worth the premium?

HOLT Market Commentary

Clarity is Confidence 1

Worth the Premium? A Systematic Approach for Assessing Acquisition Skill January 2015

Authors: Tom Hillman, CFA

Head HOLT Valuation & Analytics

312 345 6179 [email protected] Chris Morck

HOLT Model Specialist

312 345 6175 [email protected]

Key Insights:

Acquisitions are an important and significant use of capital and acquisitive

firms tend to underperform the market three years after a deal is announced.

The three-year spread in median excess cumulative total shareholder return

between the highest skilled acquirers and the lowest skilled acquires is

greater than 40 percent.

HOLT’s Merger & Acquisition scorecard provides investors an indicator of

past acquisition skill and is a valuable reference when a holding makes an

acquisition.

The scorecard applies a systematic approach to more than 16,000 public and

private global transactions since 1992; utilizing HOLT’s framework that

unwinds the distortions caused by acquisition accounting.

Introduction

Mergers & Acquisitions (M&A) are the largest means by which managements deploy capital1. Exhibit 1

presents a global long term view of acquisitive firm shareholder returns surrounding the acquisition. In the

three years preceding an acquisition, the median excess return of acquiring firms outperform the market by

4-6% per annum, but after a material transaction, the median firm underperforms over the next three years by

1-3% per annum. Why is there such a noticeable decline in performance?

Exhibit 1: Global Excess Shareholder Returns for Acquisitive Firms

Source: Credit Suisse HOLT M&A Scorecard. Universe: 9,972 Global Acquisitions from 1992-2010.

1 Michael Mauboussin and Dan Callahan, “Capital Allocation: Evidence, Analytical Methods, and Assessment Guidance,” Credit Suisse, August

5, 2014.

-4%

-2%

0%

2%

4%

6%

-3 yr -2 yr -1 yr DealAnnounced

+1 yr +2 yr +3 yr

Media

n 1

2 M

onth

Fw

d

Exc

ess

Retu

rns

(%)

This is market commentary and not a research document. 2

Clarity is Confidence

There are many reasons acquiring firms underperform the market after an acquisition. One important reason

is acquisition timing. M&A activity is driven by the market cycle, peaking at market highs. Allocating

significant capital and paying a control premium at a market peak can compound the pressure on the stock

price as a market cools off. In addition, companies frequently fail to achieve their growth expectations and/or

realize their synergies. A decline in CFROI® level in the years after a transaction is common.

How can investors assess the past acquisition skill of a management team? This report provides a systematic

approach for assessing the acquisition skill of frequent acquirers using the HOLT M&A Scorecard. With this

information, investors can quickly and effectively assess management’s acquisition skill and make hold or sell

decisions when a company they own announces a deal.

Using Three Dimensions to Assess Acquisition Skill

The HOLT framework allows investors to assess acquisition skill across three dimensions:

Pricing skil l measures management’s proficiency at negotiating an attractive purchase price

(minimizing the premium paid).

Operating skil l measures management’s ability to assimilate the acquired firm, which is expressed

as an improvement in operating returns generated through cost synergies and operating efficiencies.

Growth ability measures management’s ability to grow the combined firm after an acquisition, either

organically or through subsequent acquisitions.

Exhibit 2 presents the findings of this study. For each deal year2, we measure pricing skill (left axis) by

classifying acquisitions as either “Cheap” or “Expensive”. We then cross-reference the pricing skill against

both operating skill and growth ability.

We designate operating skill as “Declined” or “Improved” based on the change in operating return (measured

as the change in CFROI three years after the transaction). Likewise, growth ability classifies firms into two

groups designated as “Grew Slower” or “Grew Faster”. After we designate each acquisition into one of four

quadrants for pricing skill vs. operating skill and for pricing skill vs. growth ability, we show the median three-

year cumulative excess total shareholder return (TSR) following the announcement of the deal.

2 Deal year is defined as a material acquisition year. An acquisition is considered material when the Enterprise Value (EV) of the target is greater

than or equal to 5% of the combined acquirer and target EV at the time of announcement. Firms making smaller acquisitions that accumulate to

at least 5% EV in a given fiscal year are included as a deal year.



