Companies make acquisitions all the time. But what the heck is a “distractquisition”?
“Distractquisition” is the term I coined for acquisitions that distract management and shareholders from previously failed acquisitions or strategies. They’re usually intended to right these wrongs. But more often than not, these acquisitions just end up being distractions.
They are mostly done by public companies in mature markets. But they do occasionally occur in growth markets as well.
Of course, no management would ever admit to making a distractquisition. That would be like the President saying that going to war stimulates the economy.
Distractquisitions have been perpetrated by managements across many industries. However, they are not the domain of large cap companies only; they are done quite often in the sub-billion dollar market cap space.
Tightly-controlled boards lack the discipline to prevent such abuses of shareholder capital. They don’t think through how to communicate the rationale of the acquisition to shareholders today, and what the consequences of distraction might be tomorrow.
Large institutional holders are not inclined to hang around if the “benefits” of an acquisition don’t start to materialize within a few quarters. That’s how a “growth” or “GARP” (growth at a reasonable price) shareholder base turns over into a “value” base – seemingly over night.
What about those Forecasts?
There is a commonality among managements that make distractquisitions. They generally lack vision, mission or strategy for generating value from the assets they currently oversee. Yet these acquisitions often come with grand proclamations about vision, cost synergies, or strategic “fit”.
On conference calls with the investment community, management will explain how the acquired business will drive expansion and build shareholder value. They’ll make exaggerated claims of a new total addressable market (TAM) that they will never conquer.
Distractquisitions are usually accompanied by flawed growth and ROI assumptions that are presented with “preliminary” forecasts. Gullible analysts or those rife with conflict, will incorporate these unrealistic assumptions into their models.
But none of this can justify the valuation paid for the acquired business. Instead, it will turn into a distractquisition. Once absorbed into the company, the preliminary forecasts are no longer relevant for a variety of “integration-related” reasons.
Over time, distractquisitions tend to experience a talent drain. This frequently occurs at the acquired business. But many times it affects the acquiring company as well. The result is an erosion of intellectual property (IP) that further undermines total contribution and return, further undermining the reasons for doing these acquisitions.
Negative effects are compounded when the acquired company has not digested its own acquisitions, or distractquisitions. In instances where the acquiring company incurs debt to pay for the distractquisition, the consequences can be catastrophic. Shareholders – those that remain – will experience large operating and goodwill write-offs in the aftermath of the wreckage.
And since they also tend to require disproportionate management time, the term applies in the sense that the acquisition distracts management from running/fixing the core business. It’s at this juncture that the company may attract an activist shareholder with the intent of undoing the mess and trying to salvage what remaining value is left.
As mentioned earlier, distractquisitions are often pursued by managements without a vision, mission or strategy for the business. The most obvious clue is in companies with a track record of failed acquisitions that neither expanded the company’s market reach nor grew value for shareholders.
Another easy one is a shelf registration for issuing equity or debt, which may be a precursor to an acquisition. A third easy one is if the growth rate is slowing – either of the overall category or the company’s specifically (which may suggest market share loss).
Sources of clues also come from listening to or reading transcripts of quarterly conference calls. How a management team articulates their message and answers questions, particularly about M&A, can be quite revealing.
Speaking of conference calls, a management that has consistently over-promised and under-delivered on guidance may feel pressured to make a distractquisition. This could be particularly true if there has been turnover in senior sales or field operations positions.
Don’t Blame the Bankers
M&A bankers are not to blame for distractquisitions. They have their own agenda and P&L missives. And they are only capitalizing (read: taking advantage of) weak management.
There are many situations in which a business is “sold to”, rather than “acquired by” a management. While the company’s own bankers may be charged with due diligence and valuation analysis, it’s ultimately the responsibility of management to say “yes” or “no” to the acquisition.