It’s Jungle Out There
By Randall Coleman, Portfolio Manager, CFA
It’s a jungle out there. In their never-ending fight for survival, companies prove that they are alive. Not only are they comprised of real humans, they exhibit traits of live organisms: they live, die, grow, shrink, get sick and eat. One method of eating is Mergers and Acquisitions, commonly abbreviated as M&A. There are a wide variety of M&A deal types and various associated motivations. Several high-profile examples will touch on a few of the whys and hows of corporate M&A. It’s important to understand the basics of M&A because these deals have a significant impact on security returns and portfolio performance.
When companies are of similar size, a combination of the two is typically a merger. The 1998 merger of NationsBank and Bank of America (BofA) was initially announced as a merger of equals, but was actually NationsBank buying BofA and assuming full control. The primary motivation for this merger was to create a true national bank, as NationsBank was dominant in the Southeast and mid-Atlantic, while BofA was dominant on the West Coast. Although NationsBank was technically the acquiring entity, the decision to retain the “Bank of America” name was strategic. Bank of America was a well-established and highly recognized brand, both on the West Coast and internationally. Leveraging the stronger Bank of America brand was a secondary motivation for the merger.
M&A, or the threat of M&A, can lead to significant value creation. The owner of Circle K convenience stores, Alimentation Couche-Tard, proposed an acquisition of Japan’s Seven & i Holdings (owner of the 7-Eleven convenience store chain) two weeks ago. Should the acquisition go through, Couche-Tard would not only gain a huge store base in Japan, but would also become the #1 convenience store owner in the US. Seven & i Holdings has a reputation shared by many large Japanese companies: top-heavy management, slow decision-making, and lack of creativity. A takeover by Couche-Tard would potentially cure those ills. However, significant hurdles to the deal exist. Financial terms haven’t been disclosed yet and significant resistance to what would be the largest foreign takeover of a Japanese company is gaining traction. Regulators on both sides of the Pacific would have to sign off for the deal to happen. Regardless, our view at ACM is that value will be unlocked in Seven & i’s shares independent of the transaction. Both companies have similar gross margins, yet Couche-Tard’s return on capital is nearly three times better than Seven & i’s. We believe Seven & i’s management will be forced to speed up its game and move quicker and increase profitability, regardless of the deal’s outcome.
M&A has cycles, with some periods rife with transactions and some very lean. The chart below shows the aggregate number (blue lines) and value (green line) of global M&A deals for the last 25 years.
Source: Bloomberg
In the early 2000’s, the SmallMid portfolio had four companies acquired in a single year, adding over 800 basis points of performance to investors in that strategy. Potential M&A is never the sole reason for ACM to own shares in a company, but it is a welcome outcome when it adds to investor returns.
Significant risks surround deals and not all combinations end up “happily ever after.” Hewlett Packard’s acquisition of Autonomy Corp. in 2011 is tragically in the news of late. At the time, HP paid over $11 billion for Autonomy and took an $8.8 billion write down just a year later, alleging accounting fraud at the target company. Another epic example of a failed merger is the AOL Time Warner tie-up of 2000. This $165 billion deal is one of the most notorious failed M&A deals, owing to a strategic misalignment, cultural clashes, and the collapse of the dot-com bubble. This led to massive financial losses, and the companies eventually separated in 2009. Whether we’re in a swamp or a jungle, at the end of the day, M&A is a manifestation of the organic nature of companies. It’s part of the ecosystem that fosters growth, adaptation and continual improvement. M&A sharpens focus, trims dead wood and exemplifies the long-term nature of the asset class we invest in. Don’t fear M&A, embrace it. After all, it’s part of life.
The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.