Exhibit 2: Global M&A Acquisition Skill Matrix

Source: Credit Suisse HOLT. Universe: 9,972 Global Deal Years from 1992-2010.

The results are quite striking; with significant relative excess TSR between the highest skilled acquirers (upper

right quadrants) and lowest skilled acquirers (lower left quadrants) of 44% and 35% respectively for each

matrix. Additionally, if a firm pays a large premium (expensive), but recoups this with operating improvements

or growth, they outperform, as observed by the lower right quadrants excess TSR of 3% and 6%,

respectively. Buying at a low premium (cheap) does not guarantee shareholder performance gains, as

subsequent declines in operating performance or slowing growth can erode those gains, as exhibited in the -

17% underperformance in both upper left quadrants.

This study was completed leveraging HOLT’s framework and the insights derived and the assessment of

acquisition skill at the company specific level can be immediately applied through interpretation of a Relative

Wealth Chart in HOLT Lens™. Exhibit 3 presents the three panels of the Relative Wealth Chart along with

annotation of the three dimensions of acquisition skill used in this study.

Cheap

-17% 15%

Cheap

-17% 10%E

xpensiv

e

-29% 3%

Exp

ensiv

e

-25% 6%

Declined Improved Grew Slower Grew Faster

How did CFROI levels change? Did the firm keep growing?

Quadrants defined by 50th Percent i le of factor on a Sector relat ive basis. (Table 1)

Median 3 year Post Acquisition Excess Total Shareholder ReturnP

ric

ing

Sk

ill:

Ho

w m

uch p

rem

ium

was p

aid

?

Operat ing Skill Growth Ability



Three Dimensions of Acquisition Skill using HOLT’s Relative Wealth Chart

Exhibit 3: HOLT Relative Wealth Chart for General Dynamics Corp.

The top panel illustrates the firm’s

historical CFROI operating levels

(dark blue bars) and Transaction

CFROI levels with goodwill included

(light blue bars). The forecast

includes three data points; FY1 and

FY2 forecast CFROI levels (pink

bars), HOLT’s empirical fade pattern

of future CFROI levels (black line),

and the market implied CFROI levels

(green dot).

The market implied CFROI levels

are derived by solving for the future

forecast CFROI levels needed to

justify the current stock price. A

target’s take out price can be used

to solve for synergy expectations.

The middle panel presents asset

growth of operating assets (dark

pink bars). Asset growth including

goodwill (light pink bars) indicates

significant acquisition years.

The third panel presents the firm’s

TSR relative to its local index.

Source: Credit Suisse HOLT Lens™, Data Date: November 2014

The three acquisition skill factors listed below are annotated in Exhibit 3 for General Dynamics’ 2003

acquisitions of General Motors Defense and Veridan Corporation.

1. Pricing Skill: Change in Transaction CFROI3 level in year acquisition is complete.

2. Operating Skill: Change in operating CFROI 3 years post transaction.

3. Growth Ability: Average real asset growth 3 year pre versus 3 year post acquisition.

General Dynamics was very acquisitive from 1995 through 2009 as indicated by the frequency of asset

growth with intangibles in the middle panel. The large spread between the operating CFROI and the

Transaction CFROI indicatives a significant amount of goodwill on their books, but the change in Transaction

CFROI levels in the year of acquisitions are minimal, indicating good pricing skill. Operating CFROI levels

3 Transaction CFROI represents an approximation for the CFROI inclusive of goodwill. It’s measured by multiplying the operating

CFROI by the ratio of operating assets to operating assets plus goodwill. Large spreads between the CFROI and the Transaction

CFROI means significant amounts of goodwill was created from acquisitions. For further understanding see Samuel Eddins, Bartley

Madden and Thomas Hillman, “Acquisition Goodwill”, HOLT Value Associates LP, May 15, 2000.



have generally been stable and upward trending over the acquisition period, exhibiting good operating skill.

The firm’s growth rate has been fairly consistent, exhibiting strong growth ability.

General Dynamics is an excellent case study on capital deployment4. The financially distressed firm was

transformed by divesting low return, non-core businesses and focusing on improving operations in the early

90s. Once the financial health of the firm had been restored, the focus turned to growing via acquisitions.

