Are acquisitions ever successful?

There are two ways by which a company can chart its growth path. One is the organic way and second is the inorganic way. Organic growth comes from expanding the current line of business. Inorganic growth comes from acquiring another company. While the former is a slow and steady way to growth, the latter results in instantaneous expansion. In inorganic path, the acquiring company gets direct access to the products, geography and technical knowhow of the company being acquired. Of course, a price has to be paid for it but this strategy results in instantaneous expansion. Hence, many companies prefer to take the inorganic route while expanding their business.

However, has this route yielded any results to the acquiring companies per se? Let us analyze a few real life examples to understand the same.

Before doing that let us understand the problems that can arise from acquisitions. Most acquisitions culminate only when the acquiring company pays a premium to the existing market price of the acquired company. Thus, the challenge arises in accurately valuing the company that is being acquired. The second issue arises in determining the premium that should be paid. The tendency to overpay in both the cases cannot be ruled out.

Now, let us take a look at how some real world acquisitions have fared till date. In assessing the acquisitions, we see how the market price of acquiring company has moved from the date of acquisition till today. It gives a reasonable idea as to whether the acquisition was successful or not. While this may not be a true benchmark as post acquisition, there are various factors that influence price. Also, the time frame selected for price performance comparison may or may not be adequate to judge successes of certain acquisitions. Nonetheless, it gives a reasonable idea as to how has the company performed till date post acquisition.

Let us start with Tata Steel and Corus.

Tata Steel, one of the India's largest steel company acquired Corus in October 2006 for US$12.98 bn. This is one of the largest ever acquisition by the Indian company in foreign land. Here is the performance detail since acquisition.

Deal Value	EV/EBITDA Multiple	Price performance since acquisition
US$12.98 bn	8-9x	-44%

Since the acquisition, which happened almost six years back, the stock price has fallen by 44%. While some of the fall may also be attributable to the down cycle in the steel industry, we feel that six years is a sufficient time span to analyze the acquisition performance. Also, it should be noted that the management of Tata Steel recently took an impairment charge of US$1.6 bn on the said acquisition. This indicates that the value of Corus business has declined since its acquisition. Was it a case of overpayment? Probably, yes.

Now let us take a look at Bharti Zain acquisition.

In February 2010, Bharti Airtel, India's largest mobile company by subscriber base acquired Zain Africa. The deal value was pegged at US$10.7 bn. Here are the details.

Deal Value	EV/EBITDA Multiple	Price performance since acquisition
US$10.7 bn	8-10x	-7%

Even in the case of Bharti Airtel the price performance since acquisition is nothing to boast about. While it would be too early to say whether the acquisition is successful or not (since it was made in February 2010) the initial signs are not encouraging.

Let us take another example of Hindalco- Novelis acquisition.

Hindalco acquired Novelis in February 2007. It paid US$5.7 bn for the acquisition. Here is the price performance since then.

Deal Value	P/BV Multiple	Price performance since acquisition
US$5.73 bn	11x	-42%

After six years into the acquisition the stock has not delivered returns to its shareholders. While some may argue that the current commodity down cycle has got to do with the more recent depreciation in price it could be partially true. However, it may be noted that paying about 11x on book value basis for a loss making company did not go well with the markets at that time.

Take the recent case of Apollo Tyres as well. The moment the news of Cooper acquisition was made public, the stock lost 25% of its value.

So, why is it that acquisitions are generally being taken negatively by the markets? Well, there are a couple of reasons for it.

For one, acquisitions more often than not are likely to culminate at a premium. Hence, the stock price of acquiring company will always take a temporary beating. The primary concern by the market is that the acquiring company over paid for the target. But for acquisitions you will have to pay the premium. Thus, the immediate knee jerk reaction is expected. However, what is more concerning is the failure to deliver over the long term.

Even after 5-6 years into the acquisition, the acquiring company in most cases is generally unable to deliver the returns to its shareholders. And this is most concerning aspect of acquisitions. The primary reason for this is the management's inability to turn around the acquired business. Acquisition debt also adds to the worries. Thus, only few companies with prudent managements are able to pull off large acquisitions.

Also, it should be noted that whenever a management acquires a company it thinks over the benefits of the acquisition from long term perspective. For management, time horizon is virtually perpetual in the sense it has time to turn around the acquired company until they remain in existence. Hence, they are willing to accept the near term under performance witnessed in the first few years. However, market punishes these companies for this near term under performance. Overpaying concern also worries the markets.

By citing above examples we do not intend to say that all acquisitions fail and companies should follow an organic growth path only. What we intend to say here is that the success of any inorganic strategy depends mostly upon the price the management pays and the synergies it is able to extract.