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all stock mergers - good or bad?


scorpioncapital
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i know Buffett don't use stock much in deals but why is that?

for example, if your stock is super overvalued and you buy something - anything - you will exchange something not worth it for something potentially much more valuable.

then, the new company, which was overvalued can become undervalued so the new incoming shareholders and the existing ones who should have been scared before of the overvaluation might now justify the high priced stock.

is the risk that finding such a new good deal, or shareholders to accept your overpriced stock is hard?

 

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The share exchange ratio is typically problematic. It has to be set the night before the announcement, and cannot reflect any of the 'drama' post announcement. The acquirer will  pay a higher premium, the seller will claim they are worth more, key shareholders may not want to sell, and the consideration is paper - not cash (all primarily agency driven).

 

In the short-term, a debt-financed acquisition boosts financial leverage on the same share count. As long as incremental cashflow can cover incremental interest cash outflow, synergies and cost capitalization will raise EPS and share price. A year later, synergies fail to deliver, and the write-offs arrive - lowering share price. Agency incentive to finance with the cheapest debt possible, extract whatever fees you can, and sell into the higher share price - if/when the share price fails, it is someone else's problem.

 

A WEB typically has too much cash. Incremental cash flow only has to exceed the interest lost on the cash used, and EPS rises sooner. Relative agency risk declines as well, as there is less involvement and greater competition for the business.

 

As with the share exchange route, market float can be bought in at any time. 

 

SD

Edited by SharperDingaan
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I think Berkshire has mostly not issued stock because the shares have mostly been fairly valued to undervalued during their history. There have been a few times they got pretty high and iirc thats when he did stock acquisitions (ie BNSF).

 

A stock acquisition can be very good for shareholders if done with overvalued paper. For example, Steve Case doing the Warner deal may have generated more value for AOL shareholders than any other corporate action ever. The value was all transferred from Time Warner shareholders.

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16 hours ago, bizaro86 said:

I think Berkshire has mostly not issued stock because the shares have mostly been fairly valued to undervalued during their history. There have been a few times they got pretty high and iirc thats when he did stock acquisitions (ie BNSF).

 

A stock acquisition can be very good for shareholders if done with overvalued paper. For example, Steve Case doing the Warner deal may have generated more value for AOL shareholders than any other corporate action ever. The value was all transferred from Time Warner shareholders.

 

Good points. A company that sells itself for 'better paper' has to depend on a somewhat less competent buyer. I presume AOL shareholders did very well getting the Warner paper but did they do well over time going forward because the entire entity of Time Warner would have been decimated by the bad decision? I guess even if AOL was a zero, getting anything was great even if it lagged or stayed flat since flat is better than zero!

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5 hours ago, scorpioncapital said:

 

Good points. A company that sells itself for 'better paper' has to depend on a somewhat less competent buyer. I presume AOL shareholders did very well getting the Warner paper but did they do well over time going forward because the entire entity of Time Warner would have been decimated by the bad decision? I guess even if AOL was a zero, getting anything was great even if it lagged or stayed flat since flat is better than zero!

I'm not saying they did well- anyone who owned AOL at the peak should have sold immediately. But AOL shareholders ended up with a lot more money than they would have otherwise had. Some of their losses got transferred to to Time Warner shareholders.

 

It seems to me that if you have very overvalued stock the best capital allocation is to sell as much of it as possible. A stock acquisition is a backdoor way of doing that.

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On 12/10/2021 at 6:42 AM, sleepydragon said:

It’s like getting re-married after you are already rich and you are not signing a prenuptial agreeement.

 

I don't know.  Prenups are not all what many think.  I didn't have a prenup and I was able to get a 70%-30% decision in my favor because I had significant 401k and IRA assets prior to my date of marriage and those assets grew enormously while married.

 

The law treated those as my "separate property" (inclusive of all the investment returns upon them).

