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Do Acquisition Premiums Matter?

A herdlike mentality leads many companies to acquire more at the top of the stock market cycle than they do at the bottom.

Gregory V. Milano, | US
July 29, 2011

Stratergies and Acquisition

Interesting to read about the strategy adopted in expenditure for a Merger and Acquisition activity to create value. Read an excellent white paper on strategies for successful merger integration

Posted by gnanesh Gnanesh | August 23, 2011 03:40 am

Premium vs. Value

Correct me if I'm wrong, but I believe that one of the implications here is that the increased number of transactions at the high end of the market in 2011 will ultimately result in a higher percentage of acquisitions that deplete value, as compared to those acquisitions made when the market was lower. This, despite the fact that, based on your analyses, the latter seem to be more expensive. I couldn't agree more. In addition to the "herd mentality" you mention, I believe that another force driving the quantity of transactions is that many companies, having accumulated record amounts of cash during the past few years, are under great pressure to put that cash to use. My guess is that in time we will find that the shareholders of many of these companies would have realized more value (in the form of TRS) had that cash been used, for example, for share buyback programs or to pay special dividends. While many companies may point to lower premiums paid or comparable multiples to, at least in part, justify a particular acquisition, I find it difficult to believe that they don't recognize the concept of value creation you identify from a different perspective, with great insight. Regardless of the manner in which it is phrased, however, the concept of value creation is always the same. When all is said and done, an acquisition should be based on fundamental value. Irrespective of the premium or the multiple, the incremental value to the acquirer, generally based on free cash flows (regardless of how derived), should exceed the price paid for the acquisition today. Shareholders want returns. For a variety of reasons, management often favors growth as the preferred method for pursuing those returns. We know that, in practice, the pursuit of growth does not always produce maximum results. As evidenced by the record amounts of cash currently sitting on many companies' balance sheets, some companies already generate superior cash returns on investment. In this case, in order for an acquisition to make economic sense, the investment must, at least in theory, generate cash returns greater than existing returns. If not, even an investment that generates positive returns, may destroy value. When this chapter in history is written, I believe we will find that many of the transactions of 2011 will not have maximized their desired results, and that someone in the not-too-distant future will be writing a similar article.

Posted by Jeff Moskovitz | July 30, 2011 05:46 pm

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