This strategy created significant shareholder value as exhibited in the third panel of the Relative Wealth Chart.

General Dynamics’ rank as a highly skilled acquirer in HOLT’s M&A scorecard in Exhibit 4. Given past

performance investors will likely have confidence in the firm’s ability to execute future deals.

HOLT M&A Scorecard

Using the three dimensions pricing skill, operating skill and growth ability, the M&A Scorecard is constructed

by ranking for each deal year the three acquisition skill dimensions on a sector relative basis across the global

M&A database. The ranks (100 highest to 0 lowest) for each deal year for a given firm are then deal size

Enterprise Value weighted to derive the company specific acquisition score. Exhibit 4 provides the results for

the most acquisitive firms with market capitalization over $15B USD. This score provides investors an

indicator of past acquisition skill and is a valuable reference when a holding makes an acquisition.

Exhibit 4: HOLT’s M&A Scorecard

Source: HOLT M&A Scorecard; firms with market capitalization > $15B, with > 4 material deal years and total EV acquired >70%. Material deals defined as target at least 5% EV of overall firm. M&A Scorecard methodology: Deal years are EV weighted and sector relative ranked across operating, growth, and pricing skill. Note

4 William N. Thorndike, Jr., The Outsiders: Eight Unconventional CEO’s and Their Radically Rational Blueprint for Success, (Boston, MA:

Harvard Business Review Press, 2012).

Universe: Filter: Filter: Weight: Weight: Weight: Sum: Percentile:

