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It’s always sensible to view anything chief executives say with a healthy dose of scepticism, but especially so when they’re talking up the merits of a huge ‘value-adding’ takeover. Engineering firm FKI, broadcaster ITV, now pubs group Mitchells & Butlers, and of course, let’s not forget the biggest of the lot, Microsoft’s mind-numbingly large $44.6 billion approach for search engine Yahoo. Yes, $44,600,000,000. Sorry, I’m just taking that moment I mentioned last week... OK, I’ve had a lie down and I’m feeling much better, thanks. (Incidentally, for those that are interested, 1,362 years it would take to initial that lot of notes!)
Most takeovers destroy value for shareholders. Every academic study of the subject has come to this conclusion yet these findings are conveniently swept under the carpet on an all-too regular basis.
Among the more powerful studies on corporate takeovers was a sizable tome by Mark Sirower in 2000, an adviser at the Boston Consulting Group, which found that around two-thirds of takeovers ended in tears, tears of investors who suddenly found their shareholder value in tatters. The study also concluded that among the main reasons why so many takeovers destroy value rather than creating it is because chief executives feel they must prove themselves in the macho world of mergers and acquisitions. This makes sense since part of a chief executive’s role is to actively look for takeover opportunities, so it’s only a matter of time before testosterone ups the ante and they end up overpaying on a deal.
Of course, investors are sold on takeovers in a very different way. One of the most common ways to rally the investor masses behind a deal is to promise that it will be ‘earnings-accretive’, either because a combined entity will drive a faster pace of growth than two separate firms could manage, or because savings can be squeezed out of the enlarged group, achieving the same thing. This is the largely straightforward selling point behind Punch’s takeover proposal of M&B. Its chief executive, Giles Thornley believes over £50 million can be stripped out of the combined group, largely by merging the head offices.
Yet this type of pitch doesn’t necessarily factor in all the issues, such as the new shares that will flood the market, needed to meet the asking price. Other factors also come into play. As analysts at investment bank Lehman Brothers point out, such a tie-up could destroy value by upping Punch’s exposure to more cyclical managed pubs. At the moment just 887 of its 8,500 outlets are managed; taking over M&B would add another 2,000.
There’s a simple rule of thumb that means you don’t have to trust a chief executive to come clean on if a deal will bolster earnings, just look at the underlying PEs – the buying company’s should be higher than the target’s. On Lehman Brothers’ calculations, the underlying buyout multiple for M&B is about 9.7 times’ earnings, yet Punch’s PE is nearer nine, making the deal look expensive and earnings-dilutive, potentially swiping 3% off earnings, says Lehman Brothers.
Yet Punch is far from unique, most takeovers fly in the face of logic and overwhelming academic evidence. The City knows this, of course, but discouraging chief executives from doing deals just wouldn’t do, deals mean fees, big juicy fees, which turn into great fat bonuses at the end of the year, and we all know City people live for their bonuses. In fact, I reckon acquisitions are addictive to just about everyone involved barring the shareholders themselves, and it’s left to them to break the habit because everyone else in the takeover process is incentivised to keep on inhaling, often hugely incentivised. Last weekend’s Sunday Times reported that advisors working on the Microsoft/Yahoo deal could net an unthinkable £1 billion fees windfall.
With that in mind, I leave you with a final thought. Possibly the best investment you will ever make will be in one of those corporate advisors that bag so much of the loot from this crazy M&As money-go-round.