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(originally published by Booz & Company)


The Case for Pricey Acquisitions

To be sure, high-multiple acquisitions run bigger risks in the short run and often encounter skepticism in the form of investor churn and temporary stock-price weakness. There is an understandable wait-and-see attitude while Wall Street determines whether the high price meant that too much was paid for an unattractive target or that a fair price was paid for a desirable one.

A higher-multiple target may also involve a foray into a less stable sector, such as telecommunications or energy; in other words, higher risk commensurate with potentially higher return. Today’s shareholder base may not like the shift in direction. But for every shareholder who wants out, there are bound to be many more who will consider investing. Preoccupation with the existing shareholder base ignores the reality that today’s markets provide an unconstrained source of efficient capital.

Yes, high multiples raise the stakes. But if companies have been diligent about choosing the appropriate acquisition, a target’s seemingly high multiple shouldn’t be a deterrent. On the contrary, it may point to the rare situation in which one plus one can be made to equal three.

Author Profile:

Justin Pettit ([email protected]) is a vice president with Booz Allen Hamilton who specializes in shareholder value and corporate finance. He is the author of Strategic Corporate Finance: Applications in Valuation & Capital Structure (Wiley, 2007).

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  1. Kathleen P. Fuller, Jeffry M. Netter, and Mike Stegemoller, “What Do Returns to Acquiring Firms Tell Us? Evidence from Firms That Make Many Acquisitions,” Journal of Finance, vol. 57, no. 4 (August 2002): In studying shareholder returns after acquisitions, the researchers find that purchasing a private firm or subsidiary provides more value than acquiring a public firm. Click here.
  2. Rick Leaman et al., “Where M&A Pays: Who Wins & How?” Corporate Board Member, December 2004: The M&A study by UBS that uncovered the value of high-multiple targets. PDF download.
  3. Sara B. Moeller, Frederik P. Schlingemann, and René M. Stulz, “Firm Size and the Gains from Acquisitions,” Journal of Financial Economics, vol. 73, no. 2 (August 2004): The researchers examine mergers and acquisitions and find that small companies are good acquirers and large firms are not. PDF download.
  4. Justin Pettit, Strategic Corporate Finance (Wiley, 2007): The article’s author translates principles of corporate finance theory — performance measurement, capital planning, risk management, and capital structure, among other things — into practical methods for implementation. Click here.
  5. Mark Sirower and Stephen O’Byrne, “The Measurement of Post-Acquisition Performance: Toward a Value-Based Benchmarking Methodology,” Journal of Applied Corporate Finance, vol. 11, no. 2 (Summer 1998): The writers provide a methodology for measuring post-acquisition operating performance. PDF download.
  6. G. Bennett Stewart III, The Quest for Value (HarperCollins, 1991): The bible of “Economic Value Added,” the financial performance measure that attempts to capture the creation of shareholder wealth over time, by one of the inventors of the concept. Click here.
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