Murders and Executions in the Stock Market

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Patrick Bateman: Ask me a question.
Club Patron: So, what do you do?
Patrick Bateman: I'm into, uh, well, murders and executions, mostly.
Club Patron: Do you like it?
Patrick Bateman: Well, it depends. Why?
Club Patron: Well, most guys I know who are in Mergers and Acquisitions really don't like it.

The dialogue from American Psycho illustrates an important point when it comes to mergers and acquisitions; it sometimes isn't easy to differentiate a smart and productive purchase from a destructive, perhaps even lethal, corporate deal. Although there is no exact way to tell one kind of deal from another, some important aspects can bring light to the issue.

A Poisonous Deal

When the acquired company is small in comparison to the acquirer and it doesn't include the potential for many unpleasant surprises, investors know that the risks are contained. This is precisely the opposite of what happened with the acquisition of Countrywide by Bank of America (NYSE: BAC) during the financial crisis.

It looked like Bank of America was doing a great deal by purchasing a major mortgage lender at a bargain price, but not only were Countrywide's assets more toxic than expected, the acquisition also exposed Bank of America to an unquantifiable amount of legal liabilities. In fact, the company is still working to fully recover itself from the consequences of that acquisition.

Warren Buffett once said: "I've never gone to bed with an ugly woman, but I've sure woke up with a few." Some deals look very attractive before they are consummated, but once you find out what lies beneath the surface, things can turn out to be much more complicated. When analyzing a corporate acquisition, investors should probably pay more attention to the risks than the opportunities and try to understand the full implications of a negative scenario.

Apple (NASDAQ: AAPL), on the other hand, only acquires small companies with valuable patents or technologies to incorporate into its products. It's very complicated to evaluate if any these deals will finally be beneficial for shareholders, but in case they don't, the downside risks are quite limited. Besides, its voice assistant Siri and a big part of the company's touchscreen technologies have been the result of acquisitions, so Apple's management deserves the benefit of the doubt.

Tell Me the Motives and I will Tell You the Results

There are different kinds of reasons to make an acquisition, and this has a lot to do with the final results of such deals. When management tries to run away from its problems by purchasing other companies, there is a high probability of value destruction down the road.

Hewlett-Packard (NYSE: HPQ) has been trying to escape from the commoditized hardware business with several acquisitions in the software industry over the last years, including some particularly shady deals. Predictably, most of these transactions have turned out to be very expensive mistakes, and the company has taken big impairments on the value of those assets. The motives behind HP's acquisitions were not the right ones, so the results could hardly have been much better.

The acquisition of Teavana by Starbucks (NASDAQ: SBUX) looks much better from that perspective. The coffee company is doing very well in its core business, and it could have chosen to keep building it's tea offerings on its own. But Howard Schultz and his team decided that Teavana is a convenient purchase for Stabucks, so they decided to go ahead and buy the company. There is no guarantee of success (there never is), but at least the decision seems to be based on the right motives.

Track Record Matters

Disney (NYSE: DIS) has done some considerably big deals over the last years, including the purchase of Pixar, Marvel and, more recently, Lucasfilm. These purchases are mostly based on intellectual property and intangible assets, so it’s complicated to say if the price is fair or not. But Disney has proven to investors that it can integrate the acquired companies successfully and capitalize those assets in a big way; the tremendous success of “The Avengers” is a clear example of that.

The House of Mickey Mouse paid nearly $4 billion for Lucasfilm, and that's a big bet, even for a giant like Disney. The transaction can be considered risky from that perspective, but the company's reputation and management's track record bode well in terms of its long term implications for investors.

A Matter of Life and Death

Acquisitions can be a great strategy to grow and consolidate a company strategically; but they can also have some very destructive consequences for shareholders. Although there is no way to know for certain the long term impact of any particular deal, investors should closely watch the key relevant variables in order to differentiate acquisitions from executions.

acardenal owns shares of Apple and Disney. The Motley Fool owns shares of Apple, Bank of America, Walt Disney, and Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Apple, Walt Disney, and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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