Some companies can’t seem to grow organically. This may be due to market maturity, shifting market realities, or even incompetence of top management.
This can lead a company’s management to focus on acquisitions for growth, especially when the firm’s product lines are mature and they have no roadmap to develop new and disruptive products. They see buying market access or technology as a path forward.
Good companies don’t stick with mature, slow growth markets. They are constantly renewing their products and assaulting new market segments. This is exposed by their research and development (R&D) spending, as a percent of revenues. An R&D approach causes a dilemma for the company because investors, especially in public companies, are normally short-term focused. R&D is long-term by nature. Investors might punish the company and its management, since R&D spending hurts earnings and delays new revenues.
This dilemma – a company that wants to grow, and yet stay in the good graces of investors – will make acquisitions appear to be a good growth strategy. But an acquisition strategy comes with a serious price. In most instances, an acquisition growth strategy requires the acquiring company to take on debt. And I don’t mean a little debt – I mean tons of it.
There is no free lunch. Taking on debt affects earnings too, but in a different way. GAAP reporting requires companies to include these acquisition costs in their earnings report. To get around this, many companies report only non-GAAP earnings that exclude these acquisition costs because investors then focus on revenue growth.
This is not a good long-term strategy for a company, for several reasons:
1) Debt is never good, especially as interest rates go up.
2) Growing only through acquisitions puts the company at risk for sustained growth, since there is no infinite supply of good targets to acquire.
3) A growth-through-acquisition strategy mutes internal innovation and entrepreneurship, which is the true source of sustainable growth.
The recent M&A splurge in my semiconductor industry will likely do what it has in the past – turn some formerly innovative companies into debt-hobbled “also rans.” Instead, companies should acquire others when doing so augments the markets you want to grow into as part of your overall innovation strategy.