Monday, October 5, 2015

Managers, Pigeons and M&A

Nine month 2015 M&A activity is within 2% of the pre-crisis 2007 record. Most of the buyers are strategic corporate. Even LBO volume recovered in 3Q15 driven by large levels of PE dry powder. As Ralph outlined there are many reasons, some good and others not so good, for the increased volume. A sometimes neglected reason for M&A growth is based on B.F. Skinner who influenced animal (pigeons) behavior thru rewards.
Investors have reacted positively to buyer M&A announcements for the last 3 years. This is in contrast to their negative reaction for the 1996-2011period subject to anticipation effect adjustments. Since the end of the great recession, investors have rewarded firms who could profitably reinvest capital; those who could not were rewarded for the return of cash via dividends and repurchases. The initial acquisition, 2012-2014, spurt involved lower prices, both premiums and multiples, strong strategic rationale, and smaller targets. Bottom line they were attractive deals.
Current late in the cycle acquisitions are getting pricey in terms of premiums over bull market inflated stock prices (40 %+) and multiples often exceeding 12 X EBITDA. Furthermore, they are becoming quite large. Although dollar volumes are up the number of transactions is actually down this year. This is reflected in the number of large $10B+ deals, which now total 47. Larger deals combined with higher premiums put more acquirer shareholder value at risk (SVAR). Additionally, larger deals involve increased integration risk. Consequently, investors are justifiably becoming concerned with the recent number of higher risk announced acquisitions. Some managers, like Skinner’s pigeons, have been conditioned to think (all-most?) acquisitions will be positively received by investors, and are sailing full speed ahead.

Just like investors, mangers need to become more discriminating about acquisitions. This means addressing the following issues:

1)     Red Flags: be prepared to sit out current late stage acquisitions that involve SVAR greater than 20% of the acquirer’s pre bid market value due to size and pricing premiums unless you are REALLY REALLY sure.
2)     Timing: remember the best of deals are made during the worst of times; while the worst of deals are made during the best of times-like now.
3)     Growth: not all growth is good. The key is return on invested capital. Overpriced deals relative to value received never work.
4)     Best Owner: unless you are the best owner of the target you are likely to fall prey to the winner’s curse.
5)     Strategic Basis: why are you buying? The best answers include achieving economies of scale or scope, expand geography by expanding into adjacent markets, and to improve operations of a poorly run target.

Managers, just like Skinner’s pigeons, cannot expect positive investor reaction to all acquisitions. Investors are evaluating the fundamentals of each deal based on factors similar to those previously stated. This does not mean all M&A is bad again. Rather, it means managers need to be more selective just like investors and less like pigeons.


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