strengths of the target company.  In two insurance acquisitions, I saw the acquirer throw away valuable divisions that they could not understand, firing people more talented than the acquirer was.  At least they should have sold the division to someone else.
  • Generates goodwill, which makes the company harder to analyze, an lowering its valuation versus book.

That’s why I don’t buy companies that do scale acquisitions.  They tend to flounder and lose money.

But I do buy companies that do tuck-in acquisitions.  Tuck-in acquisitions are buying a little company that adds:

  • A new technology
  • A new marketing channel
  • A new product or service

Which is complementary to their existing business, and they will grow it organically.  With a tuck-in, the competition is less, integration issues are less, almost every difficulty versus large acquisitions are less.  Prices are low.

One use of free cash flow is acquisitions.  Companies that focus on small acquisitions and organic growth use free cash flow wisely.  Large acquisitions overpay to buy a trophy asset that the acquirer may unintentionally destroy.  Avoid such acquisitive companies.  The company  may grow, but the stock price likely will not.

By David Merkel, CFA of Aleph Blog

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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