Monday, May 11, 2015

Stock Talk - Acquisitions

If you're looking for a pretty good bearish indicator, consider the company making an expensive (the more expensive, the better) acquisition. This is especially true in the high-tech sector. My boss for many years, a bona fide entrepreneur and CEO, used to say that, in high tech, the odds were 10-to-1 against, and I've never seen any evidence that he was wrong. At the present time, CEOs of companies holding a lot of cash are particularly vulnerable. All that cash is yielding little or nothing, and analysts are always egging them to "do something," because that gets the company's name in the papers and generates lots of commissions for the deal-makers. Moreover, a lot of insiders will get wealthy, because acquisitions are always made at a premium to the market, and a spike in the acquired company's stock price will follow the announcement. So the reaction of analysts is almost always positive, because the M and A (mergers and acquisitions) business is considered exciting.

So there's time to sell or short the stock of the acquiring company - maybe weeks or months. What happens then, all too often, is that (a) the acquired company's key employees move on, (b) the acquiring company finds bugs in the acquired company's profit and loss reports or balance sheet, (c) the owners, once the lock-up period is over, dump their stock, (d) a major customer, for one reason or another, doesn't like the combination, or (e) the synergies that were touted as reasons for the acquisition aren't there. There are other potential problems, but you get the idea: The brokers who were selling the deal were overplaying the benefits and underplaying the pitfalls.

There are some acquisitions that make sense. My friend didn't say the odds were 10-0; he said the odds were 10-1. Every now and then a company will acquire a winner. But in investing, the odds are stacked against acquisitions, once the buzz dies down. Instead, bet on companies that use their money to fund new projects internally