Perhaps counter-intuitively, the largest number of mergers and acquisitions typically occur during bull markets, when valuations and stock prices are at cyclical highs. By contrast, during a recession, companies tend to tighten their purse strings causing mergers and acquisitions to come to a screeching halt at a time when valuations are at cyclical lows. With the volatility in today's market and the Dow trading at upper resistance levels, there's a good probability that a pullback will present a better opportunity. The closest comparison in e-commerce for Amazon is likely eBay (Nasdaq:EBAY) and it's currently trading at a forward P/E of about 13, and trailing P/E of 18.
Companies that make major acquisitions during bear markets are often a signal that those companies have strong balance sheets, strong cash flows and a management team that is focused on long-term growth. Unfortunately, sometimes an acquisition can also be part of an attempt to add growth when the company's core business is deteriorating. Let's take a look at two big acquisitions in July. (For a primer on mergers and acquisitions, take a look at our Mergers and Acquisitions Tutorial.)
IN PICTURES: 7 Forehead-Slapping Stock Blunders
Amazon and Zappos.com
Amazon (Nasdaq:AMZN) announced last week that the company would acquire shoe and clothing retailer Zappos.com for approximately $900 million. After failing to get much success with its own shoe store launched back in 2007, Amazon will finally get significant market share in the fast growing online shoe sales segment.
Year to date, Amazon is up nearly 65% and just recently released strong second-quarter results. Excluding charges for the settlement with Toys "R" Us, Amazon recorded revenues of $4.65 billion, a 14.5% gain year over year. Operating income came in at $304 million, up 24% year over year (excluding the settlement), partly due to improved gross margins of 60 basis points. Both results exceeded analyst expectations.
With a forward P/E of about 39, a trailing P/E of 55 and the stock trading at the top end of the 52-week range, I wouldn't recommend its current valuation as an entry point if you're considering adding AMZN to your portfolio.
Sprint Nextel (NYSE: S) announced this week that it would acquire Virgin Mobile USA (NYSE:VM) in a deal worth approximately $483 million. Sprint already owned 13% of Virgin Mobile prior to the acquisition, and its $5.50 stock exchange should allow it to acquire the remainder of mobile carrier.
Virgin Mobile USA is best known for its prepaid cell phone service, and the acquisition will add approximately 5.25 million customers to Sprint's customer base. Unfortunately, prepaid cell phone service primarily caters to value-minded customers and doesn't offer margins as good as mid to high-end subscribers.
In the second quarter of 2009, Sprint Nextel reported a net loss of $388 million, worse than many analysts had expected. The carrier also reported a loss of 257,000 customers, which was ugly considering major competitors AT&T (NYSE:T) gained 1.4 million new subscribers in Q2 and Verizon Wireless added 1.1 million new subscribers in the same quarter. It may appear as though Sprint is trying to buy customers through its acquisition with Virgin Mobile USA to make up for increased subscriber losses.
Also, it looks like AT&T and Verizon's upgrade to the high speed 4G soon with new networks such as the LTE and HSPA+ could further erode Sprint's market share if the company doesn't keep pace with these competitors. Sprint does have a partnership with Clearwire that gives it access to 4G but only in a few markets. In my opinion, investors should hold off entering into any long-term investments in Sprint Nextel until the company can show it can turn around subscriber losses.
The Bottom Line
Amazon's acquisition of Zappos.com expanded its market share and should fit smoothly into its long-term goals. On the other hand, instead of focusing its efforts on improving their core business, Sprint Nextel decided instead to acquire Virgin Mobile to offset its struggling business. (Learn more about what metrics to look at when analyzing the telecom industry in our article, Dial Up Choice Telecom Stocks.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
With the volatility in today's market and the Dow trading at upper resistance levels, there's a good probability that a pullback will present a better opportunity. The closest comparison in e-commerce for Amazon is likely eBay (Nasdaq:EBAY) and it's currently trading at a forward P/E of about 13, and trailing P/E of 18.