Merger Activity - A Record Year?

Tuesday's Wall Street Journal contains a very interesting article on this year's merger activity. (See Merger Activity is on Pace for Record, by Dana Mattioli and Dan Strumpf).  Citing Deal Logic as a source, the authors note that if the current pace of deals continue, it will outpace 2007 - the last record year.  Illustrative of this is Berkshire Hathaway's $32 billion deal to acquire Precision CastParts Corp.  the largest deal in Berkshire's history.

What interests me most about the article are the reasons cited for the large number of deals.  We've covered most all of these in these posts - and also urged caution.  Some of the main issues are noted below:

• Low interest rates - and the fear future rates will rise
• Executive confidence
• Fear of being left behind
• The desire to boost growth through acquisitions (as growth from other sources becomes limited)
• The "economy isn't in free-fall"
• Accumulated cash on acquirer balance sheets

I firmly believe these concepts are on the minds of today's executives and I don't doubt they are driving deal activity.  What concerns me is that with the possible exception of confidence none of the reasons are valid by themselves for doing deals.

Sure, low interest rates are better than high rates, but if a deal doesn't make strategic sense, low rates are not a sound motive for doing deals.  (See Any Deal is a Bad Deal at Some Price; Not Every Deal is a Good Deal at Some Price).  The same is true of fear of being left behind.  On the face of it, it implies a 'keeping up with the Jones' mentality. It could also imply an 'eat or be eaten' mentality.  While shifting landscapes are certainly catalysts for deals, it is important to understand the economics behind these shifts.  Again, deals that fit the strategic plan of the company are best and sometimes the best deals are those you don't attempt.  In some situations, selling the company is actually the best move for shareholders.

Joe has talked extensively about the attempt to boost growth through acquisitions.  If the benefits don't exceed the costs, the deal is bad, even if it produces a short term boost to earnings.  Unfortunately, it can be easy to get caught up in deal fever and overestimate benefits and understate the difficulty in integration.  (See A Man Hears What He Wants to Hear).

The economy not being in free fall is a good thing, but hardly enthusiastic support for doing deals.  Finally, accumulated cash is absolutely no justification for doing deals.   Each company must ask - can I earn a superior return on this cash for my shareholders.  If not,  it should  be returned to its owners - the shareholders.

So this brings us back to executive confidence.  Confidence can be driven by many desirable qualities - knowledge and experience come to mind.  Confidence can also be driven by emotion and influenced by every one of the other factors in the list.  Bottom line - only attempt deals that make strategic sense and that are justified based on a hard look at the costs and benefits.  Without this step, none of the other items matter.

All the best,

Ralph

One Sided Activism? A Note on the Symmetry of Market Problems and the Asymmetries of Activists

There are a couple of really interesting articles about activists in the last two Wall Street Journals.  The first is yesterday's "Activists Are On A  Roll With More to Come", which documents the power and success of activists, noting the growth in the number of campaigns and in the number of assets under control.  The article also notes the increased success rate of proxy campaigns.  

The second article, entitled A Radical Idea for Activist Investors presents a provocative question.  If Actists are so smart, why are they one sided in their attacks? As the article notes:

"The vast majority are making similar demands of their targets, delivered with what now feels like a dull percussion: Raise the dividend, buy back shares, cut these costs, spin off that division, sell the company."

Wouldn't we expect a similar pressure by activists encouraging at least some firms to invest more?  Shouldn't we expect at least some activists campaigns to push firms to be less conservative, to invest more, to pursue heretofore missed opportunities?  

The article suggests three reasons for the one-sided attacks.  First, CEOs can be driven by ego and are motivated to expand not contract.  Second, such an attack requires a longer term investment to reap rewards.  Activists tend to be more short term.  Third, it could cause destabilizing investor turnover as one type of investor replaced another.  (I confess to not fully understanding the latter idea.  How does this ever stop value creation?  Don't takeover attempts do the same thing?)

But I'd like to offer a fourth reason that activists are not prone to pushing firms to invest differently and it is simply this:  Activists are not by nature, build it, type individuals.  Also, the expertise it takes to recognize over investment is likely to be more plentiful than the type of expertise it takes to build something.  I'm not saying one of these skills is more valuable than the other, just that it is not surprising that activists don't possess these skills.  Also as the article notes:

"These are the very opportunities that private-equity firms exploit, capitalizing on the market’s impatience for such undertakings."

So from my perspective, there is nothing unusual about specific types of investors being adept at different approaches.  Both articles offer a lot of food for thought and are well worth reading.  

All the best,

Ralph

Shareholder Lawsuits May Prove More Costly

We've noted the likelihood of being sued after completing a deal, especially a large one.  An article in the Wall Street Journal suggests that a recent court ruling may make those suits less attractive to plaintiffs lawyers.  In particular, companies are adopting a clause that requires plaintiffs to pay the firms legal fees if a suit fails.  The court upheld a bylaw a company had adopted requiring such payments.   The article also reveals declining awards for plaintiffs' attorneys over recent years. 

All the best,

Ralph