Long-Term Financial Management Decisions: Why do most acquisitions result in losses?

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Why acquisitions?

For example, if Company A with revenues of $50 million Acquires Company SA with revenues of $10 million, the Newco mathematically would have revenues of $60 million. The anticipated performance of a well thought out strategic purchase might result in combined revenue for Newco of $100 million within a 1 to 2 year period. A second category of strategic acquisition would focus on an improvement of the profit margins of Newco.

Let's use two companies that are recognized as among the best at making successful acquisitions, General Electric and Cisco Systems. As their stockholders will happily tell you, these companies have been star performers in growing shareholder value. General Electric is a giant conglomerate with business lines such as GE Capital, GE Plastics, GE Power Systems, GE Medical, and several others. Cisco Systems could be categorized as a high tech growth company primarily focusing on voice and data communications hardware, software, and services.

The first rule of strategic acquisition we learn from these two prolific and successful companies is that they do it on purpose. They have a well thought out defined approach. To quote GE, "We are allocating capital to businesses that can increase growth with higher returns, businesses requiring human capital as opposed to physical capital. We are disciplined and integrators and we grow the businesses we acquire. Over the past 10 years Cisco Systems has acquired 81 companies. If you track their stock price over the same period, it is up a remarkable 1300% over that same period. GE, starting with a much larger base, still outperformed the S&P 500 index over the same period 3 to 1.

If you study the acquisitions of these two companies as well as good middle market growth through acquisition companies, you find some common strategic themes. The core principal that runs through almost every example is INTEGRATION. With the exception of establishing the original platform, GE expanding from their original roots and establishing a presence in plastics, for example, all of these acquisitions focus on integration.

An example that I use to summarize strategic acquisitions for Cisco Systems is not a real acquisition, but a hypothetical company that should demonstrate a point. I have been a very happy stockholder for over a decade. It seems like every year they would announce an acquisition that looked like this - Today Cisco announced the acquisition of Optical Solutions Company for $30 million in stock. Optical Solutions Company manufactures the OptiFast Switch, the fastest optical networking switch on the market today. The Company was started two years ago by two Stanford Electrical Engineering Professors. Current sales are $1.5 million and last year they lost $700,000. My initial reaction was, "What the heck are they doing?" What they were really looking at was what this technology could become as it was integrated into the Cisco family. First, Cisco has 5,000 sales reps, 12,000 value added resellers and systems integrators that sell their solutions, and 600,000 customers that think Cisco walks on water. Cisco knows their market, their customers, and the first mover advantage in their market. With this backdrop, the OptiFast Switch achieves sales of $130 ...