While the strongest resurgence in dealmaking since the financial crisis is cheering investors and emboldening acquirers, history shows that the largest mergers are often more trouble than they’re worth.
About two-thirds of company takeovers exceeding $20 billion since 1996 -- including the unions of Pfizer Inc. and Pharmacia Corp., Sprint Corp. and Nextel Communications Inc., and Daimler-Benz AG and Chrysler Corp. -- generated losses for the acquirer’s shareholders, according to data compiled by Bloomberg. The 78 buyers lagged behind the MSCI World Index by a median of 13 percentage points in the three years after completing the transactions, falling 21 percent, the data show.
With takeovers climbing to the highest level in four years and the potential buyout of Dell Inc. stoking optimism for a further acceleration, this month’s departure of Rio Tinto Group’s chief executive officer after a $14 billion writedown provided the latest reminder that the biggest mergers often destroy value. Acquirers typically spend too much because they overstate the importance of expanding the size of their companies, according to Warren Buffett, the world’s most successful investor.
“Large deals are flashy and they get people’s attention,” said Scott Rostan, who once analyzed mergers at Merrill Lynch & Co. and now runs New York-based Training the Street, giving instruction on takeovers to new hires at banks. “But the large, transformational deals are really hard to pull off. Typically you have to pay a big price to convince the seller. Synergies are very hard to realize. There may be cultural differences. Put that all together and you’ve got a recipe for disaster.”
As the pace of deals has increased -- with more than $700 billion announced in the fourth quarter, the most since Lehman Brothers Holdings Inc.’s collapse sent global markets into turmoil in September 2008 -- reminders of past transactions gone bad keep cropping up.
Rio Tinto, the world’s second-largest mining company, said this month that CEO Tom Albanese quit and the value of his purchases would be written down by about $14 billion. Those include the $43 billion acquisition of Alcan Inc. in 2007.
When announced, Rio Tinto said adding Alcan would create a “new global leader” in the aluminum industry. Speaking to Bloomberg Television in February 2008, Albanese said, “We have efforts under way to streamline all the businesses, and I think we’re doing quite a good job.” The deal soured when metal prices plunged during the global financial crisis that worsened in 2008.
Hewlett-Packard Co., which fetches a quarter of the $128 billion market value it had in April 2010, has been battered by its takeover strategy. In November, the company said it overpaid for Autonomy Corp. because of fraud, boosting last year’s deal-related writedowns to $18 billion.
Hewlett-Packard’s stock market value also slumped at the end of 2012 to less than the $31 billion it spent during a five-year takeover binge. An earlier transaction, the $17.6 billion purchase of Compaq Computer Corp. a decade ago, got Hewlett-Packard further invested in the low-margin personal computer industry.
“Of the decisions CEOs make, doing a big deal is the riskiest possible one in most instances,” Pavel Savor, an assistant professor of finance at the University of Pennsylvania’s Wharton School in Philadelphia who has published research on M&A, said in a phone interview. “There are potentially detrimental consequences if it doesn’t work out. HP is a great example.”
Dell is in talks to be taken private in what would be the first leveraged buyout to exceed $20 billion since 2007, according to people with knowledge of the matter. Founder Michael Dell is seeking majority control of the company through a deal that would combine his 15.7 stake with as much as $1 billion of his personal funds, people familiar with the matter said this week.
The history of the biggest transactions shows buyers should be wary. The Bloomberg study of company takeovers exceeding $20 billion showed that the majority of the acquirers’ stocks declined in the three years after the deals closed. Transactions involving private equity firms or multiple buyers were excluded.
Pfizer, the world’s largest drugmaker, tumbled about 22 percent in the three years after completing its purchase of Pharmacia in 2003, a transaction valued at $64 billion when announced. Pfizer lagged behind the MSCI World Index of stocks in developed markets by more than 90 percentage points over that span, the worst underperformance among the 78 large deals analyzed, the data show.
Pharmacia gave Pfizer the pain-killing medicines Celebrex and Bextra. Sales of the first never fully recovered after being cut in half when a similar-acting drug was recalled, while Bextra was pulled from the market two years later.
Though Pfizer did beat the MSCI World Index after spending $64 billion on Wyeth in 2009, CEO Ian Read said yesterday that its acquisition emphasis is now on smaller, “bolt-on” deals. He also said Pfizer may consider dividing the branded medicines and generic products units into separate businesses.
Sprint and Nextel promised that their merger, valued at $41 billion when announced, would help the companies compete with Verizon Wireless and Cingular Wireless LLC, the operator now owned by AT&T Inc. Sprint tumbled more than 60 percent in the three years following the deal’s closing in August 2005. The union left the company with incompatible networks, a shrinking customer base and five years of net losses.
