How investors can play the mergers and acquisitions game
Mergers and acquisitions can produce a beautiful marriage or a disaster, says an expert on small cap stocks who looks at the good and the bad.
Sometimes they’re like kids who just got a raise in their allowances.
Give some companies enough money to play with and they can’t wait to buy another company.
Only it’s the wrong company. The marriage fails, to the detriment of all concerned. Shareholders grumble.
Other companies are like the kid who stays in to do his homework.
They think it through, make the right acquisition and multiply the value of their firm. Shareholders cheer.
The smaller the company, the bigger the risk. And one of America’s leading experts on small cap stocks, Mr. Max Bowser, points to an acquisition he thinks will work out just fine.
In the latest issue of The Bowser Report, he also tells his readers about an acquisition that failed. “Buying another company is not always the path to happiness and glory,” he observes.
Fitting neatly
Cover-All Technologies (NASDQ-COVR), as it name implies, creates web-based management technology for the property and casualty insurance business.
A month ago, its CEO, Mr. John Roblin, announced the acquisition of Moore Stephens Business Solutions LLC, a privately held company that provides “business intelligence and analysis” to the insurance industry.
Right off the bat, the acquisition seems to make perfect sense. One firm is bringing in another that works in the same business and fits neatly into what it already does, like the right drill bit.
Mr. Bowser concurs and outlines the highlights of the acquisition.
Cover-All acquired all of Moore Stephens’ assets for $2,450,000, with no debt assumed for the purchase.
95 per cent of the purchase was in cash and a promissory note, with 4 per cent in Cover-All stock.
The new acquisition is expected to start contributing to Cover-All’s 2010 earnings right away. In the past 12 months, Moore Stephens generated $6 million in revenue.
Together, the new organization will have 55 customers in the industry, “all of them part of the same target market.”
Finally, the CEO of Moore Stephens, Mr. Seth Rachlin, comes on board as head of the Business Intelligence unit. In short, the expertise the new firm brings to the marriage will carry on under the same management.
Some great companies
This may not be a momentous event on the business map of North America. Suncor and Petro-Canada it ain’t. But Mr. Roblin seems to have every reason for confidence when he states that his company “has reached the point where we are ready for break-out growth.”
The stock rose following the announcement, going from less than $1.25 to $1.75. Like most stocks, it has retreated in the past week, to $1.55. There is no dividend. But there does appear to be a bright future.
“Some great companies have been built on mergers,” says Mr. Bowser. “John Chambers’ Cisco Systems comes to mind.”
But other companies get worse, not better, when they plunk down the money to buy another firm.
The worst part of a deal
Mr. Bowser recently learned that a company he recommended in 2001 was pulling itself out from under a failed acquisition.
In 2004, Wireless Telecom (AMEX-WTT) bought privately held English firm Willteck Communications for $7 million in cash and 8,000 shares of Wireless stock.
Both firms were in the same field, and the deal was expected to double the size of Wireless. Sure enough, sales more than doubled, from $22 million to $50 million. But earnings never caught up.
By last year, Wireless was reporting a loss. A year ago, Mr. Bowser suggested the shares be sold.
In its fourth-quarter report, Wireless called Willteck a discontinued operation with a loss of almost $4 million. Wireless’ other operations did earn $2.2 million, however. Now it is selling off Willteck to another private firm for $2.75 million and the assumption of certain liabilities.
Wireless, as high as $1.78 in the past year, now trades at $0.86.
Mr. Bowser is in no doubt about the worst part of this deal — the eight million shares that were issued to complete it.
“Not only were the 2004 shareholders’ earnings diluted, but now the company is stuck with a bigger capitalization than it needs.”
This brings him back to the Cover-All deal. Mr. Robin and his staff “have carefully crafted the terms of this deal.” It was done almost entirely with cash and promissory notes, with only a “smidgen of stock” involved.
“We cringe when a small company enters into an all-stock acquisition.”
In balance, Mr. Bowser has nothing against the principle of small companies making acquisitions. “Only if all such mergers were failures would they go out of favor.”
But in the end, whether a company is big or small, the success of mergers and acquisitions really gets down to one thing. Management.
Is it spending the shareholders’ money wisely with a clear plan in mind? Is it buying a company it understands, in its own field of expertise?
Or, like the frog in Aesop’s fable that tried to puff itself up to the size of an ox, has it just bloated itself to the point of bursting?
To prosper in the mergers and acquisitions game, make sure you’re playing with the right team.
A long weekend is here, just in the nick of time for weary investors, no doubt. Enjoy it and we return on Tuesday.
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