M&A – If It Is Really Heating Up, Beware the Overconfident
In work that we published in 2012 we took a deep dive into the world of M&A in the Industrials and Basics space and concluded that while the average deal did create shareholder value, the mistakes were more memorable than the successes, and soured the overall view despite what the data tell us.
Today, we are in deal market – if you believe the hype. Certainly the cash and the cash flows are there, as is very low cost borrowing for all but the most risky ventures. The Industrials and Basic Materials group has been active, though more in portfolio restructuring than outright mergers of whole businesses. Given expectations of limited global growth, there is little doubt that many companies will be persuaded that business combinations can add shareholder value, even at high take-out premiums.
Watch out for the business optimists as they are generally the ones who overestimate synergies, cross selling opportunities, growth and all the other things that are needed to defend a high priced take-over. We have taken our optimist and conservative groups, as defined in research in December 2012 and we have looked at their collective write-downs from 2002 to 2011. Write downs are generally a good indicator of overpayments for acquisitions above and beyond the real tangible and intangible value of the target. The optimists lose again, with the 20 companies that make up that group writing down 3.5x the value written down by the conservative group. For context, the conservative group has slightly higher but similar total assets to the optimist group.
The suggestion here is that the optimist group overpays relative to the value generated. We have already shown that optimists underperform and so it important when looking at a deal to know whether your buyer is an habitual optimist or more conservative. It is more likely that the deal will create shareholder value in the latter case.
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