Aswath Damodaran: Do Not Invest In Companies That Try To Achieve Growth Through AcquisitionThe Acquirer's Multiple
Here’s a great article by Aswath Damodaran in which he warns investors who are considering investing in companies that use acquisitions as part of their growth strategy, saying:
“If you look at the collective evidence across acquisitions, this is the most value destructive action a company can take.”
Here’s an excerpt from the article:
Aswath Damodaran has a blunt message for companies considering an acquisition: “Don’t do it.”
“I firmly believe that acquisitions are an addiction, that once companies start to grow through acquisitions, they cannot stop,” he told the audience at the CFA Institute Equity Research and Valuation Conference 2018. “Everything about the M&A process has all the hallmarks of an addiction.”
That’s why he titled his presentation, “Acquirers Anonymous.”
And like every addiction, the acquisitions habit exacts a heavy toll from its abusers and those who rely on them.
Ways to Create Value
The dilemma comes down to how companies generate growth. And it turns out there are really only a handful of strategies that can accomplish that, Damodaran said, referencing data from a McKinsey study.
“The very best approach of creating growth historically has been to come up with a new product,” he said. “Look at Apple. Between 2001 and 2010, the company went from being a $5 billion company to a $600 billion company, and they built it on the iPhone, the iPad. Basically new product, new product.”
But creating new products is like playing the lottery. When you win, the payoff is huge, but wins are rare and losses common. “Think of the contrast with Microsoft’s new products in 2001 and 2000,” Damodaran said. “You can’t remember any of them, right?”
The second best strategy for growth is expansion, either into a new market or by finding new users within your market. Coca-Cola and Levi’s went global in the 1980s, Damodaran explained. As for finding new users, he pointed to over-the-counter painkillers: “You know how much bigger the aspirin market got once people discovered it was potentially something you could take to not have a heart attack?”
The third most effective approach, McKinsey found, was to grow or maintain market share in an expanding market. “Think of Apple and Samsung between 2011 and 2015 in the smartphone market,” Damodaran said. “Apple’s market share actually decreased between 2011 and 2015, but their value increased. Why? Simply because the smartphone market itself was growing. When you’re in a growing market, it gives you this buffer to have your market share drop off and still grow.”
Companies can also try to increase market share in a stable market, but that is even less effective at achieving growth and is often value destructive. Because to acquire that market share, you have to cut prices. “You will get a higher market share but your margins collapse,” he said. “Your value, in fact, becomes much more unpredictable.”
And then McKinsey gets to the dregs, what Damodaran calls “the very bottom of the barrel.”
What is the very worst way to grow?
“Go do acquisitions,” he said.
The evidence isn’t in dispute: It is piling up and pretty well disseminated. Yet the industry has yet to reach rock bottom. “This is something we’ve known for 40 years,” Damodaran said. “And as you look at M&A study after M&A study, collectively, this is not a process that creates value, and I’m afraid the disease is spreading.”
Of course, if you’re the targeted company, being acquired is a great thing. Your stock price goes up. “Targets win,” Damodaran said. “You wake up the next morning and thank God for capitalism . . . . You will never want this process to stop. This is a gravy train that is going to keep giving.”
Why is that? Because acquiring companies tend to overpay. By a lot.
You can read the entire article here – Aswath Damodaran on Acquisitions: Just Say No
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Article by The Acquirer's Multiple