Global Firms > $15B >4 > 70% 40% (a) 40% (b) 20% (c) (a)+(b)+(c) Global Relative

Name Sector Country

Total # of

Deals

# Material

Acquisition

Deal Years

Sum of Acquired

EV (%) In Material

Deal Years

Operating

Skill Score

Growth

Ability Score

Pricing Skill

Score

Sector

Relative

Acquisition

Skill Score

Universe

Relative

Acquisition Skill

Percentile

ASSA ABLOY AB Industrials SWE 86 5 77% 77.7 65.5 62.5 69.8 93

GENERAL DYNAMICS CORP Industrials USA 63 9 141% 57.1 76.1 58.3 64.9 87

CENTRICA PLC Utilities GBR 74 5 86% 56.3 65.4 61.2 60.9 85

THERMO FISHER SCIENTIFIC INC Health Care USA 139 10 153% 71.8 61.5 55.3 64.4 83

PRECISION CASTPARTS CORP Industrials USA 52 6 121% 75.3 60.5 37.8 61.9 82

ABERTIS INFRAESTRUCTURAS Industrials ESP 23 5 106% 52.2 67.5 55.0 58.9 76

CRH PLC Materials IRL 304 8 85% 61.6 58.5 61.3 60.3 75

CVS CAREMARK CORP Staples USA 20 6 153% 53.1 65.3 55.9 58.6 74

BAE SYSTEMS PLC Industrials GBR 52 6 150% 77.2 48.4 40.1 58.3 74

CARDINAL HEALTH INC Health Care USA 66 5 85% 62.9 55.1 58.9 59.0 71

ROPER INDUSTRIES INC/DE Industrials USA 58 8 94% 73.9 46.8 44.7 57.2 71

SYMANTEC CORP IT USA 59 9 191% 76.6 48.7 38.7 57.8 69

EATON CORP PLC Industrials USA 71 7 77% 49.2 58.8 66.5 56.5 69

NATIONAL OILWELL VARCO INC Energy USA 54 7 119% 61.1 58.7 46.8 57.3 68

VALERO ENERGY CORP Energy USA 16 6 150% 49.2 54.0 79.5 57.2 67

SCHNEIDER ELECTRIC SA Industrials FRA 93 7 115% 46.7 59.2 58.1 54.0 62

PUBLICIS GROUPE SA Discretionary FRA 181 5 105% 52.9 63.3 35.8 53.6 61

HUMANA INC Health Care USA 38 7 122% 55.9 56.1 44.8 53.8 59

AT&T INC Telecom Services USA 45 5 129% 48.0 50.6 57.4 50.9 59

VIVENDI SA Telecom Services FRA 155 7 126% 48.3 44.2 66.9 50.4 56

NORTHROP GRUMMAN CORP Industrials USA 31 5 153% 42.0 52.0 69.5 51.5 56

DANAHER CORP Industrials USA 130 8 88% 41.0 61.1 49.9 50.8 54

TEVA PHARMACEUTICAL Health Care ISR 27 6 93% 42.7 56.8 60.4 51.9 54

EXPRESS SCRIPTS HOLDING CO Health Care USA 12 6 90% 67.0 49.7 25.2 51.7 53

CONSTELLATION BRANDS Staples USA 21 7 122% 48.7 50.0 52.9 50.0 52

CANADIAN NATURAL RESOURCES Energy CAN 12 5 93% 65.7 32.0 51.8 49.4 50

DEVON ENERGY CORP Energy USA 12 7 226% 63.3 33.5 46.6 48.0 46

RWE AG Utilities DEU 68 6 172% 45.3 39.0 72.5 48.2 44

INTUIT INC IT USA 44 5 76% 54.5 38.7 36.0 44.5 39

TYCO INTERNATIONAL LTD Industrials USA 171 6 166% 31.7 43.4 66.1 43.2 36

BANK OF AMERICA CORP Financials USA 70 8 172% 38.2 55.8 34.8 44.6 35

ST JUDE MEDICAL INC Health Care USA 22 6 89% 32.7 64.7 21.9 43.3 31

UNITEDHEALTH GROUP INC Health Care USA 100 7 72% 46.0 43.8 25.7 41.0 26

BOSTON SCIENTIFIC CORP Health Care USA 45 6 147% 39.4 41.4 11.4 34.6 17



With these insights in mind, the remainder of this report provides detail on how the acquisition dimensions are

measured and provides sector level observations.

Pricing Skill

Measuring Pricing Skill – What premium did they pay?

The price paid to acquire represents the market value of the target, anticipated synergies or new growth, plus

the premium needed for the target’s shareholders to agree to sell the firm. The acquiring firm’s goal is to

create additional value above the anticipated synergies and growth. The lower the acquisition price paid, the

lower the hurdle to create value from the acquisition.

Change in Transaction CFROI is used to measure the pricing skill of acquirers in the study5. Transaction

CFROI is a return on capital measure with goodwill included in the invested capital. Transaction CFROI

captures the magnitude of goodwill paid relative to the operating assets and cash flows acquired. Pricing skill

is measured as the Transaction CFROI pre-merger compared to Transaction CFROI in the year of the

merger. A declining (increasing) Transaction CFROI means the price paid relative to operating cash flow and

operating assets acquired was expensive (cheap). Transaction CFROI is also influenced by the quality of the

target (high versus low CFROI levels) and the method of payment. This return on capital approach offers an

advantage over some traditional metrics, such as earnings, by including monies spent to make acquisitions.

To assess pricing skill, acquirers deal years are divided into quartiles on a sector relative basis using the one

year change in Transaction CFROI. Within each quartile, the median three year cumulative excess total

shareholder return, starting one month prior to the acquisition announcement, is observed. These results are

shown in Exhibit 5.

Firms in quartile 1 (left) have the most significant decline in Transaction CFROI level and underperformed the

market by 17%. As the change in Transaction CFROI becomes less negative (moving right), there is a

monotonic improvement in excess TSR, providing evidence the price paid for acquisitions matter. Table 1

provides the sector median change in Transaction CFROI and can be used as a guide for investors when

assessing pricing skill for past transactions.

Exhibit 5: Pricing Skill - Change in Transaction CFROI, 3 year forward TSR

Source: Credit Suisse HOLT M&A Scorecard. Universe: 9,972 Global Deal Years from 1992-2010.

5 In a prior study, pricing skill was measured using HOLT’s intrinsic valuation versus market implied CFROI based upon take-out price.

Although the results are similar using either method, the previous method was only applicable to public targets. Using Transaction

CFROI expands the number of acquisitions studied from approximately 2,500 to over 16,000 by including private targets. See

Tom Hillman and Chris Morck, “Using HOLT Framework to Assess Acquisition Skill”, Credit Suisse HOLT, May 2012.

