Mergers and Acquisitions – what are the long-term implications?
23 Oct 2014
By Shadforth Financial Group
The past 12 months has seen an increase in mergers and acquisition (M&A) activity in Australia. While corporate activity can boost share prices, what does this mean for shareholders over the long-term?
With the reversal of conditions since the GFC, especially the cheap cost of debt, there has been increased M&A activity at the smaller end of the market. For example, G8 Education, Affinity, Slater & Gordon and Cardno have been active and, on the target list have been SAI Global, Australand, Treasury Wine Estate and Wotif.com.
However, despite the conducive state of affairs for corporates to undertake M&A activity, it often coincides with inflated asset prices. During an acquisition, there is usually more value on offer in the target company (as a result of high bid offers) to the detriment of the acquiring company. A recent example of this was the takeover of David Jones by Woolworths (South Africa). As the bid price was high – a price, in fact that we haven't seen for David Jones in the past two and a half years – it remains to be seen if Woolworths can extract value longer term.
When we examine these acquisitions to assess the investment implications, we remain cognisant of the following points:
- Many studies on acquisitions highlight that over the medium to long-term the majority of acquisitions have been value destructive for the acquiring company. Some examples are Rio Tinto, ABC Learning, Billabong, Fosters, QBE Insurance, Elders, Pacific Dunlop, Transpacific, Centro, Leighton, National Australia Bank and Asciano. An exception was Amcor's acquisition of Rio Tinto's Alcan packaging business in March 2009, which has become one of the best decisions in Australian corporate history.
- The buzz word 'EPS accretive' (earnings per share accretive) shouldn't be used as a metric on its own. We prefer long-term sustainable return on equity and whether offer bids are supported by fundamentals. Acquisitions once touted as EPS accretive can later become write-downs with corporates dismissing 'mistakes' as non-cash, non-recurring items that have no bearing on the company's future. That may be true, but it still highlights that these acquisitions aren't likely to add shareholder value in the long-term.
- CEO and board remuneration structures are often aligned to the size of the company and include short-term and long-term incentives for CEOs that are linked to EPS growth. This misalignment of remuneration may be extra incentive for management to make EPS accretive acquisitions irrespective of any longer term strategic or value benefit to shareholders.
- When a company makes multiple acquisitions over a number of years, there are accounting rules that can be used to make the combined earnings generated by the company look better than they actually are. An example of a practice used is writing down the net asset value of the acquired company through impairing inventory, property plant and equipment and inflating provisions. Additionally, any acquisition makes a company less transparent to analyse, especially when attempting to ascertain the level of underlying organic growth of the business. Consequently, acquisitions can also inflate the market's perception of how well a company is actually doing (sometimes until years later).