In a recent “Simon Says” column I wrote about companies – such as Choppies, AngloGold Ashanti, Intu and Ascendis – divesting from assets they’d bought and which they claimed as great additions to their business model at the time of purchase.
Then, suddenly, they reverse track and start selling them.
This raises a number of issues that investors need to be careful of.
The first has, perhaps, been the biggest lesson of the last part of the last decade: management promises.
Every deal ever announced has always come with great fanfare, promises of synergies and, ultimately, more profits. However, it typically takes several years before the deal delivers those profits.
In addition, company management seems totally ignorant of any potential risks but, as hindsight shows us, the risks are not only significant but almost always end up being the reality – as opposed to the wonderful profits.Frankly, the first thing investors need to worry about is the reason why a company has chosen to pursue the deal.
I have written before that a solid business with defendable margins and improving profits is a great investment.
Sure, at some point all businesses become ex-growth and profit growth starts to sit around the single digits.
But the dividends will be solid and growing and what is wrong with a solid ex-growth dividend payer?
According to management, apparently everything.
So, off they rush to find new growth – at a serious cost to shareholders.
The problems with this approach generally boil down to two issues.
Overpaying and subsequently taking on too much debt that strains the balance sheet and, secondly, the magical synergies are never as great as promised.
The problem is seemingly exacerbated when the great deals are offshore acquisitions.
The reality is that if local buyers in the targeted geography of the business didn’t want to buy the business, why do our managers want them?
Make no mistake: Sellers start easy by talking to other companies in their own geography.
But when that doesn’t work, they look further afield, and they find plenty of buyers in South Africa.
The other issue is that while a CEO may be king of the hill locally, that does not ensure they will be the king in a new market.
They know the local market better than most as they’ve most likely spent an entire career working here and know the market inside out.
A new market, however, is an unknown for them and they have no competitive edge that will enable them to repeat their local successes.
This is not an SA-specific issue; we’ve seen many UK and US companies try, only to fail, at global expansion.
Then as the deals start to fail, we start seeing the attempts to fix things.
Often this starts with delays in profit flows, then write-downs on the price paid for the business.
Eventually some give up and attempt to sell the newly-acquired business – again almost always at prices below what was paid originally.
As shareholders, we need to be far more sceptical of these deals when management proposes them.
As I have stated before, having been badly burnt by Famous Brands* and Woolworths*: In future I will not only interrogate the deal more vigorously, but I will most likely rather exit a share I own where the company is proposing a large deal.
Sure, some deals may work – in which case I can re-evaluate and re-enter if required.
But often we see the price run higher on the news of the deal, but then six to 12 months later reality starts to set in, and the trouble starts.
I will look to rather exit on the hype-run higher.
*The writer owns shares in Woolworths and Famous Brands.