“Don’t ask the barber if you need a haircut”, doesn’t sound like the deep philosophical guidance that could account for why only 17% of acquisitions add value, unless of course that wisdom were coming from Warren Buffett.
Don’t ask the broker if you should do the deal. Players don’t get paid if you don’t do that deal. Of course you should do that deal.
And yes, you will get a haircut.
A KPMG study conducted in 2000 determined that only 17% of Mergers and Acquisitions examined created a substantial return and, even more discouraging, 53% destroyed value. Validating these findings, a six year study by Business Week showed that 61% destroyed value that existed prior to the acquisition (BW October 14, 2002).
Mr. Buffett uses large company acquisitions to make his points ($50M for a couple of weeks work), but I would point out that all fees in all transactions are large per time invested & that there is almost always someone “suggesting” that this is a great deal, who will be handsomely rewarded upon its completion.
That advice needs to be considered in its own light (if I understand Warren’s comments correctly).
MERGERS & ACQUISITIONS
Buffett Casts a Wary Eye on Bankers
March 2, 2010, 2:45 AM
Warren Buffet’s annual letter did more than just review how business went last year for Berkshire Hathaway, it took a shot at the fees that drive deal-making. The rewards are skewed to encourage making the deal whether it’s a good idea or not, which means, for the folks advising corporations on the wisdom of mergers and acquisitions, there are usually more good reasons to strike an agreement than to shelve it, The New York Times’s Andrew Ross Sorkin writes in his latest DealBook column.
Mr. Buffett, of course, is no stranger to deals, but as one of the world’s richest men, he’s figured out what works and what doesn’t largely on his own, which doesn’t leave much room for advice. But he’s got an idea for corporations that think they need counsel: reward one advising bank if the deal goes through, and another if it doesn’t, Mr. Sorkin writes.
The people who instinctively want to short a deal could make a living trying to prevent it, and naysayers could raise their voices against the deafening optimism that precedes even the most disastrous agreements.
Read the column here, or after the jump.
Buffett Casts a Wary Eye on Bankers
By ANDREW ROSS SORKIN
“Don’t ask the barber whether you need a haircut.”
That little nugget was buried in Warren E. Buffett’s annual letter to Berkshire Hathaway shareholders published over the weekend. It was his thinly veiled dig at Wall Street bankers and the perverse incentive system for corporate “advice” on mergers and acquisitions — namely that bankers are paid only if a deal is completed. (Bankers typically earn nothing if a deal is abandoned or collapses, giving them little reason to recommend against pursuing a transaction.)
It was a timely note from Mr. Buffett — Monday ushered in more than $50 billion worth of merger announcements — and it resurrected an age-old debate on Wall Street about how bankers are compensated for their counsel to corporate boards.
And it’s an issue that resonates far beyond Wall Street. Just think of all the other parts of life where people offer only encouraging words — “You should do this!” — because that’s the only way they get paid (real estate agents, stock brokers, the list goes on).
And Mr. Buffett has trained his sociologist’s eye on this phenomenon more broadly, too. In his 1989 letter to shareholders, he famously wrote about the “institutional imperative,” which describes, among other things, how an entire organization can rise up to help a boss justify some deal he’s inclined to do, regardless of its merit.
It’s nice to think some things can change, but the deal incentive for bankers probably isn’t one of them.
“You shouldn’t earn a lot less by keeping your client from doing something stupid, but that’s the way it is,” Felix Rohatyn, the financier and elder statesman of Wall Street, told me. “The majority of fees are conditional.”
Mr. Buffett’s letter made a bold suggestion that isn’t sitting well with the establishment.
“When stock is the currency being contemplated in an acquisition and when directors are hearing from an advisor, it appears to me that there is only one way to get a rational and balanced discussion,” he wrote. “Directors should hire a second advisor to make the case against the proposed acquisition, with its fee contingent on the deal not going through.”
Of course, acquirers often hire more than one banker to advise a board, to act as a check on the other. But all too often, both banks are given the incentive to recommend the deal.
Since 2008 in the United States, in 131 of the 230 deals that were worth over $1 billion, the acquirer hired more than one bank, and in some cases more than five. Those banks were paid an estimated $3.3 billion for advisory services, according to Thomson Reuters and Freeman Consulting.
The problem, as Mr. Buffett explained when I called him on Monday, is that the system is skewed. Companies are willing to pay advisers a supersize fee when they do a deal because then it is merely a rounding error, a tip on a lavish, celebratory meal.
It would be hard to justify a big payment if there were no deal, so the system has evolved into an all-or-nothing game. Banks are willing to play it, because the rewards are so high, and they are not shy about offering attaboys and go-get-em’s to help make it happen.
When Berkshire recently acquired Burlington Northern, Goldman Sachs and Evercore Partners — which advised Burlington — were paid almost $50 million for what equated to only a couple of weeks of work.
Mr. Buffett, of course, did not use an investment banker.
“If we need advice for a deal, we probably shouldn’t be doing it,” he said with his trademark chuckle. He told a story about how First Boston (now Credit Suisse) tried to gin up interest in the mid-1980s for Scott Fetzer, a hodgepodge of small businesses based in Cleveland. It called on 30 firms to help make a sale, but failed to find a buyer.
Mr. Buffett then called Scott Fetzer’s chief executive himself and negotiated the deal face to face. Just as they were about to sign the deal, a banker for First Boston said that the bank was still entitled to a $2 million fee. The banker asked Mr. Buffett’s partner, Charlie Munger, whether he’d like to read the firm’s analysis of Scott Fetzer. Mr. Munger replied, “I’ll pay $2 million not to read it.”
That’s not to say that Mr. Buffett won’t ever pay investment bankers. “If someone brings me a deal, I’m more than willing to pay them,” he said, referring to his favorite banker, Byron Trott, a former managing director at Goldman Sachs, who helped broker deals including Berkshire’s investment in the $23 billion Mars-Wrigley merger and its acquisition of Marmon Holdings. However, Mr. Buffett insists that typically, “I don’t think we’ve ever paid for advice.”
Mr. Buffett’s biggest gripe is not just that bankers are given improper incentives, but he thinks their advice is suspect, especially when valuing stock-for-stock deals.
He had some experience this past year with such deals when Berkshire bought Burlington (he issued 80,932 Class A shares and 20 million B shares). He was also uncharacteristically vocal with his criticism of Kraft for paying $19.6 billion for Cadbury, much of it in stock (he’s a big Kraft shareholder).
He thinks that too much attention is paid to the value of the company that may be acquired, and not enough attention is focused on the value of the stock that the acquirer is shelling out.
“In more than 50 years of board memberships, however, never have I heard the investment bankers (or management!) discuss the true value of what is being given,” he wrote in his letter.
“Charlie and I enjoy issuing Berkshire stock about as much as we relish prepping for a colonoscopy. The reason for our distaste is simple. If we wouldn’t dream of selling Berkshire in its entirety at the current market price, why in the world should we ‘sell’ a significant part of the company at that same inadequate price by issuing our stock in a merger?”
Despite hearing from some of Wall Street’s biggest names about Mr. Buffett’s critique of their profession on Monday, most were circumspect in their reply.
“As usual, Mr. Buffett has an interesting point,” said Joseph Perella, one of the deans of the deal business and the co-founder of Perella Weinberg. He said he was happy to report that some clients had begun paying flat quarterly fees for advice, regardless of whether his firm recommended for or against a deal. However, he acknowledged, “most clients aren’t doing that.”
When I invited Mr. Rohatyn to critique Mr. Buffett’s view of his profession, he replied, as so many in the business did: “Warren is Warren,” is all he would say.