Tag Archives: M&A

Arcadis NV (ISIN NL0006237562) – One deal too many ?

Arcadis is a stock which popped up in my “BOSS score model” which I still use regularly to find ideas. It is a Dutch based Design, Consulting & Engineering company with global reach and a diversified business. Historically, they have consistently produced ROE’s of 20% and grown nicely.

Some key figures:
Market cap 1,7 bn EUR
P/B 1,7
P/E 19,5 (2014), 11,6 (2015 est)

The company trades at a ~20% discount to Peers like AF AB, Ricardo or SWECO.

What I did like about Arcadis at “first sight”:

+ consulting is capital light business
+ potential growth areas like infrastructure, water, urbanization
+ ROIC as relevant measure for compensation
+ organic growth as target for compensation
+ well-regarded in the industry

What I didn’t like so much:

– large project exposure
– China / EM Exposure (26%)
– Utility exposure (22%)
– big M&A transactions in 2014
– annual report focuses on adjusted numbers
– debt significantly increased, far above target

Hyder Consulting acquisition in 2014

In 2014, Arcadis did several larger acquisitions, the largest one being the UK listed Engineering company Hyder Coonsulting Plc. After the first bid, a Japanese bidder emerged and at the end they had to pay around 300 mn GBP for a company that earned around 6 mn GBP in 2014. This really looked expensive and is maybe one of the reasons why EPS in the first 6 months 2015 fell from 0,77 EUR to 0,70 EUR per share.

Looking into historic annual reports one can see that there was little organic growth for many years (page 15) and growth was driven by acquisitions:


Arcadis looks pretty much like your typical “roll up”, gobbling up competitors one after the other. However with the Hyder deal, it looks like that they made maybe “one deal too many”. Debt is now clearly above their own targets and business is not doing well. They acquired Hyder for their Asian presence which maybe looked like a good idea last year.

Management incentives: The reality test

When I did read the annual report 2014, I really like the fact that management seems to be incentivized on ROIC and organic growth. However, this is the score card they presented with their half-year numbers:

arcad sct

At first sight the source card looks, great, everything green, only organic growth “orange”. A closer look actually shows that the only target they hit was actually external growth which in itself is a pretty stupid target. All the other targets were either misses or not available.

This slide alone to me indicates that management doesn’t take its stated goals that serious. Yes, on paper it looks great but such a “target achievment assessment” is clearly a joke.


Although the “roll up” strategy seems to have worked for some time, in my opinion there is the risk that the 2014 acquisition spree was maybe too much. If they can make the acquistions work, the stock would be relatively cheap, but combined with the current debt load the stock is now much riskier than it was in the past. Bilfinger is a good example how a seemingly working “buy and build” strategy can implode over night.

It is also a good lesson in checking if a compensation system which looks good on paper is actually implmented and followed or if management just adjusts everything to look good despite not achieving the targets.

So I will watch this from the sidelines although I like the business and industry in general.

Red flags for investments: “Transformational” acquisitions – Example Walgreen

Walgreen is one of the few large US stocks which looks good on my “Boss” Screen, with a consistently high ROE and low volatility. So I put it on my “priority” research to do list.

However,last week I dropped them from the list because of this.

Pessina had already hinted that his preferred exit would be via another merger rather than a fresh stock exchange listing: “If you do an IPO, you create financial value,” he said. “If you do a transformational deal, you create financial value and industrial value.”

Firstly, it is interesting that the seller makes this quote. Clearly, for him it was transformational as he transforms himself financially into a billionaire.

Secondly, if we look at some big “transformational deals in the past, we see that many of them fail.Some well known examples:

Daimler Chrysler
AOL Time Warner
RBS ABN Amro (Fortis, Santander, my all time favourite. everyone involved got screwed in the end))
Allianz Dresdner
Travelers Citicorp
Kraft cadbury
Vodafone Mannesmann

The list is endless. I actually don’t remember large “transformational” deals which actually worked well.

This aspect has not been unnoticed. A famous study by Bain showed that around 70% of large mergers fail:

Bain & Company M&A team leaders David Harding and Sam Rovit challenge the most common deal presumptions in Mastering the Merger: Four Critical Decisions That Make or Break the Deal (Harvard Business School Press, November, 2004) and found that while 70% of large deals fail to create meaningful shareholder value, 80% of the Fortune 100 companies have relied on mergers and acquisitions to fuel their growth over the past two decades.

The reasons are stunningly simple:

Bain examined over 50 case studies, analyzed 15 years of M&A data and surveyed 250 CEOs and senior executives about real-world successes and failures. They found that the top three reasons deals derailed were:

1. Ignored potential integration challenges (67%)

2. Over-estimated synergies (66%)

3. Had problems integrating management teams and/or retaining key managers (61%)

If we look at this article, Walgreen seem to rely heavily on point 2:

The deal will lead to cost and revenue benefits across both companies of $100 million to $150 million in the first year and $1 billion by the end of 2016, according to the statement.

Back to the Bain study. They identified a few critical success factors:

— Frequent acquirers outperform the pack – the more deals a company made, the more value it delivered to shareholders; the “frequent acquirers” outperformed the “never-evers” by a factor of two

— Frequent acquirers buy in good times and bad – frequent acquirers that bought constantly through both tough economic environments and boom times outperformed those that bought primarily in growth periods by a factor of 2.3; they also outperformed the “recession buyers” by a factor of 1.4

— Most successful dealmakers start small then ramp up – firms that focused on small deals on average outperformed those that made big bets by a factor of almost 6

In my opnion, Walgreen is unfortunately a very infrequent acquirer, to my knowledge it is the first acquisition outside the US and they only made one other acquisition in the US in the past few years. It rather looks like a desperate move to counter shrinking business in the US, which is never a good motivation to do a deal.

So despite the low valuation of Walgreen, this acquisition is definitely a “red flag” for any investor, as the chance for a positive outcome seems to be very low. However it looks like a great deal for KKR and Mr. Pessina. If you think about this, KKR and Pessina bought at boom prices in 2007 and seem to at least double their money after 5 years.

An additional remark on international expansion from retailers:Two of the best retailing companies of the world, Walmart and Tesco found out the hard way how difficult it is to transform local cometitive advantages into international markets. Walmart for instance failed in Germany, Tesco is still struggling in the US. As Bruce Greenwald said in “competition demystified”: All competitive advantages are local.


Based on historical numbers, Walgreen would look like an interesting “Boss” investment. However the large acquisition completely changes the picture. As outlined above, the success rates of such “transformational” acquisitions are 30% or lower. And historical numbers do not not ho
ave a lot of predictive power in such situations

So without any special insider knowledge, one should generally stay away from such stocks which in my case would also be the advise for Walgreen.

Sure it can work out, but the odds are strongly against a positive outcome.