An article appearing in the Journal of Finance in March 1992 discussed the findings of a study that examined large acquisitions between 1971 and 1982. The authors concluded that diversification acquisitions (those outside area of expertise) were sold far more often than were those in related businesses. Perhaps this is evidence why conglomerates are rarely successful. Who knows? What I do know is that sometimes, acquisitions are game changers. Let's look at a few.
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Fortune Brands (NYSE: FO)
Jim Beam is an integral part of the company. How it got that way is a very interesting story. In 1965, Fortune, then known as the American Tobacco Co., concluded it needed to diversify. It began buying up businesses left and right, and in March 1967 it acquired the James B. Beam Distilling Co. for $111.5 million. That was and still is a lot of money. Today, based on 3% inflation, the price tag would be $397 million.
Of course, it's worth much more. Beam's 1967 revenues were $114 million, meaning American Tobacco paid one times sales for the biggest bourbon manufacturer in the world. Thanks to its $5 billion acquisition (in concert with Pernod Ricard) of more than 20 brands in 2005, it's now the fourth-largest premium spirits company in the world. With 2009 revenues of $2.5 billion, at one times sales, its spirits business is worth at least as much. However, when you consider it paid 3.8 times sales for its big buy in 2005, and Diageo's (NYSE: DEO) current P/S ratio is 2.9, it wouldn't be crazy to suggest Beam's value is around $7.5 billion. Especially when you consider how important Beam is to its overall profitability. Without it, Fortune's a much weaker business.
Procter & Gamble (NYSE: PG)
When P&G announced it was acquiring Gillette for $54 billion in 2005, Berkshire Hathaway (NYSE: BRK.A) upped its Gillette holdings so that it would own 100 million P&G shares upon completion of the deal. Warren Buffett heartily endorsed the merger, which brought Gillette, Braun, Duracell and Oral-B into the fold. Especially important were the high margins Gillette's grooming business brought to the table.
Estimates peg the value of the Gillette and Braun brands around $45 billion. Contributing 13% of net income in 2010, its market share in razors and blades is 70% and growing. Although adding $5 billion brands to its roster was the ultimate motivation for making the deal, Gillette's addition changed the company for the better because it solidified its focus on personal care products. Although Buffett has sold 22 million shares since October 2005, the 79.1 million remaining are currently worth $4.8 billion with $605 million in unrealized profits since the merger. It's difficult to know how Gillette stock would have performed had it gone alone. What we do know is that Gillette and P&G together make a formidable team.
Chico's FAS (NYSE: CHS)
Back in September 2003, Chico's was the darling stock of retail. It could do no wrong. Then trading at $15.15 a share, after being worth only 70 cents a share five years prior, the stock was on its way to an all-time high of $49.40 in February 2006.
One reason for the stock's meteoric rise was its $93 million acquisition of the White House Black Market stores. At the time, BusinessWeek questioned whether it made sense given the average WHBM store generated a 20% profit compared to 32% for its Chico's stores. In fiscal 2004, the first full year owning WHBM, the stores contributed $142.1 million in revenue or 13.3% of overall sales. In 2007 the company hit the skids, and WHBM became a savior of sorts, generating 30% of overall revenues in 2009 on double-digit same-store sales growth. Its revenues last year, including online sales, were a record $516 million. It's definitely the major growth driver for the company, and when you consider that its WHBM stores historically sell more per square foot than Chico's, it's a deal that makes complete sense. All this from a retail brand it bought for less than one times sales back in 2003. That's a game changer.
The toughest thing for investors is recognizing game-changing acquisitions. For every massive deal like Gillette where it's obvious, many more go undetected. Although the Jim Beam purchase was a large deal for the 1960s, it was just one of many that took place over a decade-long buying spree. As for White House Black Market, it wasn't a big deal back in 2003, but it has certainly turned into one. If there's a lesson to learn here, it's that the best deals usually come from the most unexpected places. Acquisitions like Gillette are rare. (When major corporate transactions have a big impact on the currency markets, you can benefit. For further reading, see Mergers & Acquisitions: An Avenue For Profitable Trades.)
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