Premium for the Acquirer

Posted on January 10, 2014 by David Laidlaw

Over the past quarter, two of our core holdings made significant acquisitions. Sysco Corporation bought US Foods and Avago purchased LSI. Interestingly, the stock prices of both companies leapt upward after the announcement of the acquisitions.

Companies typically sell themselves for a premium and investors expect prices of acquired companies’ stock to increase. However, the acquirer’s stock does not usually appreciate much, if at all. Prices for acquiring companies’ stocks tend to stagnate or decline since buyers usually over-pay and integrating two companies is a difficult endeavor. Of the top four US mergers over the past year, two acquirers increased in price following the announcement and two decreased. The largest increase was associated with Liberty Media’s acquisition of Virgin Media. This appreciation only represented a 2% increase in Liberty’s stock price.

The day that Sysco announced its purchase of US Foods, Sysco’s shares increased 9.6%. The market’s response appeared rational given Sysco’s increased dominance in the food delivery business. Prior to the acquisition, Sysco controlled about 16% of the business, compared to US Foods which accounted for 9% of food deliveries. The combined company is now by far the largest player in the industry and will control roughly onequarter of the business. Therefore, Sysco should be able to spread its costs over a larger delivery network and face less pricing pressure from its competitors.

The market’s reaction to Avago’s acquisition of LSI does not appear as rational. On the day of the announcement (December 16, 2013), Avago’s shares advanced 9.75% topping $50 per share. Avago and LSI are both semi-conductor manufacturers, but their chips serve different functions. Avago primarily makes analog chips for wireless phones while LSI’s chips are geared to the storage and networking segments.

Avago’s CEO, Hock Tan, cited the combined company’s expanded business in the enterprise storage market as the reason for the combination in the press release announcing the acquisition. However, LSI’s revenues were down about 7.4% for the first nine months of the year compared to the same period in the prior year. Surprisingly, weak spending in the data center sector caused the shortfall in revenues.

Avago is a well run company that still sells for a discount to its intrinsic value according to our research. However, the market’s extremely positive reaction to its acquisition of LSI is probably more a reflection of the bull market mania than the merits of the underlying business combination.