-17.0% -7.4% -5.6%

1.1%

-50%

-30%

-10%

10%

30%

50%

Quartile 1

(most negative

change)

Quartile 2 Quartile 3 Quartile 4

Me

dia

n 3

yr

Po

st

Acq

uis

itio

n

TS

R

Change in Transaction CFROI



Premiums Viewed Through Reverse DCF Analysis

An alternative way to analyze premiums paid is using a reverse DCF analysis. The HOLT framework can be

used to back out the future CFROI expectations embedded in a target’s take-out price. These expectations

can be translated into the amount of synergies and/or growth needed to recoup the premium.

Precision Castparts’ December 2003 acquisition of SPS Technologies is used as an example. Precision

Castparts is a highly skilled acquirer, receiving particularly high scores in both operating skill and growth

ability, but a lower score on pricing skill as measured in the M&A Scorecard.

Exhibit 6: SPS Technologies Relative Wealth Chart, Dec 2003

Exhibit 6 provides SPS Technologies’

market implied CFROI level of 9.8% as of

the close (green dot). This market implied

level is 100bps higher than the average

market implied CFROI levels three months

prior to the August 2003 acquisition

announcement. Additional synergy cash

flow of $19M over the forecast period is

needed to recoup the premium, and is well

within management’s stated ultimate

synergy goal of $30-35M6.

Source: HOLT Lens™, Data Date: November 2014.

An aggregate of all the public targets in HOLT’s database is presented in Exhibit 7. Historically the median

target earns CFROI levels around 7%, but is forecasted to improve CFROI levels to nearly 7.8% (pink bars).

Based upon the take-out price, the median market implied CFROI (green dot) is 8.6%, representing a

140bps spread over the last achieved historic CFROI level. This improvement in CFROI is needed to equate

to fair value of the target.

Exhibit 7: Aggregate Return on Capital and Synergy Expectations for Public Targets

Source: Credit Suisse HOLT. Universe: 2,439 Global Public Targets ex-financials from 1992-2010.

6 Source: HOLT Database. The $19M was solved by comparing the cumulative differences in gross cash flow over the forecast period using the pre-announced market implied CFROI level of 8.8% versus the 9.8% market implied at close. An alternative approach using HOLT’s empirical

fade level (black line) versus the market implied at close will additionally capture any intrinsic value mis-pricing along with the premium paid.

0

2

4

6

8

10

-3 yr -2 yr -1 yr Deal

Announced

Forecast

Targ

et

CFR

OI

Target CFROI Forecast CFROI Market Implied CFROI (at Deal Close)



Separating the Target Aggregate by sector reveals more insights into synergy expectations as presented in

Exhibit 8. The All Ex Financials aggregate shown in Exhibit 7 is condensed and presented on the left followed

by the sector aggregates, sorted by the spread between the last achieved CFROI and the market implied

CFROI.

Exhibit 8: Sector Based Aggregate Return on Capital and Synergy Expectations for Public Targets

Source: Credit Suisse HOLT. Universe: 2,439 Global Public Targets from 1992-2010. Note Financials are based on CFROE.

Financials and Telecom stand out as the sectors with the largest spread, suggesting significant synergies are

needed to recoup the parent’s shareholders transfer of wealth. For financials, the high synergies expectations

are not achieved and post transaction return on equity levels fall 110 bps as presented later in Exhibit 10.

Telecom accrues synergies, but only slightly positive improvements.

Premiums are nearly always paid for transactions, but how good are managers at recouping them? Focusing

on post-transaction achieved operating results provide insights to this question.

Operating Skill

Characteristics of Acquired Firms

What observations can we make about operating performance for acquirers and targets?

Exhibit 9 plots the sector median CFROI level of the acquirers and targets the year before an acquisition.

Focusing on All firms ex-financials universe (left), the median CFROI of target firms are 270 bps less than the

acquirers. One clear observation is that targets generally have lower CFROI levels than their suitors. This

can be interpreted as higher quality firms buying lower quality firms. Another explanation is targets tend to be

smaller firms, which generally have lower CFROI levels.

