A kiss seldom turns toads into princes

Experience has taught us, and billionaire Warren Buffett, that acquisitions can end badly. But a company can improve its chance of success by making acquisitions within its industry.

Acquisitions_mergersMr. Warren Buffett, of course, became a self-made billionaire by making smart investments in the stock market. One of the secrets to his success is that he’s wary of companies that go on acquisition binges.

In his inimitable style, Mr. Buffett has written: “Many acquisition-hungry managements apparently were overexposed in impressionable childhood years to the story in which the imprisoned handsome prince is released from a toad’s body by a kiss from a beautiful princess. Remembering her success, they pay dearly for the right to kiss corporate toads, expecting wondrous transfigurations.

“Initially, disappointing results only deepen their desire to round up new toads. Ultimately, even the most optimistic manager must face reality. Standing knee-deep in unresponsive toads, he then announces an enormous ‘restructuring’ charge. In this corporate equivalent of a Head Start program, the [chief executive officer] receives the education but the stockholders pay the tuition.”

Acquirors should stick to their industry

In fact, studies of mergers and acquisitions show that two-thirds of them end up badly. But some acquisitions are more likely to succeed than others. One factor is whether the acquiror sticks to its industry. The fact is, a company that buys a competitor has a better chance of success. Certainly its chances for success are better than for companies that buy businesses they know little or nothing about.

Laidlaw Inc., for example, was doing well operating school buses. But it acquired an industrial waste-management company and an ambulance service in the U.S.—businesses it knew little about. This and the excessive debt it took on to make these acquisitions ultimately led to the company’s demise.

That’s one reassuring aspect of manufacturing stock Toromont Industries’ (TSX—TIH) acquisition strategy. It formerly operated Caterpillar dealerships in Ontario, Manitoba and part of Nunavut. It knows this business well. Last year’s acquisition of Caterpillar dealerships in Quebec and Atlantic Canada expanded its business.

This is paying off. Toromont’s earnings are expected to leap by more than 35 per cent this year, to three dollars a share. Next year the acquisition will contribute for a full year. No wonder the shares jumped by over a fifth since we published our March 30 issue.

Toromont Industries remains a buy for further long-term share price gains and growing dividends.

This is an edited version of an article that was originally published for subscribers in the August 17, 2018, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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