Growth through Acquisitions: A Fresh Look

Abstract

LBOs outbid corporate buyers and then produce extraordinary returns. How do they do it? A study of over 800 acquisitions shatters some myths about the value of timing and leverage Don't do the deal if you can't find the leader The conventional wisdom on successful corporate acquisitions is short and simple: Make them small and make them synergistic. Yet companies that rely solely on this view risk missing an entire world of valuable strategic opportunities. A year-long research program has shown that companies can pursue a nonsynergistic strategy profitably. In fact, research has uncovered a diverse group of organizations, including Thermo Electron Corporation, Sara Lee Corporation, and Clayton, Dubilier & Rice, that have grown dramatically and captured sustained returns of 18 to 35 percent per year by making nonsynergistic acquisitions. The successful acquirers fell into two groups: diversified public corporate acquirers and financial buyers such as leveraged buyout (LBO) firms. We chose to study LBO firms because, like the rest of the world, we were fascinated as we watched them outbid corporate buyers and then produce extraordinary returns without the benefit of synergies among their businesses. We compared the LBO firms' practices with those of successful diversified corporate acquirers and were surprised to find that their operating principles were remarkably similar. Yet many corporate strategists refuse to believe that they can be successful in pursuing nonsynergistic deals. In our view, their hesitancy results from two fundamental misconceptions about the way today's nonsynergistic acquirers operate. The first is that financial buyers rely on market timing to buy assets at a low price (and then turn around and sell them at a high price). In fact, we found that financial buyers actually pay substantial premiums above market price, just as other acquirers do. The second misconception is that high financial leverage is used to discipline managers. In fact, to avoid losing flexibility, the financial buyers in our study make a conscious effort to prevent high leverage from controlling managers' decision making about operations. Although many LBO firms start out with fairly high debt loads, they reduce their burden to relatively conventional levels (65 percent debt to total assets) within one to three years. Our findings are supported by the research of John Kitching, who studied 110 buyouts.(*) He found that by the second year after acquisition, debt repayment of the typical LBO exceeded repayment commitments by 600 percent. Without a doubt, the 21 companies in our sample were very successful. Altogether, they made 829 acquisitions. When asked whether they earned their cost of capital, 80 percent of the respondents (accounting for 611 acquisitions) said yes. Our sample of US corporate acquirers averaged more than 18 percent per year in total return to shareholders over a ten-year period, while the financial acquirers averaged 35 percent per year by their own estimates. Although the acquisitions of any given acquirer in our study were seemingly unrelated, successful acquirers picked a common theme and stuck to it. We noted, for example, that Clayton, Dubilier & Rice - a financial buyer - was skilled at turnarounds, often shrinking the acquired company before growing it.(**) Desai Capital Management, also an LBO firm, searched for growth opportunities in retail-related industries. Emerson Electric Company acquired companies with a core competence in component manufacturing, particularly those for which it could exploit cost-control capabilities. And Sara Lee, which has acquired more than 60 different consumer product companies - including Coach Leatherwear Company, Playtex Apparel, and Champion International Corporation - used branding and retailing as its common thread. Making acquisitions work But making this type of acquisition work is not easy. …

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