Bank of America Merrill Lynch Analyst David Errington said that companies would do better if they reinvested in their existing core business instead of fueling their appetite for growth by making acquisitions. He told clients that most of the companies he had evaluated had destroyed shareholder value when they diversified to new businesses in their quest for growth, The Australian reported.
Errington added that majority of CEOs were pressured to grow the businesses both in the short and long-terms and the most convenient way to do so would be to engage in acquisitions- a move that makes investment bankers, lawyers, accountants and other financial service providers happy. His comments were given at a time when bankers revealed that more firms are looking at acquisitions, partly because of the difficulty to attain organically the growth expectations of the market, the report said.
In a note, Errington said, "Over many years, we have seen companies that own a strong business look to expand (diversify) into new businesses - only for the strategy to (at best) generate poor returns for shareholders and (at worst) financial ruin for the company." He added that if businesses put their focus on more than one business, the inevitable result is failure.
He warned, "The end conclusion is companies looking to grow outside their core business as it is at the end of its growth cycle - are likely to make returns-dilutive decisions and underperform as investments."
Errington cited the $20 billion purchase of Coles by Wesfarmers before the financial crisis erupted. He said that it was not difficult to understand why the returns of Wesfarmers have declined since it was looking forward to successfully selling "tomatoes to mums and dads under the same corporate veil as selling coking coal to Japanese steel mills."
Errington said, "Despite management claiming it has been a successful acquisition for Wesfarmers, the facts are that returns on equity fell from more than 25 per cent pre the acquisition to 6 per cent post the acquisition and remain well beneath 10 per cent six years after the acquisition."
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