Tag Archives: pro
It’s MADness! (Mergers, Acquisitions, And Divestitures)
Approximately half of all mergers & acquisitions eventually fail. There seems to be little benefit to long-term investors from M&A. If a stock is truly undervalued, it is worth owning. How do companies create value for shareholders? In the long run, nothing matters more than earnings and earnings growth. The more a company earns, the higher the stock price should go. That might seem obvious, but it might also surprise you if you have been listening to what CEOs say. For example, Hewlett-Packard (NYSE: HPQ ) announced a few months ago that it was planning to split itself into two companies. In July, CEO Meg Whitman said, “Today, I’m more convinced than ever that this separation will create two compelling companies well positioned to win in the marketplace and to drive value for our stockholders.” In other words, the CEO argued that the sum of the parts is greater than the whole. If Whitman believes that earnings drive value, then she must also believe that the combined earnings of the two separate companies will be greater than if they remain together as one. Sounds logical. But on Tuesday, Walgreens Boot Alliance (NASDAQ: WBA ) announced plans to acquire Rite Aid (NYSE: RAD ). Rite Aid CEO John Standley said, “Joining together with Walgreens Boots Alliance will enhance our ability to meet the health and wellness needs of Rite Aid’s customers while also delivering significant value to our shareholders.” In other words, Standley believes that the whole is greater than the sum of the parts. If he believes that earnings matter, then he must be arguing that the combined entity will create more earnings and more value than if they remain separate. Can both Whitman and Standley be right? When two companies merge, they often argue that the merger will create “synergies.” In other words, they might be able to reduce total costs by getting rid of duplicate functions. (For example, you don’t need two CEOs.) The merger might increase market share and, therefore, create more pricing power. There may also be some tax advantages or perhaps a greater degree of diversification. If the benefits of the merger outweigh the transaction costs, then shareholders should come out ahead. If that’s the case, then why are there divestitures? Companies often argue that a divestiture (in the form of a spin-off, carve-out, etc.) will create value by allowing distinct business segments to separate into new companies in order to focus more intently on their separate businesses. They may claim that the market does not understand or appreciate the value of the combined businesses, and that a divestiture will “unlock” value for shareholders. So, if you believe all this, it must follow that separating a large company into two creates more value. Two companies merging into one creates more value. One company buying another creates more value. And a company splitting off a small part of itself creates more value. Well, do you believe it? There are lots of examples of mergers that have succeeded; yet, there are also plenty of examples of mergers that have failed. One of the best-known failures is Hewlett-Packard’s own acquisition of Compaq. It’s still haunting former CEO Carly Fiorina on the presidential campaign trail. When it comes to mergers, acquisitions, and divestitures, here’s what we know for sure. When Company A announces plans to buy Company B, it typically pays a premium. In order to convince the target company’s shareholders to approve the deal, it has to offer to pay more than the market price. So, Company B’s shareholders often see a quick and significant increase in the value of their shares. What happens to the shares of Company A, however, is less consistent. Sometimes they rise a little when the deal is announced. Sometimes they fall. Over the long run, how the shares perform depends on a number of factors, including whether the merger was really a case of exploiting potential synergies, or a desperate bid to grow the top line without regard to profits. As far as divestitures go, we know that they often follow mergers & acquisitions. In fact, academic studies show that 35-50% (or more) of acquisitions are later divested by the acquiring firm. In other words, it appears that approximately half of mergers & acquisitions eventually fail. They may create a lot of value in the short term for shareholders who want to sell, but there seems to be little benefit to long-term investors. Over the years, I have recommended the stocks of many companies that acquired other businesses, were acquired themselves, or that engaged in some sort of divestiture. When that happens, there is often a quick increase in value. I’m happy to take the gains. However, my recommendations are never based solely on the hope that these kinds of transactions will occur. In my view, if a stock is truly undervalued, it is worth owning. It may take a while before the true value is appreciated by the rest of the market, but that’s something I’m willing to wait for.
Risk Parity Investors Concerned About Performance
By DailyAlts Staff Risk parity strategies are designed to perform irrespective of general market conditions, but this doesn’t mean that they’ll always outperform – not even during a downturn. The global swoon that began when China devalued its currency in mid-August and picked up steam through the latter part of that month and into September left a lot of risk-based portfolios battered and bruised – and this isn’t what their risk-conscious investors had in mind. In fact, according to Chief Investment Officer’s 2015 Risk Parity survey , 42% of risk-parity investors are “quite” or “extremely” concerned about performance – no other concern, from use of leverage to peer risk to transparency – comes close. And as a result of these concerns, just 19% of respondents said they planned to increase their risk-parity allocations in the next 12 months, while 16% said they planned on decreasing their allocations. About the Survey Respondents CIO’s survey involved 93 risk-parity investors from the U.S. (74%), Europe (18%), Canada (4%), and other countries (5%). Forty-seven percent had assets of more than $15 billion, while 23% had assets between $5 and $15 billion, and 24% had between $1 and $5 billion. Small users – those with less than $1 billion in assets – accounted for just 5% of respondents. Corporate pension funds were a plurality of respondents at a 37% share, while public pension / sovereign wealth funds and endowment and foundations represented 17% and 10%, respectively. Thirty-five percent of respondents were categorized as “other.” Investor Concerns Only 13% of respondents said they were “not at all” concerned about risk-parity performance, while 21% said they were “extremely,” 21% “quite,” 23% “moderately,” and 23% “a little” concerned. By comparison 62% said they were “not at all” concerned about there being “no explicit bucket” to put risk parity in, 50% were “not at all” concerned with “the passive approach some vendors take,” and 47% were “not at all concerned” that there “are not enough viable manager offerings.” Zero percent of respondents said they were “extremely” concerned about peer risk – compared to 21% for performance. To say performance is the major concern of risk-parity investors is an understatement. Allocating to Risk Parity Fifty-three percent of respondents said they fund risk parity from their equities “bucket,” making it the most popular answer. Interestingly, 24% said they have a dedicated allocation to risk parity – up from just 18% the prior year. Nineteen percent said they funded risk parity from their alternatives bucket, which was down from 25% in 2014. The bigger the investor, the more likely they were to have a dedicated risk parity bucket: Among respondents with over $5 billion in assets, 29% had dedicated allocations; while only 14% of respondents in the $1 billion to $5 billion group and zero-percent of the sub-$1 billion group funded risk parity from a dedicated bucket. These smaller investors funded risk parity from their equity and fixed-income buckets by a ratio of two-to-one. A plurality of respondents said they used an absolute return benchmark, i.e. “T-bills +x%.” This response grew in popularity from 25% in 2014 to 37% in 2015 – while using the traditional “60/40” portfolio as a benchmark fell in popularity. Conclusion Some pundits seriously question whether risk parity may have helped bring down markets in August. According to CIO, the fact that the question is being taken seriously should “warm the hearts” of risk-parity investors, since the still-tiny strategy has successfully “seeped into the collective consciousness of Wall Street and the media that cover it.” In CIO’s view, risk parity is still too small to have caused much damage – but the increased awareness could be good for the strategy going forward.