Given that many M&A deals fail it is vital to focus on whether deals can create long-term shareholder value, says Trevor Green.
- Studies show that many takeovers fail to add value to shareholders. So careful analysis of the reasoning put forward to justify deals is essential.
- Before supporting a deal, we need to be clear on how and why it will add long-term value and whether the price being paid for a company can be justified.
- We believe there are three types of M&A activity: transformative, progressive and defensive.
- It is critical to engage with management as early as possible to understand the rationale and, where possible, quantify the long-term shareholder value that the deal will create.
Fund managers tend to have a myopic view of merger and acquisition (M&A) activity. Most simply focus on how many companies in their portfolio have received takeover approaches. But surely it is much more important to focus on the long-term shareholder value that these deals can create? The UK equities team at Aviva Investors operates on the basis of three principles, long-term, active and engaged and that is the prism through which we view M&A. So, we look at any potential deal on the basis of whether it can add long-term value. Reflecting our active and engaged stance, we tend to learn of possible activity early in the process and then communicate whether we are going to support the acquisition. Overall, we need to be clear on how and why any mooted deal will add long-term value and whether the price being paid for a company can be justified.
Deals can backfire
Large takeovers certainly carry risks – the acquisition of ABN Amro by the Royal Bank of Scotland in 2007 is an obvious example – that can have negative repercussions for many years. Timing is important. HSBC’s takeover of Household Finance Corporation in 2003 and Taylor Woodrow’s merger with Wimpey in 2007, for instance, were poorly timed in hindsight. Royal Dutch Shell’s bid for the oil and gas exploration firm BG Group provides a current example where investors will take some convincing that the price of the deal is justified and that it can add value given low oil prices.
Studies show that many takeovers fail to add value to shareholders. The reasons vary from a poor integration process, a lack of management capacity, cultural differences, overpaying for an acquisition, and inefficient use of capital. So careful analysis of the reasoning put forward to justify deals is essential. As existing shareholders, we are generally supportive of management and their capital allocation decisions but we still analyse each deal on a case-by-case basis.
Transforming a business
We believe there are three types of M&A activity: transformative, progressive and defensive. Transformative, as the word implies, involve the largest types of M&A activity and offer the highest risk/return opportunities. They are also the rarest type and, in some cases, are a collection of deals rather than a one-off event. Royal Dutch Shell’s plan to buy BG is a prime contemporary example, while companies that have undertaken transformative M&A activity in the recent past include the London Stock Exchange (LSE) and Whitbread.
When Xavier Rolet became CEO of the LSE in May 2009, he quickly realised the imperative of reducing exposure to cash equities and targeting areas with greater long-term growth potential. As shareholders we have been impressed with the ability of Rolet to achieve this goal and improve returns at LSE, which has led to the share price of the business increasing four fold under his tenure. The case of Whitbread, founded as a brewer in 1742, is a case of an evolution rather than a revolution. In 2001, management took the momentous decision to sell the brewery and pub business and refocus on the growth areas of hotels, restaurants and coffee shops. It then spent ten years implementing the strategy. Its success can be tracked by the advance in return on capital employed from five per cent in 2006 to 12 per cent today, and by a share price that has doubled over the past five years.
The planned acquisition by Anheuser-Busch InBev, the world's biggest brewer, of SABMiller is a potentially transformative deal that is currently in the headlines. Anheuser-Busch InBev has said it did the deal to expand in Africa, Asia and Latin America. The new entity will account for about half the industry’s profit and almost a third of all beer sold worldwide. We did not own SAB Miller due to concerns about poor earnings momentum and we thought the valuation was high as a stand-alone business. We were wrong given the emergence of a strategic buyer in the shape of Anheuser-Busch InBev.
Transformative deals are just as likely to involve small as well as large companies. For example, we supported the communication business Sepura’s May 2015 purchase of the Spanish wireless communications firm Teltronic. The deal will give Sepura the scale and technology needed to enter the prized US market.
Progressive deals range from those that accelerate an existing strategy to those that diversify a business in a logical manner. The value of the synergies which this activity releases is critical to their success. MoneySuperMarket’s purchase of Money Saving Expert in 2012 is a good example of a highly complementary deal with low execution risk. Martin Lewis’ business slotted perfectly into the MoneySuperMarket model. ITV, a business with a long history in broadcasting, has subtly changed its strategy by building up its content revenue, through acquisitions such as Leftfield Entertainment in 2014 and Poldark-producer Mammoth Screen in 2015. Such deals reduce the company’s exposure to the advertising cycle.
The UK healthcare company Smith & Nephew’s purchase of ArthroCare in 2014 was hugely complementary to its sports medicine portfolio and accelerated Smith & Nephew’s move into higher-growth segments. Next Fifteen Communications is an example of a smaller company that has made some laudable progressive deals. It has a blue-chip customer base that includes Google, Amazon, American Express and Facebook. Next Fifteen Communications has focused on buying early stage, next-generation media businesses including Encore Digital Media, a ‘programmatic’ advertising business and Morar, a market research consultant. It quickly absorbed these enterprises, which have already provided new insights for clients.
Defensive M&A allows companies to either deal with potential issues or trends for which they are unprepared or it provides the scale needed in a particular marketplace. We supported Dixons’ merger with Carphone Warehouse last year given the attractive revenue synergies and improved growth outlook. The combined entity is better placed to thrive than it was as separate businesses now that consumers increasingly shop online. Our engagement with various members of the management team has continued since the deal was completed.
Not all M&A involves enlarging a business. UDG Healthcare, for example, is currently selling its supply chain business as it focuses upon on its faster-growth, higher-return interests. Management achieved an attractive price, the deal makes sound commercial sense and the share price response has been positive since the sale was announced. Over time, we expect the capital to be reinvested in the remaining divisions and, as long-term shareholders, we should reap the dividends.
It is clear that a variety of factors can drive M&A but it is critical to engage with management as early as possible to understand the rationale and, where possible, quantify the long-term shareholder value that the deal will create. Management can deploy capital in a variety of ways and we need to be reassured that any proposed deals are taking place at the right time and at the right price.
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