can be so predictable sometimes.
A company announces an. The buyer's almost always takes a big hit, and the seller's almost always surges.
Because some deals never end up generating the profits promised by management, most investors choose to shoot first and ask questions later. But by asking yourself these questions first, you can do a better job of figuring out when to buy, hold or sell.
Most companies want to make 'accretive' deals, meaning earnings per share (EPS) once the deal is integrated, hopefully within a year or two. 'Dilutive' deals, which hurt per share profits, are rarely the intended outcome. But unfortunately, some deals expected to be accretive turn out to be dilutive when management over-estimates the projected benefits of a key acquisition.
I have personal experience with this phenomenon. As a former Wall Street , I once recommended clients sell shares of a magazine distributor called Source Interlink. The company announced a deal that, in management's view, would be very accretive. I, however, thought otherwise.
I believed the deal would actually be dilutive because management had unrealistic goals (by the way, this ended up causing me a great amount of grief -- Source Interlink threatened me with a lawsuit). Lucky for me (and my reputation), my analysis was correct and the company eventually declared.
So here's what to look for to see if a deal is really going to be accretive:
1) Feasibility of cost cuts
Many companies look for targets with redundant manufacturing capacity or a bloated cost structure. If costs can be cut when the two entities are combined, the acquiring company is likely to generate impressive returns on investment (ROI).
If this is the acquirer's strategy, play close attention to management's discussion when they announce the deal. They usually be very specific in terms of cost-cutting targets. Most times, those cuts do take place, and can be counted on as part of your analysis.
Cost cuts are a key factor behind Hertz's (NYSE: HTZ) newly-announced decision to sweeten itsfor Dollar Thrifty (NYSE: DTG), which I discussed last week.
Hertz has made a very clear case that it can eliminate many redundant costs and the purchase -- even at this higher price --be accretive. That's why shares of Hertz surged +7% on Monday.
2) Ability to cross-sell
Deals that rely on cross-selling can actually benefit rivals instead. That's because mergers almost always lead to an interruption in the sales force. Each sales team takes a step back to get trained on the other company's products. But customers may not be inclined to wait weeks or months for a pitch on the new broader product line. And then they are susceptible to fresh proposals from rivals.
Cross-selling has been a key factor behind Dell's (Nasdaq: DELL) recent decision to buy data storage company 3PAR (NYSE: PAR). Dell figures it can add another arrow to its quiver when pitching a broad suite of products to clients. Trouble is, if those clients already use another vendor for data storage, they are not likely to terminate all those other relationships just because Dell can now service all their needs.
3) Buying with cash vs. stock
How a deal is financed can make all the difference.
If new shares are issued to the acquired company, the buyer EPS be lower, and the deal is dilutive.need to generate even higher profits (on a percentage ) to make the deal accretive. For example, if a deal is expected to boost sales and profits by +8%, but the share count also expand by +10%, then
But if a deal is paid for with cash (not borrowed , but cash sitting on the balance sheet), then the hurdle is much lower. Dell was earning scant interest on its cash, so even if its 3PAR acquisition is underwhelming, it is still likely to generate more profits than the interest earned on the parked cash. (Though in this instance, Dell can be criticized for paying a very high price -- it probably could have found a better way to boost profits, such as with an aggressive buyback of its own stock.)
We've covered a How to Profit From Frontrunning LBOs and Tips on How to Analyze an Acquisition Announcement.of ground here on the latest buyout news. If you want to continuing learning about the exciting world of mergers, acquisitions and buyouts, check out