Germany’s Daimler-Benz agreed to buy Chrysler in 1998 for $43 billion, which at the time the largest foreign takeover of a U.S. company, according to data compiled by Bloomberg. While shares of the new DaimlerChrysler AG initially rallied, they were down about 39 percent three years after the transaction’s completion, losing to the MSCI index by 32 percentage points.
The company ended the nine-year investment in the money-losing Chrysler business in 2007 when it handed control of the carmaker to private equity firm Cerberus Capital Management LP.
While Rio Tinto’s stock slid just 3 percent in the three years after it completed the Alcan deal in 2007, it’s fallen 20 percent through yesterday. About a year after closing the transaction, Rio Tinto hit its peak market capitalization of $206 billion, versus just $110 billion yesterday.
JDS Uniphase Corp., a network-equipment maker now valued by the stock market at $3 billion, generated one of the biggest writedowns in history. It traded for more than $120 billion in 2000 when the technology-bubble peaked. Four months after the Nasdaq Composite Index reached a record high that year, JDS Uniphase agreed to buy SDL Inc. for $36 billion. In 2001, its writedowns stemming from several deals exceeded $50 billion.
“When companies make these large acquisitions, that’s usually a sign that a bubble has reached a peak because it’s finally swept everyone up,” Jeff Matthews, the Naples, Florida-based author of “Secrets in Plain Sight: Business & Investing Secrets of Warren Buffett,” said in a phone interview. “That’s what happened with Rio Tinto. It seemed like a good idea at the time.”
Representatives of Rio Tinto, Hewlett-Packard, Pfizer, Sprint and Daimler declined to comment on the deals and shareholder losses. Jim Monroe, a spokesman at JDS Uniphase, didn’t return a phone call seeking comment.
One reason large mergers often disappoint is that the buyers overpay and fail to meet goals for cost savings, said Donna M. Hitscherich, a senior lecturer at Columbia Business School in New York and a former investment banker with JPMorgan Chase & Co.
Sprint forecast $12 billion in synergies from its merger with Nextel. In an interview with GigaOm last month, Dan Hesse, who became Sprint’s CEO two years after the transaction closed, called the Nextel deal “a mistake” and said the synergies never materialized.
“You should only pay the last marginal dollar that you have to pay to win,” Hitscherich said in a phone interview. “If you pay more than something is worth, you have to make that up somehow, and you make that up in this idea of synergies,” she said. “The problem is, these synergies that you thought about maybe don’t materialize at all or don’t materialize on the time frame that you envisioned.”
Other megamergers worked out for the buyers, based on their stock prices three years after the deals closed. Zeneca Group Plc bought Astra AB for $30 billion. By April 2002, shares of AstraZeneca Plc, now the U.K.’s second-biggest drugmaker, had risen by a third, while the MSCI index slid 21 percent, the data show.
Three years after InBev NV’s $61 billion takeover of Anheuser-Busch Cos. in 2008 created the world’s biggest brewer, shares of Anheuser-Busch InBev NV more than doubled and beat the MSCI index by 100 percentage points, data compiled by Bloomberg show. The company is now seeking regulatory approval for another big acquisition: Mexico’s Grupo Modelo SAB, the maker of Corona, for $17 billion.
Buffett’s takeover strategy at Berkshire Hathaway Inc., which helped make him the world’s fourth-richest person, provides a guide for how to do deals correctly, Matthews said. Instead of tinkering with acquired businesses or melding them with already owned units, Buffett tends to leave them alone, letting managers keep doing what drew him to the business in the first place. The only difference: the cash they generate is sent to Berkshire headquarters for Buffett to reinvest.
The mistake many other acquirers make is paying too much, overemphasizing the need to expand and exaggerating their ability to turn troubled businesses around, Buffett has said over the years, including in Berkshire’s 1981 annual report.
“Many managements apparently were overexposed in impressionable childhood years to the story in which the imprisoned handsome prince is released from a toad’s body by a kiss from a beautiful princess,” he wrote in that year’s letter to shareholders. “Consequently, they are certain their managerial kiss will do wonders for the profitability of” an acquired company.
Buffett didn’t respond to a request for comment sent to an assistant.
In the annual report last year, Buffett reiterated that the amount paid is key, saying, “what is smart at one price is dumb at another.” Berkshire offered to buy exchange operator NYSE Euronext last year, two people familiar with the matter said this week, saying Buffett’s firm was the entity referred to as “Company A” in a filing. IntercontinentalExchange Inc.’s Jan. 28 document said Company A offered less than ICE.
“Buffett’s thinking about price first, foremost and always,” said Matthews, a Berkshire shareholder whose most recent book on the investor is titled “Warren Buffett’s Successor: Who It Is and Why It Matters.” Some acquirers “tend to justify the price they’re going to pay based on intangibles like synergies. There’s a lot of emotion involved, and not a lot of rationality. Buffett doesn’t do that. And one thing he’s got on his side is being able to say no.”