 

The property subject to 50/50 division is "marital property", and that was basically founded on contributions to 401k and IRAs AFTER the date of marriage.  Those assets were also worth a lot more.

 

Inheritance or gifts from family are also separate property (even if they occur during the marriage).  Investment gains on inheritance/gifts also remain your separate property.

 

A prenup would have accomplished little (for my situation) in the end.  Even if you get one, she can still live off of you after you part because California courts will take pity on her and claim she needs to at least be supported to some level the court deems fair.

 

Anyways, this isn't legal advice and I'm certainly not an attorney... it's just how it pertained to me and other situations and jurisdictions are often different.

 

I believe what I've said pertains to financial assets like stocks, but if you hold real estate as separate property I think she may have a claim on 1/2 of the appreciation after date of marriage.  Perhaps a prenup can help with that.

Edited by ERICOPOLY
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I think there are often situations where value investors extrapolate their own thinking into a market situation and give themselves high probability of getting things wrong. I would say probably 99% of the time a company is doing an all stock deal its because they arent in the financial position to pay cash; and this can in some cases being an indication that the acquisition is potentially too big. Not because they have some savvy operators who ran calcs on their shares and viewed it a better route. 

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It’s all case by case. Some of the worst (AOL / TW,worst for TW) and best (1% of $FB for Instagram) are stock for stock.

 

I generally like them because I think it decreases downside if they’re occurring well above my basis. 
 

I think stock for stock accompanied by big offsetting repo’s is underutilized. 

 

 

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Like if $AAPL took out $PTON at 100% premium in stock (about $30B), would $AAPL potentially be a 1% better company in terms of adding fitness to the ecosystem, being able to potentially bring down music royalties costs, increasing % revenue that’s subscription, etc. I would say yes. I think that’d be cool. 

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My read is that would be that AAPL realizes it’s stock has gotten ahead of itself and that something like PTON isn’t worth paying cash for if they can get away with it. I think AAPL has been a great example of a company that does bolt on efficiently and just writes a check the way a college kid picks up cigs at 7/11. I’d have been annoyed if they were just giving away stock for all these little deals they’ve done when they are over capitalized and the stock cheap. 
 

But again, a multi trillion dollar titan making a rounding error sized investment would be more of an outlier situation IMO. When I think of all stock deals I generally think of O&G land or telco and real estate where some bloated body realizes they need to hoard cash, are tapped out on debt, and kind of view their stock as a “free play” token at the arcade.

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Yea good point. Maybe to use a real example and to articulate myself more clearly: Stock for stock decreases risk in the event of a bad deal, makes it less disastrous. 
 

XOM’s purchase of XTO was bad. Would have been worse if they room on $30B of debt vs $30B of stock. 

 

you can always buy back stock after you know how merger goes, and if the merger made a sense per share value will be higher  even without repo. Debt/cash funded  bad deal potentially hurts a company more. 
 

it also allows for mergers to be more about relative value than absolute. Generally I’m a dilution / stock issuance apologist, it offends me less than it does most. 
 

 

https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/how-not-to-do-m-a-a-look-back-at-exxon-s-deal-for-xto-10-years-later-55076990

Edited by thepupil
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Incentives matter too. If the management of a company is being assessed and rewarded based on revenue growth, net profit growth, the management will be more likely to undertake acquisition using shares. If the metrics that are used to evaluate performance and EBITDA/EPS, I think you will be more likely to see a debt/cash deal

Edited by Ronchong
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A company with inflated stock has to get the buyer to accept it, and the buyer will immediately discount it to between 70-85% of claimed value. Whether the deal goes through, depends on who controls the sellers stock - and what additional incentives the seller offers them. No bribes, no deal.

 

Bit different when the seller has a very small share count. The deal almost always goes through, as nobody could possibly buy up the number of incremental shares being issued - without seriously bidding up the current share price. Management doing a reverse split ahead of an acquisition (to raise the currency's value), almost always gets fired - rips off the agents take.

 

SD

 

 

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