Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 211

7 ways acquisitions add or destroy value

Mergers and acquisitions (M&A) can add material shareholder value to companies that get it right. Conversely, failure to deliver anticipated M&A benefits will either result in destroying shareholder value, or in extreme cases, put the entire company at risk.

Acquisitions require detailed execution and integration plans that identify key issues and focus on the early delivery of synergies. M&A inevitably increases staff workloads and management will need to ensure the existing core business is not overlooked or compromised. Success rates are dramatically improved if a company has a good management team, robust systems and processes and a board with M&A capability and experience. The most successful acquisitions will typically increase earnings per share (EPS), increase the net present value (NPV) per share and provide a short payback period.

Current conditions for M&A

The current environment is generally favourable for M&A as interest rates are low and the economy is expanding slowly, so companies are attracted to opportunities that supplement low organic growth. The main negative is that valuations are comparatively high. In FY16, the value of M&A exceeded $30 billion. Larger deals included:

Over 40% of acquirers were overseas companies with private equity accounting for nearly 20% of overall activity.

Friendly takeovers traditionally result in a completion rate of ~80% compared to hostile bids with a lower success rate of ~50%. Premiums in friendly deals tend to be lower, averaging between 20-30% compared to 50% in hostile bids. Hostile acquisitions are considered higher risk due to the additional price premium and limited due diligence that is typically undertaken.

Case studies show value creation or destruction

1. Justifying the premium paid

Most companies obtain cost or revenue synergies when making acquisitions which allows them to pay a premium. The most common example is the elimination of a target’s financial, legal and other head office functions, which reduce unit overhead costs as they are typically spread over a larger revenue base. This has been a reason given for acquisitions by several companies including G8 Education, although synergies may also be gained from integrating existing systems or operating the additional centres in a cluster managed by an existing staff manager.

2. Cost synergies are more convincing

Significant cost synergy savings are generally available in the financial sector. For example, Westpac’s acquisition of St. George Bank and CBA’s acquisition of Bankwest resulted in significant head office and systems cost reductions as back offices were integrated and branch networks rationalised.

3. Boosting future organic growth

Acquisitions that contribute to future organic growth include Motorcycle Holdings, the top motor-bike seller in Australia, acquiring dealerships as part of its growth strategy. It is the only player of scale with funding in the industry, and it is able to acquire dealerships at low prices. As several dealerships only sell new bikes, it increases acquired dealership profitability by adding second hand bike sales along with accessories, finance and insurance to supplement new bike sales.

National Veterinary Care has made several vet clinic acquisitions since listing. After an acquisition, it typically introduces its ‘Best for Pet’ loyalty program, which generates increased revenue and profitability. It also identifies additional revenue streams such as dentistry and trains vets if they are not already performing this work.

4. Organic growth for both acquirer and target

Telco and software company, MNF, recently acquired Conference Call International (CCI), which provides audio conferencing to 5,000 customers. MNF will obtain organic growth by offering these services to its own customer base as well as offering its own existing products and services to CCI’s customers. MNF will also obtain cost savings by moving CCI’s customers onto its global voice network. MNF has a history of organic and acquisition growth, having delivered double EPS growth over several years and astute acquisitions provide it with a significant future growth runway.

5. Knowing what you’re getting in friendly acquisitions

Steadfast is the largest Australian insurance broker and has been a serial acquirer. A key growth strategy is to acquire interests in insurance brokers, which join its network. Steadfast’s subsequent knowledge of their profitability reduces its acquisition risk as it often consolidates ownership of these brokers.

6. Knowing what’s in the box in hostile acquisitions

Downer made a hostile bid for Spotless after a significant drop in Spotless’ share price. Although Spotless has highlighted new long-term contract wins and renewals, formal due diligence was not permitted. Acquisition risk therefore remains despite Spotless claiming the bid is opportunistic and should be rejected.

CIMIC recently acquired Sedgman and United Group opportunistically at the bottom of the cycle. Although these were similar, hostile acquisitions, the acquisition risk was again partly mitigated as relatively low prices were paid. Unfortunately, this can’t be said for Rio after it heavily overpaid for a coal asset in Mozambique and ALS, which bought an oil company at top of the cycle. Both not only destroyed significant shareholder value but also put the companies under pressure due to elevated debt levels. The assets were subsequently divested at much lower prices.

7. ‘Di-worsifying’ by making a large overseas acquisition with a broken business model

Arguably, the worst type of acquisition is ‘di-worsification’, that is, acquiring a new, different, large-scale business, potentially in a new geographic area. Slater & Gordon’s acquisition of Quindell’s Professional Services Division in the UK is an example that went ahead despite questionable management practices, poor profitability and poor cash flow. It paid a high price for the operation which also required a large equity raising. The disastrous result is well known.

Conclusion

M&A done well can be highly shareholder accretive, but healthy scepticism can save investor dollars. Investors should be particularly sceptical of M&A that simply increases earnings that trigger management rewards but does nothing to increase earnings per share or NPV/share.

 

Matthew Ward is Investment Manager at Katana Asset Management. This article is general information only.


 

Leave a Comment:

     

RELATED ARTICLES

Focus on quality yield, not near-term income

It’s the large stocks driving fund misery

A-REITS are looking at M&A activity again

banner

Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Now you can earn 5% on bonds but stay with quality

Conservative investors who want the greater capital security of bonds can now lock in 5% but they should stay at the higher end of credit quality. Rises in rates and defaults mean it's not as easy as it looks.

30 ETFs in one ecosystem but is there a favourite?

In the last decade, ETFs have become a mainstay of many portfolios, with broad market access to most asset types, as well as a wide array of sectors and themes. Is there a favourite of a CEO who oversees 30 funds?

Betting markets as election predictors

Believe it or not, betting agencies are in the business of making money, not predicting outcomes. Is there anything we can learn from the current odds on the election results?

Meg on SMSFs – More on future-proofing your fund

Single-member SMSFs face challenges where the eventual beneficiaries (or support team in the event of incapacity) will be the member’s adult children. Even worse, what happens if one or more of the children live overseas?

Latest Updates

Superannuation

'It’s your money' schemes transfer super from young to old

With the Coalition losing the 2022 election, its policy to allow young people to access super goes back on the shelf. But lowering the downsizer age to 55 was supported by Labor. Check the merits of both policies.

Investment strategies

Rising recession risk and what it means for your portfolio

In this environment, safe-haven assets like Government bonds act as a diversifier given the uncorrelated nature to equities during periods of risk-off, while offering a yield above term deposit rates.

Investment strategies

‘Multidiscipline’: the secret of Bezos' and Buffett’s wild success

A key attribute of great investors is the ability to abstract away the specifics of a particular domain, leaving only the important underlying principles upon which great investments can be made.

Superannuation

Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.

Shares

Confession season is upon us: What’s next for equity markets

Companies tend to pre-position weak results ahead of 30 June, leading to earnings downgrades. The next two months will be critical for investors as a shift from ‘great expectations’ to ‘clear explanations’ gets underway.

Economy

Australia, the Lucky Country again?

We may have been extremely unlucky with the unforgiving weather plaguing the East Coast of Australia this year. However, on the economic front we are by many measures in a strong position relative to the rest of the world.

Exchange traded products

LIC discounts widening with the market sell-off

Discounts on LICs and LITs vary with market conditions, and many prominent managers have seen the value of their assets fall as well as discount widen. There may be opportunities for gains if discounts narrow.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.