Long-term success of acquiring companies enhanced by mergers
Conventional wisdom on corporate mergers suggests investors should buy shares of the target company and short shares of the acquirer. That's the foundation of a basic merger arbitrage strategy and a lot of investors have enjoyed respectable returns by following that model.
Any merger-arb manager will admit it's a short-term strategy designed to capitalize on the brief time it takes for the market to catch up with a pending deal. But that doesn't mean there's no room for buy-and-hold investors and financial advisers to take advantage of what has become a booming corporate-merger environment.
For those not interested in trading for short-term gains, there's a long-view approach that applies to the merger-and-acquisition space.
“With most deals, the acquirer's stock does experience a short-term blip down after the announcement is made, but when you look at the impact of deals over a longer period of time as part of a program of deals, the results are a lot different than looking at a deal in isolation,” said Scott Moeller, director of the M&A Research Center at the Cass Business School at City University London.
In a report published Nov. 17, Mr. Moeller studied the stock price impact of more than 200,000 deals involving more than 25,000 companies over the 20-year period through 2013.
Among the top findings: Investors should train themselves to look past the initial stock price hit suffered by acquiring companies and instead, view those companies as strong long-term performers.
DEALS PER YEAR
Measuring stock price and acquisition activity on a rolling three-year basis, the study found that companies averaging more than two acquisitions per year (described as extremely active acquirers) experience an annualized stock price performance boost of 3.4% above their respective benchmarks.
Companies averaging one deal per year (described as very active) see a 2% annualized gain over the benchmark, and companies in the active category, averaging between one and two deals every three years, beat their benchmarks by 0.1%.
Then there are the inactive companies that average less than one acquisition over three-year cycles, and average a 0.4% stock price lag behind their benchmarks.
“Conventional wisdom says investors should avoid companies making acquisitions,” Mr. Moeller said. “But when you look at the deals as part of a company's overall growth strategy, the market is saying, "If you don't do deals, we don't think you're being as aggressive as you should be.'”
Whether it's short-term thinking or something else, the popular wisdom holds that acquisitions satisfy executive egos at the expense of shareholder value.
This is particularly relevant right now with bloated corporate cash balances, soaring stock prices and cheap credit driving M&A activity to new highs.
Through the first nine months of 2014, more than $2.5 trillion worth of global M&A deal activity was announced, up 39% over the same period last year.
NEW VS. MATURE
The Cass Business School research broke down the data to evaluate the stock price performance impact of acquisition programs at newly public companies versus mature companies.
In the former case, it pays to be in the extremely active group, where acquisition activity contributed an annualized stock price boost of 3.8% over the respective benchmark.
Anything but extremely active deal activity proved a detriment to stock price performance for newly public companies, generating benchmark-lagging returns, according to the research.
Looking at only mature companies — defined as those that had been public more than 10 years —the research found that any acquisition activity benefits stock price performance and adds shareholder value.
ACTIVE TO EXTREMELY ACTIVE
Active companies saw a 1.4% annualized gain of the benchmark, very active companies experienced a 2.5% average gain, and extremely active companies saw a 2.2% gain over the benchmark.
“This brings to light something that investors don't often consider,” said Matt Porzio, vice president of strategy and product marketing at Intralinks Holdings Inc., which monitors due-diligence research to help forecast M&A activity.
“Investors are probably not evaluating a company's M&A strategy when looking to invest in that company, but clearly they should be looking at it,” Mr. Porzio said. “Evaluating a company's acquisition strategy won't always be easy, and it could require some reading between the lines, but it's probably worth the effort.”
