Mergers and acquisitions — they’re the exciting stuff Wall Street loves to talk about, and companies clearly love pulling them off, but are they really in investors’ — or the businesses’ — best interest?
Stephen Gandel, senior editor for CNN Money, wrote an interesting article May 2 highlighting the findings of a study conducted by professors at the University of California, Berkeley, and the University of Amsterdam. The authors concluded that when it comes to acquisitions, companies shouldn’t do them if they want their share prices to keep rising. According to the study, companies making acquisitions tend to underperform rivals that don’t by 50% over the three subsequent years.
With this in mind, I thought I’d take a look at three acquisitions that illustrate how M&A handiwork usually backfires.
Wolverine Worldwide (NYSE:WWW) calls its $1.23 billion acquisition of Collective Brands’ (NYSE:PSS) Performance + Lifestyle Group (PLG) — which includes Sperry Top-Sider, Saucony, Stride Rite and Keds — “transformational” in nature.
CEO Blake Krueger said, “This transformational acquisition creates a powerful array of leading lifestyle brands that is balanced across product categories, genders and target consumers, with enormous opportunities for domestic and international growth.”
Paying approximately 10 times PLG’s 2012 EBITDA, Wolverine Worldwide expects the acquisition to be accretive to earnings beginning in 2013. While all four brands are household names, you have to wonder why it took Wolverine Worldwide management so long to bring this deal home. After all, Collective Brands announced on Aug. 24, 2011, that it was conducting a review of strategic and financial alternatives. It could have picked up the phone that very day to begin a dialog; perhaps it did. All I know as I sit here today is that eight months ago, investors felt the Performance + Lifestyle Group was worth five times EBITDA. Wolverine Worldwide is paying twice that. We’ll find out soon enough whether this deal is worth the extra $600 million.
Furthermore, with WWW shares at an all-time high, you have to wonder why Wolverine didn’t pay with stock instead of cash. The report referenced in the opening paragraph found that deals funded with stock tend to do better than those with cash. This could be a “transformational” deal — but for all the wrong reasons.
Nestle (PINK:NSRGY) announced April 23 that it was paying $11.9 billion to acquire Pfizer’s (NYSE:PFE) infant nutrition business. Nestlé paid approximately 19.8 times the estimated 2012 pretax profit. In two previous deals for similar businesses, it paid approximately 16.7 times pretax profit.
Analyst Jon Cox of Kepler Capital Markets in Zürich suggests the market share Nestlé will gain in emerging markets in Asia and the Middle East outweigh the short-term financial considerations. According to Kepler, “Nestle tends to think in decades, not in quarters.”
That’s great for the buy-and-hold investor, but what about the investor who can’t or won’t wait five to 10 years for a return on their investment? NSRGY is near all-time highs — buying now when everyone and their dog seems to agree Nestle paid a significant premium for Pfizer’s infant nutrition business suggests the next three years might not be as rosy as the last three.
The last deal I’ll discuss isn’t recent at all. In fact, it took place on May 23, 2003, when Berkshire Hathaway (NYSE:BRK.B, BRK.A) acquired McLane Company from Wal-Mart (NYSE:WMT) for $1.5 billion in cash. For those of you unfamiliar with McLane Company, it’s the largest wholesale distributor of groceries and nonfood items in America.
InvestorPlace contributor James Brumley recently made some observations about Warren Buffett’s history buying companies, suggesting it’s not as good as we might think. Burlington Northern Santa Fe and Lubrizol are two examples where Buffett clearly paid a premium; Brumley goes on to suggest Berkshire Hathaway’s three consecutive years of subpar performance when compared to the markets has a lot to do with his overpaying for acquisitions, which brings me back to his 2003 purchase of McLane Company.
In the eight-and-a-half years since acquiring the distribution company, Berkshire Hathaway has earned $2.4 billion in pretax income. Using a standard tax rate of 35%, the total net income earned to date is $1.57 billion. It took Berkshire Hathaway almost nine years to get its original investment back. That’s an incredibly poor return on investment and a classic example why acquisitions do little for stock prices.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.