0

2

4

6

8

10

12

14

All ExFinancials

Financials Telcom Materials HealthCare

ConsStaples

Utilities Info Tech Industrials Cons Disc Energy

CFR

OI

CFROI CFROI Forecast CFROI Market Implied at Close



Exhibit 9: Sector Based CFROI Levels for Acquirers and Targets

Source: Credit Suisse HOLT. Universe: 2,439 Global Public Targets from 1992-2010. Note Financials are based on CFROE.

R&D intensive sectors have the largest spread between the acquirer and target CFROI levels; this can be

partly explained by the acquisition of low return early lifecycle firms (e.g. internet start-ups and biotech).

Consumer Staples and Utility firms show the smallest delta, buying targets that are similar in quality and likely

acquiring to benefit from cost cutting or gaining scale. If higher quality firms are buying lower quality firms,

what level of integration and synergy are being achieved?

Exhibit 10 provides evidence that synergies are not achieved. The three bars plotted for each sector tell the

story. First bar represents CFROI level with acquirer and target merged together. Getting to a clean starting

point is difficult; given that acquisition accounting riddles the financial statements with distortions. HOLT’s

CFROI cleans up for these issues to measure clean operating rates of return (see appendix for further

details). Shown next are forecast CFROI level driven by consensus IBES earnings. Analysts appear

optimistic as the forecast CFROI levels are expected to improve across all the sectors. The third bar is the

achieved CFROI results three years post-transaction, showing a decline across nearly all sectors.

Exhibit 10: Achieved CFROI Post-Transaction

Source: Credit Suisse HOLT. Universe: 9,972 Global Public Targets from 1992-2010.

0

2

4

6

8

10

12

All ExFinancials

Info Tech HealthCare

Energy Financials Industrials Materials Cons Disc Telcom Utilities ConsStaples

CF

RO

I P

re-A

cquis

ition

Acquirer CFROI Pre-Acquisition Target CFROI Pre-Acquisition

0

2

4

6

8

10

12

14

All ExFinancials

IT Financials Cons Disc Materials Industrials HealthCare

Energy ConsStaples

Telcom Utilities

CFR

OI

Merged CFROI First Forecast CFROI CFROI 3 years post



One of the challenges with analysing M&A is the nature of competitive firm dynamics. Operating performance

is impacted by many items, including adoption of new strategies, competition, business cycles, or making

additional acquisitions. All of these activities make isolating the change in CFROI that is specific to M&A very

challenging. The decline in CFROI across most sectors may be caused by any of these additional factors, but

it is clear these acquisitive firms are either not achieving their anticipated synergies and/or not resisting fade in

their overall business.

In a separate analysis of 900 acquisitive US firms with data available in both HOLT’s M&A and governance

databases, we observed that only 10% have a history of including acquisition based performance metrics in

their executive compensation. Examples of these performance metrics include acquisition of strategic assets,

successful acquisitions, successful integration, cost savings, and capture of synergies. Perhaps if more

CEO’s had post-acquisition integration incentives, the success rates of acquisitions would be higher.

The next section will review how important improving post-transaction operations are to creating shareholder

value.

Measuring Operating Skill – How did CFROI levels change?

Examining change in CFROI offers insight into which acquisitive firms are best able to resist fade and achieve

anticipated synergies. Operating skill seeks to measure management’s ability to assimilate the acquired firm

and improve operating returns via synergies, operating efficiencies and growth in cash flows.

To assess operating skill, the difference between the first merged CFROI and the achieved return three years

later is measured and divided into quartiles on a sector relative basis as presented in Exhibit 11. Within each

quartile, the median three year cumulative excess total shareholder return starting one month prior to the

acquisition announcement is observed.

Exhibit 11: Operating Skill - Achieved 3 Year Change in CFROI; 3 Year Post Acquisition TSR


Firms in quartile 1 CFROI levels deteriorated the most and the median excess TSR for this group is -36%. As

the change in CFROI turns positive, the firms in quartile 4 exhibit positive excess TSR of 18%. While a direct

link between the acquisition and the change in CFROI cannot explicitly be made, one of the insights for

investors is the importance of owning acquisitive companies who have a track record achieving synergies post

transaction. Improving CFROI levels post-transaction is a strong indicator of this. Table 1 provides the

median 3 year change in CFROI level.

