Acquisitions: Creating or destroying shareholder value?
Acquisitions by publicly listed companies have always been widely debated by financial analysts. Investors’ opinions as to whether a particular acquisition will eventually prove beneficial to shareholders of the company making the acquisition tends to create wide volatility in the company’s share price in the period between the announced intention to make an acquisition and the actual closing of the deal.
Analysts very often feel that companies entering into a bidding war with others to acquire another company are forced to pay too high a price. This eventually results in the share price of the acquirer falling in the market in the aftermath of the deal. On the other hand, the takeover target company normally experiences a sudden sharp rise in its share price since a potential buyer would need to offer a substantial premium above the market price to entice the shareholders of the takeover target to accept the deal.
Therefore when more than one company is interested to purchase another company, a takeover war between them ensues with a substantially higher price being paid leaving shareholders of the target company very often capitalising on some significant gains.
Over the years, almost on a daily basis, the international press has been consistently reporting substantial mergers and acquisitions (M&A) activity taking place. The biggest merger to date was that of internet service provider America Online and media giant Time Warner. The merger was worth a reported $181.6 billion in January 2001. Unfortunately, the perceived benefits of the merger did not materialise and some analysts classify this deal as one of the biggest failures in merger history. The “tech” crash in the market that ensued forced AOL Time Warner to report a $99 billion loss in 2002. Today, the two companies are separate entities once again.
Following the global economic crises of 2008, large M&A deals have started to materialise once again. In 2009 the largest transactions were Pfizer’s acquisition of Wyeth in the US for $64.5 billion and BHP Billiton’s acquisition of Rio Tinto’s iron ore assets in Australia for $58 billion. This year the largest transaction by value was Mexico’s American Movil acquisition of Carso Global Telecom (also based in Mexico) for $27.5 billion.
Some intended and announced acquisitions also fail to materialise. The most recent example is the attempt by global mining giant BHP Billiton Limited to acquire Potash Corporation. Although BHP also went hostile with its proposed acquisition for PotashCorp at $130 per share in cash (representing a substantial premium to the market price), a few weeks ago BHP Billiton announced that it withdrew its offer to acquire all the shares of Potash in view of strong opposition to the deal by the board of directors of Potash.
Do acquisitions actually create value for shareholders of the company purchasing or do they actually destroy value? This is a highly subjective argument and a recent study by KPMG found that 83 per cent of the deals they reviewed did not boost shareholder value and 53 per cent actually reduced it. Another study found that the total return to shareholders on 115 global mergers and acquisitions was a negative 58 per cent!
What is the situation with the few M&A deals that took place involving locally-listed companies? One of the deals which was given most prominence earlier this year was Middlesea’s ill-fated acquisition of Progress Assicurazioni SpA in 2001. It is not difficult to conclude that this was detrimental to Middlesea’s shareholders since the massive losses incurred by Progress between 2008 and 2010 brought the local insurance company to its knees and MSI was saved by a rights issue in December 2009 underwritten by two of its larger shareholders, Bank of Valletta plc and Mapfre Internacional SA.
The reduction in value for Middlesea’s shareholders can be gauged by the sharp decline in the NAV of the Middlesea Group from €3.13 per share to €0.56 per share as at 30 June 2010. The drop in MSI’s share price from a high of €6.29 to a current market price of €1.05 results from the losses suffered from this failed acquisition.
Another large acquisition by local standards is Go’s purchase of a sizeable shareholding of Forthnet in 2008 and in turn Forthnet’s subsequent purchase of the PayTV business Nova a few months later. Information on recent developments at Forthnet were documented in my column last week. The purchase of the PayTV business in 2008 was conducted for a total sum of €491 million and currently Forthnet’s total market capitalisation (composed of the “old” Forthnet broadband business and 100 per cent of the PayTV business) is €65 million!! Hopefully this acquisition will eventually prove to be fruitful in the years ahead for the benefit of the thousands of GO shareholders.
Other acquisitions made by a few of the locally listed companies include Lombard Bank’s acquisition of MaltaPost plc and FimBank’s purchase of a minority shareholding in an Indian company in 2004. With Lombard Bank mainly being dependent on net interest income and failing to compete effectively with the two major banks in fund management activities, life assurance and other non-interest income generating activities, Lombard sought to purchase the local postal operator to diversify its revenue streams and grow its profitability.
Although MaltaPost had been incurring losses for a long-number of years, Lombard initially purchased a 35 per cent shareholding of MaltaPost in August 2006 for a value of €2.65 million. Prior to the complete privatisation of the postal operator in 2008, Lombard purchased a further 25 per cent shareholding from the government of Malta in September 2007 for €2.84 million bringing its total equity stake to 60 per cent. The overall cost for this majority shareholding amounted to €5.49 million equivalent to €0.327 per share excluding the net dividend of €0.84 million received by Lombard Bank in January 2008.
In January 2008, the government of Malta sold its 40 per cent shareholding in one of the most successful local IPOs to date at a price of €0.50 per share. Lombard increased its shareholding through purchases of further shares on the secondary market and scrip dividends. Lombard today owns over 65 per cent of MaltaPost plc and the current share price of MaltaPost of €0.93 per share represents a significant premium on the actual cost price for Lombard Bank. MaltaPost is today a profitable company and with the company having adopted a 50 per cent dividend payout ratio, the equity ranks as one of the highest yielding equities on the market. Lombard shareholders should therefore look at such an acquisition as representing an excellent deal for shareholders.
FimBank’s first acquisition was in 2003 with the purchase of London Forfaiting Company Ltd. While this also proved to be beneficial over the years as LFC was successfully turned around into a profitable operation, the purchase of a 38.5 per cent shareholding in the Indian company GTF surely ranks as a significant achievement. The minority shareholding was purchased for $4.6 million (at book value) and FimBank sold this shareholding for $55 million in 2008 providing an exceptional profit for shareholders only four years later.
Local companies often cite the need to expand overseas mainly through an acquisition as one of the only ways to achieve profitability growth given the limited size of the local market. While this may be true for companies who have achieved a sizeable market share in Malta, the risks of a merger or acquisition failing can be high judging by the results of KPMG’s study and the M&A activity record over the years.
Rizzo, Farrugia & Co. (Stockbrokers) Ltd, “RFC”, is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the issuer/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.
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Mr Rizzo is director of Rizzo, Farrugia & Co. (Stockbrokers) Ltd.