Attention Shareholders – Blue Light Special: Epic Failure on Aisle 4
From the Mailbag:
It seems like every morning I wake up to the news that one public company is acquiring another. Walgreens just announced it is buying Rite Aid (Anheuser-Busch is trying to buy SABMiller and, most recently, there has been chatter that Hyatt is in talks to buy Starwood). There seems to be a lot of M&A going on, but are mergers always a good thing for shareholders?
For the shareholders of the company being acquired, mergers can be a good thing… sometimes. For the shareholders of the company doing the buying… more often than not, they aren’t. Let me explain.
When a public company decides to acquire another public company, it almost always pays a premium to the current stock price. The amount of the premium varies, but if it is an all-cash deal, shareholders of the target company usually see a jump in their position’s value overnight.
That’s a good thing.
If another company comes along and decides it wants the company for itself, it may start a bidding war. And the price of the company being acquired will continue to head north.
That’s even better.
But sometimes the company doing the acquiring decides to fund the purchase with a stock swap. In this case, investors of the company being acquired will receive a proportionate number of shares of the acquiring company.
In this case, I almost always recommend investors sell their shares before the swap. Here’s why.
The vast majority of mergers and acquisitions (M&A) fail. In fact, Americans have a better shot at staying married (more than 50%) than an acquiring company has at executing a successful integration of the target.
“Big Four” auditing firm KPMG tells us 83% of merger deals do not add shareholder value to the acquiring company.
Acquiring a company, especially a big one, is risky business. Besides the cultural and integration problems, firms often pay too much. Sometimes due diligence is not performed correctly and the cost to fix problems boosts the purchase price.
In other words, it’s easy for a piece of the M&A process to go wrong. And it’s the shareholders, not the management team overseeing it, who pay the price.
Recent history is littered with mergers that turned out to be epic failures.
The one thing they have in common? Wall Street and investors initially cheered the combinations. Unfortunately, once the acquisitions closed, it didn’t take long before billions of dollars of shareholder value were wiped out.
For example, in 2005, Kmart Holding Corp. bought Sears, Roebuck & Co. for $11 billion. Orchestrated by famed turnaround investor Eddie Lampert, the announcement dramatically lifted the shares of both companies.
At the time, I was working for a small hedge fund that was considering buying shares of the new company, Sears Holdings Corporation (Nasdaq: SHLD). So I asked my dad, a 30-year veteran of retailing, what he thought of the nation’s then third-biggest retailer. He didn’t hold back.
“One big [crappy] company plus another [crappy] company equals one great big [crappy] company,” he told me. (I admit: He didn’t use the word “crappy.”) Either way, he was eventually proved to be right.
After our talk, I steered clear of Sears’ stock. I missed out on cashing in on a nice “merger mania” run in the stock. The company sold off nonstrategic assets and closed stores while investors showed their approval by bidding up the price of its shares. But in just two short years, that mania turned into depression.
By 2007, the combined company’s revenue plummeted more than 10%. Share price fell hard, too. By the end of the year, it was down 42% from its high. Now, the stock trades around $23.
What went so horribly wrong?
In the beginning, Sears was promised that the combined company would build stronger brands, have greater operational efficiencies and make higher profits than it would on its own. That didn’t happen. The synergies never materialized and existing brands deteriorated.
Management attempted to manage the merged company’s assets and cut costs. However, it failed to upgrade retail stores, so customers took their money elsewhere. The company continues to lose a lot of money today.
Shareholder value has been wiped out. Sears has survived by selling off assets and closing stores. If the company can’t execute the successful turnaround it promised investors back in 2005, it’s only a matter of time before the once-iconic retailer fades away.
Unfortunately, the Sears-Kmart collaboration is just one of many exercises in M&A gone bad.
Buyouts give shareholders an opportunity to cash out, usually at a premium. But for shareholders of the acquirer, the ramifications are riskier and play out over the longer term. The larger the target, the bigger the risk. A small acquisition gone wrong may not result in a catastrophic destruction of shareholder value.
But if a giant acquisition goes wrong… look out!
If you own shares of a company on an acquisition spree, remember this: Sometimes acquisitions work out great, but most of the time they don’t.
And if you own shares of the company being acquired – take the money and run.