|  | | Price | 15.330 | | | Change | +0.900 | |
Research Wizard
Add to MSN Stock List
Message Board
|  | | Price | 34.270 | | | Change | +0.030 | |
Research Wizard
Add to MSN Stock List
Message Board
|  | | Price | 37.480 | | | Change | +0.290 | |
Research Wizard
Add to MSN Stock List
Message Board
Related Resources
What stocks are hot or not?
What are the top-performing industries?
| | The Speculator
5 ways to give acquisitions the inquisition
Sometimes buying other companies can mean a better bottom line. Sometimes it can mask a host of problems. We find clear evidence that serial acquirers underperform those that go it alone.
By Victor Niederhoffer and Laurel Kenner
Like most transactions in life and markets, acquisitions can be very good or very bad. For an acquired company, a good acquisition lets the owner cash in and enjoy a profit -- the self-interested, wholly appropriate incentive for starting a company in the first place. For the purchaser, a good acquisition provides an opportunity to save on costs, to improve marketing or to invest capital at higher returns than are available internally.
At worst, an acquisition is a desperate attempt by the seller to unload bad merchandise based on private information of an adverse nature, or an effort by the acquiring company to create a facade of enhanced profitability.
Most acquirers, we hasten to say, would never in a million years dream of succumbing to the alluring temptations that come with acquisition accounting. But some find that a steady stream of purchases much improves their ability to deliver the consistent quarterly growth so dear to analysts, and they are not averse to gilding the lily for temporary advantage.
And nothing improves a corporations ability to manipulate earnings like a series of acquisitions. With a few flourishes of the pencil, a chief financial officer can find a cornucopia of profits in an acquired companys earnings, pension plans, medical plans and assets held on the balance sheet below market price.
Below, we attempt a statistical test of what numerous or infrequent acquisitions signal in a relatively homogenous sample of large buyers -- companies that make up the S&P 100 index. After reporting the results, which seem to support the virtue of abstemiousness on the part of large companies, well share some insights for acquirers and investors from a highly successful serial acquirer of privately held companies.
Another signal of hubris
Accountants have been vigilant for more than 50 years in trying to create rules that will make acquisition accounting fair. The Financial Accounting Standard Boards ban on pooling of interest accounting in mergers last year was only the latest example. (Without pooling, companies must amortize the premium, or goodwill, they paid for the target company over a period of years, thereby depressing earnings.) But as in all arms races, acquirers and their consultants and experts are always vigorous in mounting new attacks and finding new ways to put the best foot forward.
With investors paying more attention these days to accounting treatments, we find ourselves fascinated by the possibility of developing statistical profiles of serial acquirers vs. abstainers. Might a predilection for acquisitions be a sign of hubristic overconfidence in the companys ability to run other businesses? Are abstainers unusually confident in their ability to run their businesses without benefit of acquisitions? Unfortunately, these questions are difficult to test. We therefore started with a modest preliminary study of the relation of acquisitions to stock performance.
Taking the companies in the S&P 100 at the start of 1998, we counted the number of acquisitions each made over the next four years, through 2001. We came up with three groupings for comparison: the top 15 acquirers, companies that made no acquisitions and companies that made one acquisition. We calculated their stock performance from Jan. 1, 2002, through July 12, 2002. The results appear below.
Paying the piper for serial acquisitions
| Purchases 1998-2001 vs. performance Jan. 1-July 12, 2002 | | Company | Ticker | Purchases | % chg. | | 15 most acquisitive | | | | | General Electric | GE | 66 | -28.6 | | Tyco | TYC | 32 | -76.7 | | Clear Channel Communications | CCU | 31 | -33.9 | | Citigroup | C | 28 | -28 | | AES | AES | 15 | -79.6 | | AOL Time Warner | AOL | 14 | -59.1 | | United Technologies | UTX | 14 | -2 | | General Motors | GM | 13 | -4.1 | | American International Group | AIG | 12 | -20 | | Microsoft | MSFT | 12 | -21.7 | | Wells Fargo & Co. | WFC | 12 | -13.6 | | Cisco Systems | CSCO | 11 | -62.4 | | Ford Motor | F | 11 | -19.8 | | Intel | INTC | 11 | -40.2 | | J.P. Morgan | JPM | 11 | -16.9 | | Average % return | | | -33.8 | | | | | | | Companies with 1 acquisition | | | | | Bank of America | BAC | 1 | 9 | | Black & Decker | BDK | 1 | 13.9 | | EMC | EMC | 1 | -36.4 | | Harrah's Entertainment | HET | 1 | 19.1 | | International Paper | IP | 1 | 1.5 | | May Department Stores | MAY | 1 | -18.2 | | Medtronic | MDT | 1 | -24.5 | | Medimmune | MEDI | 1 | -47.7 | | 3M | MMM | 1 | 2.3 | | Merck | MRK | 1 | -22.5 | | Oracle | ORCL | 1 | -29.9 | | Pfizer | PFE | 1 | -19.2 | | Pharmacia | PHA | 1 | -23.6 | | RadioShack | RSH | 1 | -11.1 | | Sears | S | 1 | -2.4 | | SBC Communications | SBC | 1 | -24.3 | | The Southern Co. | SO | 1 | -0.2 | | Average % return | | | -12.6 | | | | | | | Companies with no acquisitions | | | | | Allegheny Technologies | ATI | 0 | -14.1 | | Ltd Brands | LTD | 0 | 11.4 | | Anheuser-Busch | BUD | 0 | 8.8 | | Avon Products | AVP | 0 | 3 | | Baker Hughes | BHI | 0 | -19.1 | | Burlington Northern Santa Fe | BNI | 0 | 0.2 | | Cigna | CI | 0 | -3.7 | | Norfolk Southern | NSC | 0 | 17.1 | | Campbell Soup | CPB | 0 | -19.4 | | Nortel Networks | NT | 0 | -95.5 | | Colgate-Palmolive | CL | 0 | -23.3 | | Philip Morris | MO | 0 | -6.4 | | Delta Air Lines | DAL | 0 | -65.3 | | Raytheon | RTN | 0 | 7.3 | | FedEx | FDX | 0 | -3.8 | | Toys R Us | TOY | 0 | -10.4 | | Gillette | G | 0 | -13.5 | | Xerox | XRX | 0 | -38.1 | | Average % return | | | -14.7 | | | | | | | S&P 100 | | | -21.5 |
|
As the above table shows, serial acquirers underperformed abstainers by 19.1 percentage points this year, and they underperformed the S&P 100 by 12.8 percentage points. Abstainers beat the S&P 100 by 6.8 percentage points.
The urge to merge can be good or bad, and each acquisition must be judged on its merits. However, during the most recent four years, the urge has been inversely related to year-to-date 2002 performance.
From long experience on all vantage points of the acquisition arena -- Vic founded and for 25 years spearheaded a very active mergers-and-acquisition brokerage -- we would suggest that in certain types of markets, an acquisition might offer the temptation to overstate earnings. If the truth comes out, the stock may be hammered.
Making mischief with the books
We have no knowledge of the accounting probity of any of the companies in the news today. But we can say that in general, most mischief begins with assets held on the books of acquired companies at original cost. If the acquired company bought the assets many years before, or if the assets are worth much more than they cost (as must be assumed if they were bought at a premium), then there is great potential for an acquiring company to sell off these assets at the market price for a nice profit.
A second source of temptation is the potential boost to the acquiring companys earnings from the acquisition. When a companys stock is selling at 20 times earnings and it buys something at 10 times earnings, there is an immediate pickup that can be calculated based on the number of shares and earnings involved.
A third major line of misstatements is the prospect of writing certain items up or down to advantage. The common practices of writing up goodwill for tax purposes, or writing down pension obligations and medical plans of the acquired firms, are treasure chests in this regard.
We must emphasize that we have no reason to believe that serial acquirers are any more prone to such temptations than those that acquire less frequently. Multiple acquisitions are merely a possible signal, an area of concern in certain kinds of markets.
To assist our readers in evaluating acquisitions, we are pleased to present insights from a friend who is among the worlds leading experts in the subject: Vics partner of 35 years, Dan Grossman. Grossman has managed and bought a wide variety of businesses, and through his law practice has been instrumental in forming and developing many companies, including the drug maker Syntex. Dan recently sold a number of his businesses profitably and is writing a book about his adventures in the M&A business.
Advice on acquisitions from Dan Grossman
Avoid businesses requiring exquisite management. Buy a company that regular people can run. When evaluating an acquisition, picture what it will be like trying to sell it. Look for the type of business that buyers, especially public companies, will want to acquire. Avoid mixing acquisition analysis with some other need in your life. Don't look to acquire a company because it will get you involved with golf or sailing, or because it is in a glamorous location, or because you have been laid off and need a place to work. It is hard enough to be objective analyzing an acquisition on its own merits without throwing in all kinds of personal needs and desires. Have a good accountant explain to you how inventory can be used to juggle earnings, and why, for some companies, it is almost impossible for a buyer to determine the accuracy of reported earnings for a given year. Time is the friend of a growth company, and the enemy of the bargain or value company. The longer you are going to own, the more important to pay up for growth.
Final note
The results of our preliminary study on acquisitions may unduly reflect the unusual pessimism of the current stock market. Yet given the sad fates of serial acquirers over the past few decades -- the conglomerates, the rollups and all the companies that became marquee names in the market value rankings by paying princely sums of their own soaring stock for tiny, unprofitable companies -- it does not seem inappropriate to conclude that both acquirer and investor should be on guard when reaching for the stars.
|
