How to destroy shareholder value – Brother Industries edition

What is the number one destroyer of corporate value?

Most people would say not knowing your customer, missing a secular change in the environment, or something like that. The real answer: bad acquisitions. A poorly-conceived large acquisition is the easiest way for empire-building executives to blow mountains of shareholder capital in a heartbeat. Combining two companies is extremely complex, and paying the wrong price for the wrong asset can take many years to recover from (or ruin the acquiror for good – cf Sprint/Nextel).

And when it comes to stupid acquisitions, Japanese companies have a pretty incredible track record for idiotic purchases at insane prices (cf Panasonic/Sanyo is the best example). Especially Japanese companies acquiring foreign companies, as often there is a cultural clash where the acquired foreign company ends up haemorraging key personnel who cannot jive with a Japanese management style.

Today’s announcement by Brother Industries (6448) to acquire a British label printing firm, Domino, is pretty interesting in this regard. Brother is paying ~1bn GBP, or around 40% of its own market value (and double it’s net cash position), to acquire Domino. This equates to ~16x EV/EBITDA – TRIPLE the multiple where Brother’s own stock trades, and close to 30x cash flow (again, Brother stock trades at ~15x cash flow).

Purely on the above, this should raise eyebrows. But it gets worse: Domino is not a growth business – in fact net income has been stagnant around ~40mm GBP the last 4yrs, and only ~10% growth is expected next year. Since the purchase price is ~5x Domino’s book value, Brother is trading 200bn JPY in cash for ~160bn JPY in goodwill and 40bn JPY in assets – a trade that effectively ruins Brother’s otherwise strong balance sheet and leaves it incapable of acquiring something else that may fit better down the line.

While management may claim there will be ‘operational synergies’, I actually think they will be quite limited given this acquisition is trying to get Brother to move away from home printers and into Domino’s business of labels and packaging. In any case, no amount of synergies will help ameliorate the 160bn JPY goodwill balance.

Who knows, maybe this acquisition will work out, but at this level the odds are strongly, strongly against it. Frankly, Brother management would have been far better off levering up to buy back ~40% of its own stock in the market – a business they presumably know much better, since they run it – and one that trades at a fraction of what they paid to acquire. But that of course would require shrinking rather than growing their empire…

Disclosure: no positions in Brother or Domino

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