When I first got into investing I didn’t care whether a company was acquisitive or not, but the longer I invest the less I like acquisitions. Any roll-up strategy is an instant pass for me. Two things have slowly changed my views over the years.
First, there’s a lot of evidence that acquisitions (especially large acquisitions) are a poor way to grow a company. According to a McKinsey study, the average acquisition has historically increased the value of the combined entities by 5.8%. The problem is, more often than not, all of this increased value is transferred to the shareholders of the acquired company via the premium paid (i.e. goodwill). The average public company acquisition is made at a 30% premium to its previous day close. Increasing an acquired company’s value by 30% just to break even on the price paid is a hard enough task as it is, let alone earning an adequate return on top of that. Another interesting note is that M&A activity peaked in 1999 and again in 2007. It seems managers are all too prone to make acquisitions when times are good and valuations are high.