There are not supposed to be any true secrets in the stock market, given the laws about disclosure and against insider trading. However, there are times when information may be widely known and yet still not fully understood or appreciated. The theory tells us that all information is known and immediately reflected in stock prices, thus making the market efficient. This makes it difficult for investors to gain much of an edge, supposedly. But what about situations where a big change occurs, such as when one company buys another company, and it takes some time for the analysts who follow the stock to grasp fully the implications for the combined entity's future? This may be less of a secret ingredient and more of a special spice, the added element that provides that extra kick, something for your portfolio, rather than your taste buds, to savor.
Even novice investors understand that nice profits can accrue from owning stock in a company that is the object of an acquisition. Typically the stock of the company being bought will soar, while the stock of the company doing the acquiring may slip a bit, presumably because they are going to be shelling out a lot of money. But sometimes the company doing the acquiring is the one reaping the most benefits. Shares of Valeant Pharmaceuticals (VRX, $202) soared some 25 points (15%) Monday on the news that it had struck a deal to acquire Salix Pharmaceuticals (SLXP, $156) for $158 per share. VRX is something of a serial acquirer, with the notable acquisition of Bausch and Lomb from private equity firm Warburg Pincus PLC in 2013. VRX has stated that its goal is to become one of the top pharmaceutical companies in the world, and it plans to get there by buying other companies. Pushed by activist investor Bill Ackman, Valeant tried to buy Botox-maker Allergan (AGN, $232) last year, but lost in the bidding to Actavis (ACT, $289). Actavis today is itself the result of a combination with what was once Watson Pharmaceuticals, then known primarily for its generic drugs. What the Salix and Allergan deals have in common is that these are both specialty pharmaceutical companies with strong franchises, Salix with its gastrointestinal treatments and Allergan with Botox. Wall Street seems to like all of this, even if tracing a corporate lineage can be more complicated than figuring out the family relationships in a William Faulkner novel. Shares of Salix are up 237% over the last three years, and shares of Allergan are up 164% over that time span. But that same three years saw Valeant rise by 314% and Actavis by 400%.
As we noted in the last post here, companies can start down the acquisition trail in an attempt to reverse declining relevance. One of the more obvious areas of the economy threatened by irrelevance is the newspaper business, as people get more of their news through non-print sources. Gannett (GCI, $35), best known as the publisher of USA Today but also the owner of many other daily and weekly papers, has responded to declining ad revenue from its printed media by going on a shopping spree for television broadcast stations. General Mills (GIS, $53), known for cereals such as Cheerios, Trix, and Lucky Charms, has sought a greater presence in the healthier food category by acquiring Annie's, a maker of natural and organic foods. Tyson (TSN, $41), the major purveyor of chicken, has bought Hillshire Brands, thereby adding pork and a variety of packaged foods to its corporate menu. The Tyson situation intrigues me, because the stock is up only about 5% over the past year. Investors were spooked by the high price that Tyson had to pay for Hillshire to prevail in a bidding war against chicken rival Pilgrim's Pride (PPC, $27). We'll be watching to see whether Tyson can realize the projected cost synergies from this combination.
As for the cost savings that can result from a corporate marriage, they are not unlike what occurs in a literal marriage. When two people get married, assuming they have not already been living under the same roof, they enjoy the magic economics of reducing the expenses of two households to the cost of supporting only one. Just another of the many benefits of marital bliss. Critics will contend, though, that "cost synergy" is really a euphemism for "job loss." That can be true, but it is not necessarily the case. Valeant, for example, has said that it has no plans for any reductions in Salix's specialty sales forces, given their specialized knowledge of the company's gastrointestinal treatments. And we can only speculate as to whether the cameras would have rolled for a new Star Wars movie (to be released later this year) had Disney (DIS, $105) not bought Lucasfilm. For that matter, Captain America might be languishing in comic book limbo today had Disney not brought Marvel into the corporate fold.
That really brings us back to our main point, which is that the ultimate benefits of such corporate combinations may not be initially obvious. This is true of any major change, of course, and the outcome can be very positive or it can be a miserable failure. Such changes have a way of throwing existing assumptions and projections off of a comfortable equilibrium, and uncertainty can prevail for a time. The analysts will even tell us that their earnings models for a particular company do not include the impact of an upcoming acquisition. What we can say is that Disney is a very different company today from what is was 20 years ago, before ESPN, ABC, Pixar Animation, Marvel, and Lucasfilm. Big acquisitions are not always transformative game-changers, and that calls for careful analysis to distinguish the opportunities from the traps, to find those situations where one-plus-one might equal more than two. If we follow Emeril's command to pay attention, though, we might just get to enjoy some tasty new gumbo.
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/or I own shares of VRX, ACT, GCI, TSN, and DIS. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.
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