The Boat Owner’s Impasse

March 5, 2018
The Boat Owner’s Impasse

Dion Hershan, Managing Director and Head of Australian Equities, provides his observations from an eventful February 2018 reporting season.

I am not a boat owner (or enthusiast) but have often heard about the ‘two happiest days of a boat owner’s life’ (i.e. the day they buy and the day they sell).

The anecdote seems an appropriate one this reporting season, with some clear parallels to M&A activity in Australia. In fact it was quite likely one of the clearest messages from what was generally a solid reporting season.

The irony runs thick that there were so many companies announcing ‘strategic’, ‘synergistic’, ‘accretive’ and ‘transformation’ deals. While on the other side, we saw more than a few companies announce ‘impairments’, ‘strategic reviews’, ‘downgrades’ and ‘divestiture programs.’ A few salient examples, in no particular order, have included:

  • QBE confirming it will exit most of its Latin America business and reshape the business through ‘brilliant basics’, a retreat after undertaking over 100 acquisitions;
  • Wesfarmers announcing an impairment and strategic review of its Bunnings UK business (have we all forgotten about Woolworths’ disastrous foray with Masters?);
  • Ramsay’s restructuring of its French operations (which at €44m will take nine years to pay for itself, if it’s successful) and confirming further weakness in its UK business;
  • Orica putting its tunneling and construction business up for review and taking $300m of impairments; and
  • Vocus cutting its guidance for the sixth time in the past three years following four large acquisitions.

Specifically, in our view:

It’s dangerous to be categoric, but there is clear empirical evidence that the majority of M&A destroys shareholder value. CEOs who typically have short tenure (i.e. less than five years) are implicitly incentivized to pursue M&A, and the trend is exacerbated in a low interest rate/low growth environment.

In our opinion some – but not all – companies have the requisite experience, temperament, and integration skills to create value (e.g. Seek, ResMed, Downer EDI) but they are in a distinct minority. When our portfolio companies undertake meaningful acquisitions, we look at them through a dispassionate lens, asking ourselves a pretty simple question: if we didn’t already own the stock, why would we buy it here and now? It’s critical to ensure that shareholders and not investment bankers are the beneficiaries of any corporate activity.

Finally, Warren Buffett in this year’s shareholder letter had some insightful comments on the topic (no surprises) that every CEO should take note of, including:

  • “Once a CEO hungers for a deal, he or she will never lack for forecasts that justify the purchase”;
  • “Spreadsheets never disappoint”;
  • “We also never factor in, nor do we often find, synergies”