As the article linked above exemplifies, M&A is read-into far too deeply and misconstrued by many. The linked piece begins as follows:
"Deal wave indicates that natural growth may be limited. To those of us who watch the technology business, it seems like money is burning a hole in the pockets of large high-tech companies."
In this super low interest rate environment, money really is burning a hole in the pockets of any company that is holding a large amount of cash on their balance sheet in terms of relative returns/opportunity cost. If a company has excess cash on hand that can fully fund an accretive acquisition (meaning one that will have a net benefit to the acquiring company's EPS), it would be ridiculous not to do so! (Not to mention completely irresponsible from the fiduciary standpoint of that company's board.)
Assuming a company is already dedicating necessary resources to R&D/CapEx, as is especially the case with tech firms, acquisition activity is in no way indicative of "natural" (organic) growth prospects. Leave it to the over-thinking under-informed financial media to always present a baseless negative spin on a positive story.
I am in complete agreement with Mr. Ruttenberg on this article. Sure, the consumer demand for new technology is virtually insatiable. And as the last few years have shown, the various companies that have stakes in Silicon Valley know that simply upgrading all their technology isn't necessarily the most practical solution.
ReplyDeleteApple seems to be one of the few companies that is deciding to avoid M&A and instead is creating its own demand, but unfortunately other companies cannot simply replicate Steve Jobs's success. It's a remarkable tactic, to be honest: instead of creating products based on what consumers want, they tell consumers what they SHOULD want, and demand for their own products seems to be endless no matter how many iPod and iPhone versions are churned out. To make the situation harder on the competition, Apple churns out patents as frequently as it churns out products: the tech blog community is currently abuzz with Apple's 3g Macbook patent (Source: http://www.ubergizmo.com/15/archives/2010/10/apple_granted_patent_for_3g_macbook_netbook_in_the_future.html). With competitors unable to generate products that rival Apple, it is safe to say that Apple is miles ahead of the game when it comes to expanding through production.
Companies are beginning to realize that they cannot all simply model Apple's one-step-ahead production strategy. Instead, they see their only option as a corporate solution as opposed to an economic one: using their thick wallet to buy out other competitors before the other big league businesses shut them down. Since we now know the pressures the tech consumers are putting on the corporations, is it truly unreasonable to say that the companies are justified in seeking their own interests through mergers? It sounds to me like they're looking out for themselves and their stakeholders, and using their wallets to do so when their production lines can't. In that respect, M&A seems like the perfect way for a wealthy business to attempt to refuel its profit stream. Though it may be a gamble, it is up to no one other than the corporation and its stakeholders to decide if a merger is the best solution in the dog-eat-dog tech industry.
"..it is up to no one other than the corporation and its stakeholders to decide if a merger is the best solution.."
ReplyDelete(Assuming there are no anti-trust issues at stake) Warren makes a great point here. I would expand this to include the hotly debated topic of "executive compensation". No one except the company and its stakeholders should have any say in what an employee of that company is paid. Perhaps a topic for another post.
Warren makes very valid points about how some companies need to make acquisitions to supplement their (organic) profit growth. However, the conclusion of the original referenced article, the one that I am arguing against from a strictly logical standpoint, is (put simply): If a company makes an acquisition it necessarily means that that company could not grow their profits organically (on their own).
This argument commits the logical fallacy of "affirming the consequent". Companies often do make acquisitions to supplement lagging growth, such as in the example Warren provided. This does not, however, mean that every acquisition was the result of lagging growth.
To restate my prior post more clearly: Any time a company has more cash than they need (enough to fund an acquisition), and an acquisition would result in a greater return on that cash than from it just sitting earning interest, the company should absolutely make the acquisition, regardless of its current organic profit growth potential.
For example:
Company A (the acquiring firm) is the best company of their sector by far. Their projected compound annualized growth rate (CAGR) is 15%, while the industry average projected CAGR is only 6%. This company obviously does not need to make an acquisition because of growth potential problems. However, let's say Company A has $5b of cash sitting on their balance sheet, even after spending as much as would be productive on R&D/CapEx/paying down debt. This $5b is only earning 3.5% interest and if they do nothing their EPS will be about $2.15 going forward. If Company A can buy Company B (the target) for $3b, and the effect is that even after all transaction related costs/expenses Company A's EPS will now be $2.20 going forward, they should certainly make the acquisition. This example shows a situation where a decision about making an acquisition is completely independent of organic growth prospects.