Monday, November 18, 2013

Goodwill Hunting Revisited

An earlier Post focused on goodwill Impairments as a measure of M&A value destruction. Duff & Phelps has released a new Study which contains some interesting results:

1)   Goodwill impairment surged 76% from the prior year to $51B.They still remain below the peak 2008 crisis related levels which were centered in the financial services industry.

2)   Buyers paid the lowest premiums in nearly 20 years, less than 20% v a historical 30%+.

3)   Impairments were concentrated in industries and firms undergoing structural change. IT was the industry experiencing the largest share of impairments. Two firms in that industry, Hewlett Packard (HP) and Microsoft (MS) had the largest impairments at $13.7B and $6.2B respectively representing nearly 40% of total annual impairments. HP’s impairment concerned its Autonomy acquisition while MS’s related to aQuantive.

The biggest source of M&A value destruction is overpaying. No matter how good the fit, how good the target, how flawless the integration, or the amount of due diligence, if you overpay, reflected in the amount of goodwill created or earnings and book value dilution, your shareholders will suffer.

Conceptually, the target’s pre bid share price plus the premium equals price paid. The value received is the target’s standalone value (reflected in the pre bid price) plus any synergies. Thus, the acquirer’s net value received is synergies less the premium. Premiums are, however, a fact while synergies are an opinion subject to behavioral bias.

As a rule of thumb, premiums exceeding 40% are prima facie evidence of overpayment. Think about it, a 40%+ premiums means you have to improve the target’s performance by over 40% just to breakeven. Unless, the target was grossly mismanaged, this will be difficult in a low growth highly competitive market.

The HP and MS acquisitions were grossly overpriced with premiums of 64% and 85% respectively. Such actions reflect desperate buyers gambling for redemption (AKA Hail Mary pass). Both HP and MS are former growth stars experiencing slumping sales growth and eroding margins. Their management teams, both of which have or will be replaced following their disastrous acquisitions, believed large transformational acquisitions would serve as a growth elixir. Unfortunately their shareholders were forced to drink from the poisoned chalice of value destruction.


PS We are approaching the next offering of our Acquisition Finance Course in Amsterdam and that also means approaching the deadline to sign up.

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