Ah, memories.
I'm reminded of one of my earliest investing mistakes today, after hearing that French electrical equipment maker Schneider Electric has agreed to purchase American Power Conversion
Why does this seem like a mistake to me? APC, which sells backup power supplies for computers to both consumers and businesses, isn't exactly a blockbuster business. Look how badly margins and returns have deteriorated since 2003:
|
Metric |
2003 |
2004 |
2005 |
TTM* |
|---|---|---|---|---|
|
Gross margin |
42.1% |
40.1% |
36.3% |
33.9% |
|
Return on assets |
8.5% |
7% |
6% |
4.4% |
|
Return on capital |
10.3% |
8.5% |
7.4% |
5.5% |
|
Return on equity |
12.5% |
12% |
9.2% |
6.8% |
* Trailing 12 months
Ouch.
For all that, Schneider will pay more than three times APC's estimated long-term growth rate. In doing so, the company will take out a $5.7 billion loan, issue millions of new shares via rights offering, and sell additional corporate debt.
To put it in simpler terms, Schneider will be adding roughly $6 billion in leverage to a business whose few redeeming qualities include a clean balance sheet. (APC had roughly $539 million in cash with zero debt as of June, according to Capital IQ.)
For its part, Schneider told Reuters the deal would create a leader in power services, since APC's products complement those of Schneider's MGE UPS subsidiary. Executives also told the news service that the combination would produce $220 million in cost-saving synergies, 70% of which will be realized by 2009.
Perhaps that's why Schneider says the APC purchase meets its projected three-year return on capital requirement for acquisitions? Maybe, though I have a hard time believing that a larger, more leveraged outfit will do better at delivering returns on capital than APC has on its own. We already know how that's turned out. (See the table above.)
That all brings me back to 2000, and my own purchase of APC shares. I bought at roughly the same time that value investing guru Whitney Tilson sold. I should have listened to his rationale:
Normally, when the stock of a company I own (and therefore understand well and have confidence in) gets whacked, I'm more interested in buying than selling due to the more attractive valuation. But this assumes that my core investment thesis remains intact, which I'm not sure is the case with APC. I thought that this is a solid growth company, but am questioning this due to the recent decline in margins, profits and cash flow, a weakening balance sheet, and the fact that future growth appears to depend largely on penetrating markets that have significantly lower margins and in which there is entrenched competition.
Sound familiar, Schneider?
Maybe I'm overreacting. If so, I apologize. It's just that I already lost 50% on my investment in APC when I sold in 2001, when the business was ailing much as it is now. Why should Schneider's shareholders suffer a similar, or worse, fate? Answer: They shouldn't.
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Fool contributor Tim Beyers still uses an APC power supply in his home office. He only recently replaced the battery after eight good years of use. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. Get an inside peek at all the stocks he owns by checking Tim's Fool profile. The Motley Fool's disclosure policy is a capable backup.