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Investors routinely cheer and bid stocks up on merger and acquisition announcements. What's generally lost in the short-term noise is how often the long-term truth is that companies overpay for the entities they acquire.
Microsoft's (Nasdaq: MSFT ) just-announced $6.2 billion charge related to its aQuantive purchase is a stark reminder. CNBC's Herb Greenberg wrote a thought-provoking piece warning about M&A frenzies, the accounting associated with them, and the psychological and market effects when companies overpay for acquisitions and then years later take non-cash accounting charges.
Data show that companies frequently overpay for mergers and acquisitions rather than driving a hard bargain for better deals, and the goodwill impairment charges that can occur years later don't truly reflect the loss of paying too dear a price.
There are plenty of good examples to draw from. eBay (Nasdaq: EBAY ) wrote off $1.4 billion related to its Skype acquisition. (Incidentally, Microsoft subsequently purchased Skype from eBay.) Procter & Gamble (NYSE: PG ) wrote off $1.5 billion related to its acquisition of Gillette, which widely worshipped investor Warren Buffett initially described as a "dream deal." Hewlett-Packard (NYSE: HPQ ) has built quite a reputation for frequently overpaying for acquisitions as shareholder value deteriorated.
Some Walgreen (NYSE: WAG ) fans recently questioned my scrutiny of the drugstore retailer's $6.7 billion purchase of a partial stake in U.K.-based drugstore chain operator Alliance Boots, but given how many deals don't deliver anything near the value investors automatically assume, I counter that time will tell.
Harvard Business Review said last year that studies repeatedly show that the failure rate of mergers and acquisitions lies somewhere between 70% and 90%.
The reason for this could vary from managements that are desperate to find a way to spur future growth (and impress investors with the short-term possibilities rather than worrying about the long-term reality) to even the hubris of throwing around the big bucks in bidding wars, all the while lacking a real concrete strategy for what happens after the "win."
Greenberg brought up the idea that one day soon, accounting may be changed to more adequately reflect the losses companies incur through misguided, overly pricey acquisitions. Investors, curb the short-term enthusiasm for M&A activity. The truth about some of these pricey deals will come out over the long haul, and the statistics don't look good.
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