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What does growth by acquisition mean, and what are the risks?


Investors often under-estimate the hidden risks of company that acquires growth by acquisition.

A growth by acquisition strategy is inherently risky. It’s a little like buying new stock issues.

These acquisitions generally come on the market when it’s a good time to sell. That may not be, and often isn’t, a good time to buy. Insiders and managers at the selling company know a lot more than the buyers about the company itself, and its business strengths and weaknesses.

Some takeovers work out well for the buyers, of course. This doesn’t diminish the inherent risk. More important, risk multiplies as takeovers become a habit.

Takeovers are more likely to succeed when the buyer is already a successful company and is under no pressure to buy anything. That way, the buyer can take its time and wait for a truly attractive, low-risk opportunity to come along.

Alimentation Couche-Tard, our 2012 stock of the year in Stock Pickers Digest, has been careful not to overpay just for the sake of growth. For example, in late 2010, it dropped its $2-billion U.S. hostile takeover offer for Casey’s General Stores after competitor 7-Eleven outbid it.

Since then, though, it has done very well by using a growth by acquisition strategy. This includes the successful integration of its 2012 purchase of Norway’s Statoil Fuel & Retail gas station chain for $2.7 billion, and the March 2015 purchase of The Pantry and its 1,500 convenience stores in 13 southern U.S. states for $1.7 billion. More recently it bought 279 of the Esso gas stations still owned by Imperial Oil. It is currently pursuing another major convenience store chain CST Brands.

Alimentation Couche-Tard’s shares have climbed tremendously since our 2012 recommendation, but we continue to see the stock as a buy.

If a takeover starts to falter, well-managed companies are likely to cut their losses while there is still some value to salvage.

For example, eBay Inc. sold its Enterprise division to a group of private investors for $925 million. It bought the division for $2.4 billion in June 2011. At that time, the division operated under the name GSI Commerce. Prior to that, it was Global Sports Inc.

eBay shareholders forgave eBay for the $1.475 billion misstep because eBay’s stock price more than doubled after it bought GSI. For that matter, eBay (a 1998 new issue) has done vastly better than most other Internet mania start-ups. We only began recommending the stock as a buy in December 2010, 12 years after its new issue debut. Since then, eBay has gained tremendously.

To top it off, eBay set up its PayPal division as a separate company, and spun it off (handed it out as a special dividend) to its shareholders.

Spinoffs generally work out well over a period of several years for both the spun-off stock and its parent. We have a high opinion of the long-term prospects of eBay and PayPal. However, both companies may need time to find a new niche in the investor marketplace. So, for the moment, we view both stocks as holds.

Another growth by acquisition example—of sorts—is by our long-time buy recommendation, Cintas Corp. The funny thing is that the company started out describing it as a sale.

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Cintas sells office and business equipment and supplies, including uniforms, office cleaning and first-aid kits. In May, 2014, the company sold its document-shredding operations to Toronto-based Shred-it International. Though described as a sale, the transaction bears some similarity to an acquisition. Cintas received $180 million in cash, plus 42% of the combined firm.

A year later, Cintas received a $113.4 million dividend from Shred-it. Soon after, Shred-it was about to make its first public sale of shares in the company. But it scrapped that plan. Instead, it accepted a $2.3 billion takeover offer from U.S.-based Stericycle (Nasdaq symbol SRCL) and Cintas will got somewhere between $550 million and $600 million for its stake in Shred-it.

Cintas felt that document-shredding was not a good business for it to be in. It feels the same way about its Global Document Storage and Imaging business, which it now treats as a discontinued operation in its accounting. Both businesses face declining profit margins.

The lesson here is that major, successful, well-managed companies do succeed in growth by acquisitions. But they use them as a tool for pursuing a core business, rather than making acquisitions the core of their business.

A growth by acquisition strategy isn’t foolproof, even the best managed companies stumble, and fail. The best companies cut the risk by only making takeovers that help expand their core business. They are willing to get out, even at a loss, when they see an exit as the smart thing to do.

That’s one more reason why, in our publications and portfolio management service, we focus on high-quality, well-established companies. They make fewer takeover blunders. When they do make mistakes, they tend to recognize them earlier, and cut their losses before they reach catastrophic levels.

Do you understand the growth by acquisition strategy used by today’s businesses? If you have questions, feel free to share them in the comments section.

This article was updated on Aug. 17, 2016.


  • TSI Editorial Team 

    This company would do a lot with CST Brands if it is successful in winning the bid for that chain. I look forward to that.

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