The stock market had a bad day Tuesday with United Technologies leading the slide, finishing the day off nearly 6 percent as the Dow Jones average slipped 234 points.
This was no shocker, as United Technologies had just agreed to pay a big price for an acquisition. So investors did what they usually do, and sold the stock of the buyer.
That’s what makes Tuesday such an interesting day for H.B. Fuller Co. Its stock ended up about 2.5 percent in the first trading day after news of its own big deal, to acquire Royal Adhesives & Sealants for $1.6 billion.
At first glance there doesn’t seem to be much here for investors to really love. Royal is in the same business, so there’s no dramatic departure coming for Fuller’s strategy or business model. The acquisition price doesn’t appear to be a screaming deal either. At a little over 11 times Royal Adhesives’ cash earnings, a common yardstick for pricing a business, H.B. Fuller seems squarely in the market these days if not bidding a little rich.
Ah, but there will be synergies. Fuller intends to save a lot of money in the combined operation, with new opportunities to exploit that Royal wouldn’t get on its own. And what the market is telling us from the reaction Tuesday is that unlike most corporate deals, this time the case seems to make sense.
That H.B. Fuller announced a deal is not surprising, as it had been looking to make acquisitions to get sales growth, with about $500 million of targeted annual sales growth through deals by 2020.
It got to that goal in one move here, because Royal has annual sales of about $650 million, bringing the combined annual sales to about $2.85 billion.
In the same business as Vadnais Heights-based H.B. Fuller, Royal produces adhesives and sealants for a bunch of different applications, from holding together insulating glass to sealants used on cars. Part of its appeal lies in what Fuller called highly specified applications, meaning formulations and materials that solve a customer’s tough problem, not just a barrel of glue that could be good enough for all sorts of jobs.
Yet much of the pitch to investors Tuesday was about the value of “synergies,” one of those business terms that’s gotten a little tarnished, both because of how it’s been used as a euphemism for firing people as well as the justification for deals that later lost money.
As a basic business idea it’s not controversial, as two organizations in the same business should be able to run more efficiently when combined. There’s obviously going to be one group of C-suite executives, for example, not two. And two manufacturers buying from the same material supplier will now be one, much bigger customer, and should be able to get lower prices.
The reason investors sell the stock of corporate buyers, though, is that a vague promise of synergies just may be what the CEO promises when the math doesn’t quite work without some spreadsheet fiction, with few of the supposed synergies really identified.
Investors have also learned the hard way that even sensible plans to save on costs can sometimes fail. The simplest explanation for that, based on experience, is that bringing two companies together means bringing two sets of people together. And people don’t always get along or do the right thing.
That could mean that the best people handling a staff job are the ones who ultimately get canned. Or it might be that the wrong computer system gets standardized companywide and it only works after millions of dollars of unplanned technology consulting time has been thrown at the problem.
Fuller CEO Jim Owens didn’t shy away from synergies when justifying the deal on a conference call Tuesday with investors, pointing to $35 million in potential cost savings. But an analyst’s question also gave him the chance to talk himself into a bigger cost savings number. He wisely passed. “We wanted to share with investors what we knew we can deliver,” he said.
The company is also looking for additional revenue neither would have gotten without the combination, including making Indiana-based Royal Adhesives more of a global company and expanding its products into markets and customers where Fuller has done business for years.
All of which made Royal worth more to Fuller than it would be to a private equity firm that may have also been bidding for the deal.
By tacking on $35 million to the annual cash earnings of the acquired business, and using a multiple of cash earnings as the valuation measure, what Fuller ends up paying looks closer to nine times cash earnings rather than more than 11 times. A private equity firm couldn’t get that kind of deal.
So Fuller, in the 2017 merger market, seems to have made a good buy. Now all Owens has to do, once the deal closes, is to go prove that his team really did identify all those annual savings.