There is a thin line between the behavioural finance sin of confirmation bias and the simple pleasure of having one’s prejudices confirmed. Still, here on The Value Perspective, we are hopeful we fall on the right side of it as we highlight a recent piece of analysis by Michael Mauboussin on capital allocation, which chimes with our own thinking on the potential dangers of merger and acquisition (M&A) deals.
Our most recent look at the subject was in the context of the will-they-won’t-they two-step now in progress between tobacco giants BAT and Reynolds. The first point we will highlight from Mauboussin, who is one of our favourite market commentators, relates however to an issue we have covered on a more regular basis over the years – dealmakers’ poor timing.
Take a look at the following chart, which plots the progress of the S&P 500 index over the last three and a half decades versus data on M&A volumes taken from Mauboussin’s Capital Allocation: Evidence, Analytical Methods and Assessment Guidance note. As we have noted in pieces such as Confidence trick, few companies are inclined to take the value approach of buying low, preferring instead to pile in when markets are high.
M&A v S&P
One point of Mauboussin’s that we have not really considered before is that not all M&A is created equal. Among connoisseurs of the practice, it is possible to distinguish between many different varietals, including ‘bolt-ons’, ‘line extension equivalents’, ‘lynchpin strategic’, ‘speculative strategic’ and not one but two types of consolidation – ‘mature’ and ‘emerging’.
Mauboussin highlights work done by M&A specialists Peter Clark and Roger Mills on the probability of different types of deal being successful, and as you can see from the chart below, the one with the best odds goes by the quaint name of ‘bottom trawlers’. It is not really the sort of description we would be rushing to add to our business cards but it is undeniably the one that has the closest association with how we approach investing, here on The Value Perspective.
Probability of M&A success based on type of deal
Based on Peter J. Clark and Roger W. Mills, Masterminding the Deal: Breakthroughs in M&A Strategy and Analysis (London: Kogan Page, 2013),
The last point we would note – and to our minds the most important – is Mauboussin’s comment that “the empirical evidence on M&A underscores the challenges that buyers face”. He goes on to highlight research by McKinsey that concluded about one-third of M&A deals actually create value for the acquirers, with the other two-thirds being “value neutral or value destructive”.
Now, it may be all too easy to make hindsight-assisted judgements but that does mean one should ignore the lessons of the past. And yes, with the benefit of hindsight, it is possible to point to a number of recent instances where M&A activity has been the cause of, or at least the canary in the coalmine for, some high-profile corporate woes.
Take, for example, specialist manufacturer Essentra, which has seen profit warnings and the departure of its chief executive in the wake of its acquisition of rival Clondalkin. Or manufacturer Cobham, whose acquisition of Aeroflex led to a rights issue and, again, a series of profit warnings.
Then there is engineer Amec, which found itself carrying too much debt after it splashed out on Foster Wheeler at the wrong point in the cycle, and … well, you get the idea. None of which is to suggest M&A is in and of itself a bad thing – but M&A done at the wrong time, at the wrong price and which saddles the acquirer with too much debt certainly is.
That may seem a terribly obvious thing to say and yet, with corporate management teams making the same mistake time and time again, it is equally obvious it is a lesson some otherwise very shrewd people are simply unable to grasp.