Merger mystery – If one M&A deal will often destroy value, why would businesses rack up 20?
Here on The Value Perspective we never cease to be amazed at the enthusiasm with which companies embark upon mergers and acquisitions in the face of all the evidence such deals tend, on average, not to create value but destroy it. Are companies working on the basis that, the more M&A they do, the more they learn from past mistakes or are they perhaps hoping the law of averages means they will eventually get one right?
Either way, recent work by our friends at Empirical Research Partners suggests they are heading for a big disappointment. Straight from the outset, we should stress that Empirical’s analysts were not looking at whether acquisitions add to or destroy shareholder value as such, but rather at how the share prices of more acquisitive businesses perform over the long run.
Even so, if looked at over a long enough timeframe, it should be indicative of a relationship. The chart below runs from 1994 to April 2015 which is a decent length of time over which to make a judgement, taking in the years of the dotcom boom as well as the M&A bubble in the mid 2000s that preceded the credit crunch. What Empirical has done is group companies according to the number of acquisitions made in a particular window of time and then look at the average relative returns made by holders of these companies’ shares over the following three-year period.
Relative returns over 3yr periods of US companies making acquisitions. 1994 to April 2015.
As you can see from the chart, companies doing one, two, three, four, five, six to 10 and even 11 to 20 deals showed uninspiring levels of relative performance – from modestly positive to just the wrong side of -10%. However the story for the most acquisitive companies – those racking up more than 20 deals – was much worse. For these businesses, the average relative returns were -40% cumulatively over three years.
Here on The Value Perspective we often talk about the positive effects of compounding but could what we are seeing here be the compounding effects of value destruction? Even if value is only being destroyed in tiny amounts by individual deals, that will build up over time and it will erode not only shareholder value but also investors’ confidence in the way a company is being run.
The market may be unhappy with the value destruction itself or it may not like a management strategy that risks value destruction but, either way, the share prices of highly acquisitive companies are being marked down. For any businesses now in the high teens of M&A deals in a short space of time, it is probably in shareholders’ best interests that there be a rethink of strategy.
Fund Manager, Equity Value
I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.
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