Revisiting the Deal That Worked

Jul.30.10 | About: Stanley Black (SWK)

The New York Times Dealbook published an article last week on a corporate deal that worked for the right reasons (see A Merger that Works). According to the NY Times:

Academic studies generally support the idea that shareholders of companies that make acquisitions get the short end of the stick.

MY COMMENT: Yes, that’s a fair assessment of the academic literature. Most deals fail; and often, shareholders of the acquiring firm end up bearing the brunt of the costs (see Great Shareholder Ripoff and Why M&A Deals Go Bad).

But that’s not always the case. Stanley Black & Decker, the tool giant created this year, is shaping up to be a notable exception if Wednesday’s quarterly report is any guide. Investors might want to make a punch list of the deal’s key components.

From the start, the merger, announced last November, looked good on paper. Stanley Works agreed to buy Black & Decker for stock valued at a 22 percent premium…[but] the amount Stanley was paying above Black & Decker’s market capitalization was dwarfed by the value of cost cuts promised by the deal.

MY COMMENT: OK, but I am hard pressed to think of a deal in which decision-makers don’t justify the acquisition by appealing to “the premium is justified by the cost cuts” rationale. The numbers, however fabricated calculated, should always come out that way. Otherwise, the deal makes no sense. Where most deals fail is in the integration phase – in the process of trying to capture the supposed cost savings/revenue enhancements. And in fairness to the author of the NY Times piece, he/she recognizes that…

These, of course, were no sure thing; achieving them depended entirely on management making them happen. But in the first full quarter as a combined group, these are now being captured.

The company reported better-than expected second-quarter results and raised its outlook… Moreover, the company said it was “firmly on track” to meet its estimates for cost cuts and was examining opportunities for revenue synergies.

Since the deal was announced, Stanley shares have risen by more than 20 percent…By comparison, the Standard & Poor’s 500-stock index has added just 4 percent.

The lesson should be fairly simple: mergers can work if the blueprints are solid. In the Stanley Black & Decker case, the elements included overlapping businesses with broad scope for expense reduction, a modest premium amply justified by the synergies, clear governance and control, and a shared distribution of future gains. Put those tools in the box, and there’s no reason shareholders can’t benefit from such deals.

MY COMMENT: Maybe. But I think that most managers enter such deals believing (perhaps erroneously) that their blueprints are solid. Further, we always hear about synergies and the benefits of buying overlapping businesses, and yet most deals still fail.

And therein lies what makes evaluating individual deals so difficult.

First, we don’t get to observe the counter-factual. Although the share price of the combined entity (in this case Stanley Black & Decker) (NYSE:SWK) may have risen (by 20% according to the author), we don’t get to observe what would have happened to Stanley Works’ stock and Black & Decker’s stock individually had the deal not gone through. Perhaps it would have increased by more than their combined shares, perhaps by less.

In addition, there is another potential explanation for Stanley’s positive outcomes that I think the author may have overlooked: market power. Bringing together two powerful competitors within a largely commodity business is one way to quickly extract value. Whereas the firms previously competed vigorously with each other in various segments of the market, the ability to remove a competitor via acquisition enhances the pricing power of the combined entity. So although there may have been cost cutting synergies for Stanley to exploit, the true benefit may have come from the industry consolidation itself. The lesson: Industry structure matters … and that is not easy to replicate no matter how complementary the businesses.

So when it comes to M&A deals, I am always weary of a one-size-fits-all punch list. And you should be too.

Disclosure: No positions