When big takeovers work

Most acquisitions fail and, the bigger they are the worse they fare. Here are three deals that work despite being *gulp* company transforming. 

Mentioning the words 'company transforming acquisition' to any seasoned investor can be entertaining sport. You will see facial contortions that start with surprised disbelief and end with resigned disgust.

History is littered with awful acquisitions; the more audacious and transformative, the worse they usually are.

Perhaps the most infamous is Time Warner's takeover of AOL in 2000 for US$165bn, a move that marked a peak in the dot com boom. Just three years later, the deal was undone and, having sunk about US$300bn in shareholder value, it is widely regarded as the worst deal in history.

But it has lots of competition for the mantle of worst ever. Consider Rio Tinto's (ASX:RIO) takeover of Alcan at the height of the mining boom; Chrysler's merger with Daimler; or RBS's acquisition of ABN Amro. It seems that whenever giants merge, shareholders get crushed.

It happens often enough that a big merger or acquisition is almost always met with scepticism and dismissal. Most of the time, this reflex serves us well but habit should never substitute thought. Good deals do happen but we can only recognise them if we're willing to break the usual rules and take a look.

In that spirit, we present three recent deals on our own market that fight the trend for mergers and acquisitions. Each is big and transformative. Yet each combination is better than the sum of its parts.

New Hope Corporation

First up is New Hope's (ASX:NHC) acquisition of the Bengalla coal mine. At a time when most coal miners are shrinking, New Hope has doubled down by buying 80% of the high-quality Bengalla thermal coal mine in the Sydney Basin.

The purchase was made in two tranches from two parties at what appear to be high prices - it paid $1.7bn all up for its 80% share but it did so at cyclically low coal prices. Bengalla is now New Hope's largest asset.

Crucially, it made these purchases from two sellers - Rio Tinto and Wesfarmers (ASX:WES) - who were selling for reasons that had nothing to do with value. Both businesses sought an exit from coal. Although they are hardly dummies, they were motivated by time, sought an immediate cash sale and had no interest in waiting for better coal prices.

New Hope has been lucky that coal prices have bounced so swiftly but that doesn't detract from the discipline and judgement shown by management. They sat on a billion-dollar cash pile for most of the boom and waited for the right opportunity to act. Kudos.

Santos

We've been scathing about Santos (ASX:STO). Part of that is probably due to the pain of losing money on it, but more important has been how management has reacted to distress. It hasn't sold assets or shrunk the way the best miners have and has raised capital in large and heavily dilutive raisings. To cap it off, it spurned a series of takeovers, the best of which was still way above the current share price and triple recent lows.

Yet new management has redeemed the company with a deal to acquire Quadrant Energy, a business that owns gas resources and three processing hubs. Santos shares equity in some of these assets and knows them well while Quadrant's raw gas can be put to work in assets owned across the group.

Management recently outlined a credible plan to double production. About 80% of that increase will come directly from newly acquired assets. These assets generate 50% higher margins than the legacy business and boast higher free cash flows and lower costs. Without the acquisition, Santos was reliant entirely on higher oil prices for growth.

Santos has managed a rare feat: its new acquisition is certainly big and transformative but it also improves the business on every metric.

TPG

Long rumoured and finally confirmed, TPG Telecom's (ASX:TPM) tie-up with Vodafone Hutchinson Australia (VHA) is a game changer for the business and for the industry. It marries the most competitive broadband business in the industry to a large, high-quality but underutilised (and often mismanaged) mobile network.

The new business, to be called TPG, will finally be able to offer bundles, which help secure higher margins and lower churn. They will also be able to chase lucrative enterprise deals and funnel more customers across a large fixed asset base to raise margins. TPG is a tenacious competitor and the impact on the mobile market following the tie-up shouldn't be underestimated.

It's unusual for three stunning deals to overlap in such a short time and we should retain the reflex that urges us to be sceptical of most big mergers and acquisitions. Yet that reflex should not come at the expense of thought. As we've seen, we can only recognise a good deal if we're prepared to look before we loathe.

Disclaimer
Intelligent Investor provides general financial advice as an authorised representative under the AFSL held by InvestSMART Publishing Pty Limited (Licensee). InvestSMART Funds Management Limited (RE) is the responsible entity of various managed investment schemes and funds and is a related party of the Licensee. The RE may own, buy or sell the shares suggested in this article simultaneous with, or following the release of this article. Any such transaction could affect the price of the share.

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