Not only can premiums be recouped through synergies, but growth can also be used to recoup premiums and

create new wealth.

-36%

-10%

2%

18%

-50%

-25%

0%

25%

50%

Quartile 1 Quartile 2 Quartile 3 Quartile 4

Med

ian 3

yr

Po

st

Acq

uis

itio

n T

SR

3 Year CFROI Change



Growth Ability

Aggregate Growth

Growth ability relates to management’s ability to grow the combined firm after making an acquisition. Exhibit

12 provides the median real asset growth rate in the three years pre-acquisition, the year of consolidation, and

the year three years post-acquisition. Preceding the acquisition, growth was 8-10% and accelerating. After

the acquisition, two observations can be made; the level of growth is lower and decelerating, which is not

surprising given a focus on integration.

Exhibit 12: Aggregate Real Asset Growth Before and After Acquisitions

Source: Credit Suisse HOLT. Universe: 9,972 Global Deal Years from 1992-2010.

Maksimovic, Phillips and Prabhala find a large amount of restructuring is done after acquisitions and examined

plant-level data for manufacturing firms. They found that 27% of plants acquired are sold and another 19%

are closed within three years of the acquisition7. While this study was limited to manufacturing firms, the

restructuring most likely occurs in other industry groups. Acquisitions of whole entities means management

teams are deploying capital into assets that may not be core or that are duplicative in nature and may eventual

sell off or shutting down these assets.

Measuring Growth Ability – Did the firm keep growing?

One of the most interesting observations is that firms that continue to grow after an acquisition tend to

outperform. Growth Ability was measured as the difference between the three year average real asset growth

before and after a material deal year. A positive spread indicating the firm is growing at a faster pace than

before an acquisition.

The results of the growth ability study are presented in Exhibit 13. Growth Ability is divided into quartiles on a

sector relative basis and then the median cumulative excess three year relative total shareholder return

observed. Firms in the first quartile that grew slower underperformed by -32%. A strong monotonic

relationship exists as firms who grew faster exhibit higher excess return, with a return of 16%. Table 1

provides the sector change in three year average real asset growth rate.

7 Vojislav Maksimovic, Gordon Phillips and N.R. Prabhala, “Post Merger Restructuring and the Boundaries of the Firm” SSRN Working

Paper, August 1, 2008.

0

5

10

15

20

-3 yr -2 yr -1 yr Merged +1 yr +2 yr +3 yr

Real A

sset G

row

th (

%)



Exhibit 13: Growth Ability - Achieved Change in Asset Growth, 3 Year Forward TSR


In addition to divestment of non-core or duplicative assets, another explanation for slowing growth rates may

be due to a firm’s position in the corporate life cycle. Maturing firms starved for growth may make large

transactions that take time to digest and are primarily meant to scale production and lower costs. While firms

in their growth phase may acquire to complete product offerings, grow into new areas or are serial acquires.

Despite the challenges of maintaining growth, firms showing the ability to continue growing are more likely to

outperform the market.

Conclusion Capital allocation is one of the most important responsibilities of firm management and M&A is the area where

the largest amount of capital is deployed. Management’s goal in acquiring is to create additional shareholder

value, but acquisitive firms tend to underperform the market for three years after deal announcements. HOLT

has developed a systematic approach to critique management’s acquisition skill along three dimensions;

pricing skill, operating skill and growth ability. Insights from the HOLT framework can be used by investors to

help them decided when to hold or sell a firm after an acquisition announcement.

Use HOLT Lens™ to assess acquisition skill:

Review HOLT’s Relative Wealth Chart:

1. Is the firm a frequent acquirer? Asset growth with intangibles provides evidence of frequency and

magnitude of transactions.

2. Pricing Skill: How much premium was paid? Firms with small decline or small increase in

Transaction CFROI levels indicate good pricing skill.

3. Operating Skill: How did CFROI levels change? Stable or increasing CFROI levels post-

transaction indicate execution on synergies or new profitable growth opportunities are being found,

indicating good operating skill.

