This Decade-Old Wisdom Is Wrong

In 2011, a Harvard Business Review article caused panic on Wall Street...

It claimed that between 70% and 90% of mergers and acquisitions (M&A) fail to generate any value – and worse, that they actually destroy the value of the acquiring company.

That's the last thing investment banks want to hear... as they make a huge chunk of money advising M&A deals.

Thankfully, the article didn't seem to stop companies from trying to be part of the minority that did succeed.

However, it created a bit of a stigma around M&A for investors. While the stocks of acquired companies tended to do well after a deal was announced, the stocks of the acquirers typically struggled.

And that stigma seems to still be in place today...

Take Microsoft's (MSFT) ongoing acquisition of video-game company Activision Blizzard (ATVI), for example.

On January 18, 2022, the software giant announced it was buying Activision for $69 billion, making it the biggest deal in gaming history. Activision's stock shot up about 26% that day, while Microsoft's stock fell about 2%.

In the months that followed, shares of ATVI remained above their pre-announcement price, while shares of MSFT took a nosedive, falling nearly 10% by March. (And keep in mind, this was before federal regulators got involved and tried to block the deal.)

Shares of Microsoft have since recovered, and the deal is set to close this month. Even still, it's clear that investors feared a potential decline in value for Microsoft after the acquisition's announcement.

However, new research tells a different, more promising story of the acquisition landscape...

As we'll discuss today, companies with a game plan can be successful in M&A. We'll cover a few companies that have a good track record when it comes to acquisitions... and we'll share some best practices for the types of M&A that are likely to do well.

Successful M&A takes a sound strategy...

The secret is to start small.

According to a recent Wall Street Journal article, companies that do frequent smaller deals tend to outperform, as it allows them to better identify targets, integrate businesses, and reap the financial rewards.

Those that set their sights on nothing but big acquisitions, without a sound playbook for success, are bound to struggle.

Now, that's not to say that all large acquisitions will fail... Rather, companies that start with several smaller acquisitions tend to be better acquirers.

For instance, medical-equipment maker Thermo Fisher Scientific (TMO) has acquired about 40 companies in the last decade.

Some were tiny. It bought molecular-diagnostics company Premaitha Health for just $4.2 million back in 2015. And in 2018, it acquired rapid-DNA-technology company IntegenX for $66 million.

Those helped it succeed with its $21 billion blockbuster acquisition of clinical-research leader PPD in 2021, after which, Thermo Fisher's stock actually outperformed the stock market.

Danaher (DHR) is another master acquirer...

The $160 billion life-sciences conglomerate designs, manufactures, and markets professional, medical, industrial, and commercial products. Its devices are used in everything from genetic testing to clean-water analysis.

Overall, Danaher is a great example of a company that uses M&A to create value...

It has made more than 50 acquisitions since 2013. Most of them have been small... like Danaher's acquisition of Pall-Austar for $35 million and Sutron for $44 million.

And that strategy has paid off handsomely. The company's share price has surged more than 1,000% since 2009.

Take a look...

To put it plainly, Danaher does M&A the right way. In fact, it follows a specific playbook when it comes to acquiring new businesses... which it calls the Danaher Business System ("DBS").

The DBS ensures that Danaher only acquires companies that make its business more profitable. It buys companies where it can either cut costs by using its larger distribution network or where it can increase sales while keeping costs roughly flat.

Take a look at Danaher's Uniform return on assets ("ROA") over the past decade-plus. As you can see, the company has managed to maintain impressively high profitability while making acquisitions...

Danaher's Uniform ROA has stayed above 15% since 2007. And it has more than doubled since 2019... That's rare for a company with so many acquisitions.

Many acquirers don't have a good playbook for integrating new companies into their business. It can take months, sometimes years, to integrate. And worse yet, the process ends up being more costly than expected.

Danaher, on the other hand, has found a way to avoid these problems with the DBS.

And it's still making strategic acquisitions today...

In August, Danaher announced that it's acquiring life-sciences company Abcam (ABCM) for around $6 billion.

In this case, Danaher should be able to run Abcam's protein consumables through its existing distribution network. That should help it grow its sales while keeping costs low.

If history is any indication, this should only help Danaher get larger and more profitable. And yet, its stock has stumbled about 6% since the acquisition was announced...

To us, that looks more like a buying opportunity than a reason to stay away.

Regards,

Joel Litman
October 12, 2023