Wesfarmers yesterday proved the old rule with regard to takeovers — in most instances a takeover will benefit the target company’s shareholders and be very costly for the acquirer.
The possible exceptions to the rule are earnings accretive “bolt-on” type acquisitions or cases where the merged company is able to earn “monopoly rents”. In most instances, acquirers will loudly trumpet expected synergies which result from the planned corporate activity (often forgetting Warren Buffett’s percipient note that synergy “is a term widely used in business to explain an acquisition that otherwise makes no sense.”)
Similarly when a takeover target mounts a strong defence campaign it is, in most instances, bad for shareholders. This point has been proved in recent years by Rio Tinto, MYOB and Fairfax.
After Rio Tinto rejected BHP’s 3.4 for 1 takeover offer in November its shares fell substantially. The sudden drop was caused by the removal of a takeover premium but also shareholder realisation of Rio’s crippling debt load. The debt was acquired in February 2008 after Rio played a classic defensive move against BHP’s hostile offer, choosing to undertake a “top of the market” acquisition of aluminum producer Alcan for US$38 billion. The Alcan purchase achieved two ends — (1) entrenching Rio’s management in their multi-million dollar roles; and (2) confirming those very same managers’ reputations as being appalling managers of shareholders’ capital.
The Alcan acquisition was an unmitigated disaster, with the US$38 billion cost paid by Rio probably worth less than US$10 billion now. Amusingly, Rio CEO, Tom Albanese, who was paid US$12 million last year to oversee the debacle claimed that BHP’s offer for Rio was “two ballparks” away. Turns out he was right. Since BHP left the scene, Rio shares have slumped by around 50%. Rio’s arrogance in pursuing a terrible acquisition and spurning BHP’s offer has cost its shareholders tens of billions of dollars.
MYOB shareholders have also seen both sides of the coin — and neither has been pretty. Back in 2004, MYOB acquired fellow IT company Solution 6 by scheme of arrangement. While both companies operated broadly in the same field, MYOB largely serviced smaller and medium-sized companies, whereas Solution 6’s products were primarily geared towards big business and major firms. Based on MYOB’s share price in June 2004, it paid an approximate 41% premium for Solution 6 (compared with the target’s share price prior to the announcement of the merger), valuing Solution 6 at around $250 million.
Four years later the entire merged entity was valued at approximately $400 million. MYOB shareholders haven’t been as fortunate as Solution 6 shareholders; the board initially rejected a takeover offer from private equity firm, Archer Capital, in February 2008 which would have valued the company at around $950 million. At the time, MYOB labeled the $1.90 per share bid as “inadequate”.
Archer (and partner, HarbourVest International) returned in November with a far lower offer, valuing MYOB at around $400 million. Archer’s revised bid was welcomed by substantial shareholders (such as Guinness Peat) but was initially rejected by management. Eventually, MYOB ceded to Archer’s takeover offer, of effectively $1.16 per share — almost 40% less than Archer’s earlier offer.
Like Rio, MYOB shareholders fell victim to management hubris, twice: first in conducting the ill-advised acquisition of Solution 6 and then in rejecting a high-premium takeover offer. In both instances, management thought they were better at running their company than their acquirer (and better at running Solution 6 than its incumbent management) and were happy to risk shareholder money to prove the point.
Fairfax managed to achieve an even more impressive feat by combining its takeover follies in one hit — undertaking an expensive acquisition which also prevented Fairfax itself from being taken over.
In April 2007, Fairfax completed the $2.8 billion acquisition of Rural Press. Fairfax claimed that the deal was made in order to lessen the group’s reliance on dwindling classified income from The Age and Sydney Morning Herald. While the concern was legitimate, it appears that such ambitions were a secondary benefit of the deal — the real gain from the Rural Press purchase was that it made Fairfax virtually takeover-proof (at the time Crikey noted that Fairfax was undertaking the deal as a Pac-Man takeover defence).
Just before the Rural Press purchase, the Federal Government weakened cross-media ownership laws which made Fairfax a legitimate takeover target. By purchasing Rural Press (and later, squandering several hundred million dollars on the appalling acquisition of Southern Cross) Fairfax effectively made itself too large, too leveraged and too unwieldy to acquire.
When Fairfax announced its acquisition of Rural Press, this column noted that the deal was “an earning[s] dilutive takeover of a fully priced, efficiently run business with little synergistic benefits while at the same time removing a takeover premium from their own share price.” To Fairfax shareholders’ detriment, the board took a different view. Since the deal, Fairfax’s market capitalisation has slumped from more than $7 billion to around $2.5 billion — less than the market value of Rural Press at the time Fairfax acquired it.
Executives relish deal-making, deals vindicate an executives’ role and enlarge their domain (meaning that they are usually paid more). Or as academic Peter Drucker once noted, “I will tell you a secret: Dealmaking beats working. Dealmaking is exciting and fun, and working is grubby. Running anything is primarily an enormous amount of grubby detail work … dealmaking is romantic, s-xy. That’s why you have deals that make no sense.”
No doubt Rio Tinto, MYOB and Fairfax shareholders will agree.