[08/12/17] If a Company Makes a Big Acquisition, Run for the Hills

Teva, the world largest generic drug company lost since the beginning of August 43% of its value. “Cheerful” news for all Teva’s shareholders heading for the August vacation. A distressing second quarter 2017 report and clouds on the horizon (increasing generic competition and price pressure in the U.S., revenue declines and patent challenges to its leading money maker Copaxone, etc.) were the trigger for shareholders’ stampede to the doors but the slide in Teva’s stock price and fortunes started much earlier.

For several years, Teva struggled with a one-drug problem: Copaxone, an MS drug, responsible for 50% of Teva’s profits, was steadily approaching the end of its patent life. Without similar blockbusters in its pipeline, Teva started desperately to look for acquisitions to fill Copaxone’s approaching void. Several small acquisitions didn’t do the trick, so Teva looked for the big one. It came with the acquisition in July 2015 of Actavis, Allergan’s generic division, for $40.5 billion. “Through the acquisition of Actavis Generics, we are creating a new Teva with strong foundation…” said Teva’s CEO. In fact, Actavis, with its huge debt burden ($35 billion currently), was a major contributor to Teva’s downfall.

Which reminds me of another big acquisition: Hewlett-Packard, October 2011 purchase of U.K-based Autonomy (software, cloud) for $11.7 billion. Within a year, HP wrote-off (declared a total loss) of $8.8 billion of Autonomy’s value amid charges and counter charges of fraud and mismanagement. Autonomy was supposed to regenerate HP’s flagging growth. Instead, it almost brought the tech giant to its knees. The business history is replete with big acquisitions which failed to live up to their promise: Microsoft—Nokia (2014, for $7.9 billion), Google—Motorola (2011, $12.5 billion), Bank of America—Countrywide (2008, $4.1 billion), eBay—Skype (2005, $2.6 billion), Sprint—Nextel (2005, $35 billion), Kmart—Sears (2005) and, of course, the biggest flop of all: AOL—Time Warner (2000, $164 billion).

Why do big mergers so often fail, and sometimes bring down the parent company too? First and foremost, most big acquisitions are done out of desperation: the parent company’s erstwhile growth came a halt, its stock price starts declining, and the specter of a takeover looms large. Investment bankers’ and consultants’ recipe: a big acquisition to rejuvenate growth. The problem: there aren’t many good candidates for acquisitions, so you grab the first one, and often overpay for it (the premium over market price for Autonomy was 79%). Furthermore, small acquisitions are easy to “digest” and reap the benefits. With big acquisitions you get different cultures and strategies, and successfully merging operations is a huge challenge.

So, the lesson to investor is: when a company you are invested in announces a big acquisition (more than 20-25% of its value), dump the stock. Particularly so when the acquisition is promoted as rejuvenating growth and boosting share price. They rarely, if ever do.

 

(Featured Image Credits: Heavy.com. For illustration purposes only.)

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