4. Growth Ability: Did the firm keep growing? Continual reinvestment as evidenced in real asset

growth rates indicates good growth ability.

More advanced assessments can be achieved by:

A systematic review of companies using HOLT’s M&A Scorecard (available upon request).

Access HOLT’s M&A database in Lens to view public targets relative wealth chart at take-out-price

and to quantify market implied expectations.

View pro-forma firms for major announced transactions to see the dilutive impact of a target and

combined market expectations.

Screen in Lens™ on 3 and 5 year average organic growth rates.

-32%

-11%

0%

16%

-50%

-25%

0%

25%

50%

Quintile 1 Quintile 2 Quintile 3 Quintile 4Med

ian 3

Year

Po

st

Acq

uis

itio

n

TS

R

3 Year Average Growth Rate Pre - Post Merger



Table 1: Sector Median Acquisition Skill Factors

Pricing Skill Operating Skill Growth Ability

One Year Change in Transaction

CFROI

Change in CFROI 3 Years Post

Acquisition

Change in 3 Yr.

Average Real Asset Growth Pre

and Post

Acquisition

Consumer Disc.

-0.5 -0.6 -0.6

Consumer Staples

-0.5 0.1 0.1

Energy

-0.5 -0.3 -0.3

Financials

-0.6 -0.8 -0.8

Health Care

-0.5 -0.4 -0.4

Industrials

-0.4 -0.4 -0.4

Information Technology

-0.5 -2.2 -2.2

Materials

-0.2 -0.4 -0.4

Telecommunication Services -0.3 -0.1 -0.1

Util i ties -0.2 0.2 0.2 Source: Credit Suisse HOLT M&A Scorecard. Universe: 9,126 Global Deal Years from 1992-2010. Sorted: alphabetical.

This table provides the 50th percentile (median) level of each acquisition skill factor presented in Exhibits 5, 11

and 13. For example, in Consumer Discretionary the median change in Transaction CFROI is negative 50

bps, meaning acquirers with drops in Transaction CFROI greater than negative 50 bps exhibit poor pricing

skill. For operating skill the median three year change in CFROI level is negative 60 bps and for growth ability

the median change in average real asset growth rates is negative 60 bps post acquisition. These data points

are a useful reference for investors analyzing acquisitions in HOLT Lens™.



Appendix

Measuring Clean Operating Economic Rates of Return Acquisition accounting riddles the financial statements with distortions that take years to unwind, making track

records less reliable. For firms that continually acquire the problem is compounding and unending.

It was sorry day in 2001 when the US accounting boards adopted the distortion causing purchase accounting

rules. For example, assume two firms that have similar track records of earning steady 20% CFROI levels

merge in an all-stock transaction. Merged Operating CFROI levels will be around 20%, but only if adjusted to

remove acquisition distortions.

As an example, Inbev acquired Anheuser-Busch in November of 2008. With the late year acquisition, 10

months of income are missing from Inbev’s 2008 income statement, making traditional metrics hard to use. As

seen in Exhibit 14, RONA declines from 17% to 5%, while the cleaned-up CFROI metric remains relatively

stable, reflecting the dilution of Anheuser-Busch lower CFROI level of 11%.

Exhibit 14: Inbev Acquisition of Anheuser-Busch

Source: Credit Suisse HOLT

The HOLT framework unwinds the distortions caused by acquisition accounting to get back to pooling

accounting and has made over 40,000 adjustments8. The major adjustments include.

Gross Plant Recaptured – restated the plant account back to historic cost.

Missing Cash Flow – capture missing cash flows prior to the acquisition close date. Purchase

accounting only requires recording the income statement effect from the acquisition date forward. For

late year closes, this can be a significant adjustment.

Missing Rent Expense – captures full year of rental expense to capitalize all off-balance sheet leases.

Missing Sales – captures sales prior to acquisition date to measure organic growth rates.

Acquired R&D – captures the historic R&D expenditures of the acquired firm.

8 Tom Hillman, Chris Morck, and Dave Larson, “Removing Acquisition Distortions and Measuring Organic Sales Growth”, Credit Suisse,

February 2014.

Exhibit 12: Inbev CFROI versus RONA



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