In his 1995 letter to shareholders, Warren Buffett suggested investors "keep in mind the story of the man with an ailing horse. Visiting the vet, he said: 'Can you help me? Sometimes my horse walks just fine and sometimes he limps.' The vet's reply was pointed: 'No problem -- when he's walking fine, sell him.' In the world of mergers and acquisitions, that horse would be peddled as Secretariat."
Perhaps such misleading labeling is why, according to the Harvard Business Review, between 70% and 90% of mergers fail.
Thermo Fisher Scientific (NYSE:TMO) was itself formed by a merger in 2006 between a company focused on lab equipment and one focused on scientific instruments. Over the following 14 years, the combined entity has made almost 40 acquisitions of its own -- and it shows no signs of slowing down.
Given all these acquisitions -- and the notable likelihood that any acquisition might fail to achieve the results intended -- skeptical investors might ask themselves whether these deals are creating value for shareholders. After all, the company is already home to more than 200 different brands.
Big checks and big opportunities
One way a company can go awry is by making acquisitions that aren't aligned with its strategy. Thermo Fisher Scientific has avoided this pitfall by spending exclusively in life sciences research. Though the field is broad -- including areas such as biology, biotechnology, genomics, pharmaceutical research, and others -- the products and services within it are all focused on the same things: diagnostics, therapies, and lab productivity.
Management has also proven they aren't afraid to swing for the fences. The $13.6 billion the company spent acquiring Life Technologies Corporation in 2013 was more than its annual revenue at the time, and the move pitted Thermo Fisher against industry leaders Agilent (NYSE:A) and PerkinElmer (NYSE:PKI). The size of this particular acquisition was an outlier, but the company has continued to acquire large businesses; in fact, it's spent more than $15 billion to that end since the Life Technologies deal.
The spending spree makes sense, as the life sciences market is booming. A recent company presentation cited a $165 billion addressable market growing by 3% to 5% a year. Just the analytics part of the life sciences sector was recently pegged as a $14.3 billion opportunity, with a growth rate of 12.9% annually.
All that glitters is not gold
Evaluating the success of an acquisition strategy such as Thermo Fisher Scientific's is difficult; benefits tend to show up over longer periods of time as complementary products are sold through the same channels, costs are wrung out, and reduced competition leads to price increases.
One potential way to examine this is by combining data on multiple years with significant acquisition spending and evaluating the key metrics, such as sales growth and profit margins, in the years that follow. What does this approach tell us about the success of Thermo Fisher Scientific's strategy?
|Six-Year Period||Acquisitions as % of Revenue||Average Annual Revenue Growth||Average Operating Margin|
|2014 to 2019||25%||15%||16%|
|2008 to 2013||14%||5%||12%|
This paints a clearer picture of the company's success and reinforces its strategy of spending big on acquisitions. In periods of increased acquisition activity, the company has increased revenues at three times the pace, while growing profitability as well.
Can they keep up the pace?
One drawback of this strategy -- no matter how successful -- is that with each acquisition a company makes, the pool of potential future acquisitions shrinks. Thermo Fisher itself recently tried and failed to consummate another large acquisition. In mid-August, its proposed $12.7 billion offer for fellow life sciences company Qiagen (NYSE:QGEN) fell through.
For now, though, the market sees no signs of the well running dry. At the end of 2013, the stock traded at a price-to-earnings (P/E) ratio of 30. Today, the stock trades at a P/E of 47 . It may be difficult to evaluate a company that makes a lot of acquisitions, but considering several years at once does provide some insight. This industry leader looks to be creating shareholder value with the billions of dollars it spends buying other companies -- and the P/E ratio suggests that the market agrees. Interested healthcare investors may want to wait for a dip in price before buying in.