Q4 2016 CIO Insights: U.S. Growth Equity – Mid & Small Cap
When one company acquires another, it can often produce positive inflection points in the new enterprise’s business fundamentals. A highly competent management team can transform a combined company into one that is more capable and has more to offer than the two legacy companies.
During election seasons, we are bombarded with messages and concerns about social issues, taxation, government spending, foreign policy, economics, trade and more. These concerns are genuine and important; however, from an investing viewpoint they are largely out of any one person’s control. We choose to focus on fundamental analyses and to look for themes we can exploit in order to build wealth in our portfolios. Tracking acquisition-minded companies is an example of a theme with considerable potential within our investment discipline.
A transformative acquisition typically involves one company acquiring another company that also has considerable size and capabilities. Successful acquisitions fundamentally recalibrate operations and meaningfully accelerate earnings potential by integrating strategic, financial and operational capabilities.
“Successful acquisitions fundamentally recalibrate operations and meaningfully accelerate earnings potential by integrating strategic, financial and operational capabilities.”
General and administrative expenses are the indirect costs of running a business and can be reduced by eliminating redundant jobs in areas such as procurement, payroll, finance, human resources and information technology. Operating costs can be lowered in sourcing, freight and logistics. Plant and manufacturing efficiencies can reap economies of scale by combining or eliminating inefficient facilities, and leveraging better technology.
The performance of the new enterprise can be enhanced by leveraging the best practices of both legacy entities. Balance sheet optimization can be achieved by refinancing existing debts, optimizing terms on existing loans, and obtaining new lines of credit. The prudent allocation of capital, such as paying down debt or repurchasing shares can enhance short- and long-term share value.
Sometimes overlooked are the growth opportunities represented by revenue synergies. New customers and sales can be captured by tapping into new distribution channels, rolling out new products and services, and taking advantage of cross-selling opportunities.
Newell Brands Boosted by Acquisition
Newell Brands is the company born of Newell Rubbermaid acquiring Jarden Corporation in early 2016. Newell is realizing substantial cost savings from the acquisition, and also expects organic sales improvements in several legacy segments. Yankee Candle, for example, is a former Jarden brand achieving organic sales growth by introducing new products, selling in new geographic areas, and leveraging Newell’s distribution channels.
Newell itself benefited years earlier by changing from a hodgepodge of brands to a cohesively run operating company. Newell believes applying a similar approach to Jarden will allow it to focus on fewer, more profitable products; speed up new product introductions; cut costs in raw material sourcing; and optimize manufacturing and distribution facilities.
Successful acquisitions drive higher organic sales growth, margin improvements, profitability and higher stock prices. Ideally, those qualities come at a cost of acquisition that neither reduces the acquirer’s stock price nor makes the objectives of the acquisition too difficult to achieve. While we follow acquisition-minded companies and management teams with acquisition successes, we apply our bottom-up process to individual security selection to build our portfolio of diverse, growing companies.
References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
The opinions expressed are those of David Hollond and are no guarantee of the future performance of any American Century Investments fund.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.