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Why CEO's pay so much for deals?


LongHaul
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I have never been an M&A banker and have trouble understanding the psychology or mindset of CEO's that go out and pay a huge price for deals.  I think I read about 80% of deals destroy shareholder value (for the acquiring shareholders).

Any war stories or experiences that could explain the behavior would be most appreciated. 

 

One quick one a friend told me is of investment bankers auctioning off a company.  The funny thing was there was only 1 bidder and the bidder kept upping the price vs his fake opponent!

 

 

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In my experience, working with a very acquisitive company, inorganic growth was much easier to get than organic growth. Buy vs make. There are lots of reasons, perverse incentives, egos, other people's money etc that can be cited as reasons. But one thing stood out for me, the guy who put the deal together was required to write a white paper that justified the deal, showing 1,2,3 year payback.  But guess what, not one, I mean not even one of those hotshot deal makers (the fast trackers) stayed in the position for even a year. It was on their resume that they did the deal which got them their next gig for sure and in most cases, someone after them had to deal with the carcass. The white paper always overstated the benefit and understated the ease of integration or cost of pulling off the deal, my choice of the word carcass is appropriate.Of course they overpaid for the deals, the investment bankers worked for the seller and their fees based on the size. Also, many of the deals had a lemon like quality to them, almost always, they pulled in orders during the due diligence etc. Why wouldn't they? It was sickening to see this, deal after deal. How about that white paper 3 years after the deal? Who cares? There was always someone else to blame for the botched integration.

 

Munger is right, they teach the wrong things in biz schools and M&A is surely one of them.

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What is amazing to me is how bad they are on the timing which would resolve 90+% of the bad deal issue for the acquiring company.

 

They never seem to buy stocks that are down or when a sector is down. They always seem to buy after the stock or the sector has almost fully recovered. Sometimes their own stock is doing relatively well and they won't even think of using their stock as a currency to buy a beaten down peer. It is almost like they are afraid to suffer a similar fate upon announcing such acquisition.

 

I think that is just it, they simply don't want to do anything controversial. The majority have gone up through the corporate ladder trying to please everybody and not making too many waves. So when it becomes time to do something uncomfortable or that may be interpreted negatively even if all the mathematical evidence suggests otherwise they won't act.

 

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Deals are fun. And if you want to do a deal, you usually have to pay up. Even Buffett can't help himself sometimes.

 

Go and start a business, then form a JV with or acquire one of your competitors. Or even just negotiate terms with a competitor. Then you'll understand the thrill of the deal.

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I was previously an M&A banker so I have a few thoughts on this.

 

1. EPS accretion "myth" is the cornerstone of much public company analysis, with the E in EPS often heavily adjusted to remove all "bad" things (non-cash PPA, restructuring, deal expenses, etc.)

2. Non-fundamental "valuation" methods drive price negotiation, e.g. multiples of precedent transactions or even "precedent premia paid".

3. Aggressive forecasts and aggressive synergies forecasts.

4. Investment bankers paid on success fee basis and other consultants generally incentivized to generate future business on integration (management consultants, tax, etc.). Corporate development team needs to justify existence and budget.

5. So many psychological factors that relate to the above... falling in love with the deal "if we don't buy this now we'll never get it" / sunk costs, overoptimism, high self-regard, social proof justification of M&A during hot markets, competitive spirit in auctions / avoidance of "loss", poor incentives (growth, levered metrics), inconsistency avoidance resulting in denial of negative data as diligence goes on and on.

6. Complicit boards.

 

At the end of the day the CEO needs to be a) comfortable with their job and focused on the long-term, b) experienced in M&A so they can identify the problems and c) incentivized properly or else all of the above factors will encourage action over inaction and delude them. I have honestly heard of several occasions where the company tells the bankers to put away their spreadsheets. M&A suffers many of the same psychological challenges of investing but many multiples worse and limited liquidity to change your mind.

 

Horrible business so glad I am out.

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