Beware Mega-Merger Mania

Posted On December 20, 2016 10:11 pm

As the second longest bull market in history continues to age, (and hit all time highs), merger & acquisition or M&A activity continues to heat up. This can lead to some very nice short-term pops for investors in the company being acquired. However, I feel the need to warn investors to avoid buying shares of a company on takeout rumors, because such a strategy is a highly speculative one fraught with peril.

Take for example the recent 9% pop in Mondolez (MDLZ) on rumors that Kraft Heinz will buy out the cookie and cracker giant. On the surface it makes sense for a slow growing food conglomerate to buy another food giant, because organic growth is tough to come by in this industry.

BUT let’s not forget that Kraft, which was itself spun off from Phillip Morris (now Altria), then spun off Mondolez back in 2012. At the time management claimed this would unlock shareholder value, so I’m dubious as to how suddenly now repurchasing what Kraft once owned, for a likely takeout price of $82 billion, would be good for shareholders.

This actually gets at another important lesson investors need to consider. Just as it almost never makes sense to overtrade, it also doesn’t make sense for companies to constantly churn the same assets, buying, selling, and buying again the same brands, each time for a greater premium.

This results in a ton of goodwill on the balance sheet, which often ends up getting written off as a loss that delivers a big blow to earnings. That makes intuitive sense given that if a company spins off assets, and then buys them back later at a higher price, it’s the same as if management were buying high, and selling low.

Personally, as a dividend growth investor I appreciate a good conglomerate, whose business model includes a diversified cash flow stream that secures the payout, and allows it grow into the future. Which is why I am such a fan of Johnson & Johnson (JNJ), and 3M (MMM), who are disciplined in their acquisition approach and generally avoid churning through assets in what is generally just a sign of poor management.

After all, high paid CEOs need to earn their giant comp packages, which can run into the tens of millions a year in salary and stock. One way of doing this is to change corporate strategies, and either attempt to build an empire, ie growth at all costs, or to break up the former CEO’s acquisitions. In the meantime investment banks, who make millions from M&A and spin off advising, are all too willing to herald every new deal as a great win for investors.

In reality, it’s no different than asking your barber if you need a haircut. Of course the person who will profit from the transaction will be in favor of it. Which is why long-term dividend investors need to be skeptical of M&A deals, and always invest with a long-term view of a company’s cash flow.

This can help you not just treat your portfolio like a cash flow focused business, but also potentially avoid buying some poorly run companies that will hinder your ability to reach your long-term financial goals.

About author

Dividend Sensei

I'm an Army veteran and former energy dividend writer for The Motley Fool. I'm a proud co-founder of Wide Moat Research, Dividend Kings, and the Intelligent Dividend Investor. My work can be found on Seeking Alpha, Dividend Kings, iREIT, and the Intelligent Dividend Investor. My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives. With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and income streams and achieving long-term financial goals.

Related Articles

Leave a reply

Your email address will not be published. Required fields are marked *