Pfizer-Allergan: Why Growth At Any Price Is A Dangerous Game
— November 24, 2015
By Aswath Damodaran
Growth but at what cost?
One of the most dangerous maxims in both corporate finance and investing is that it is better to grow than to not grow, and that a company that faces stagnant or declining revenues (and income) should seek out higher growth (at any price). In a previous post, I looked at the value of growth and noted that the net effect of growth depends on how much you pay to get it, and that overpaying for growth will give you higher growth and a lower value. In the graph below, you can see the effect of growth on value for three companies, all of which grow, the first by making investments that generate returns that exceed the cost of capital, the second by making investments that earn the cost of capital and the third by making investments that earn less than the cost of capital.
It is this perspective on growth that makes me skeptical about companies that grow through acquisitions, especially when those acquisitions are big and are of public companies. Since you have to pay market price plus (a premium of 20-30%) to acquire a public company, for a growth-motivated acquisition to create value, you have to be able to find a growth company that is under valued by more than 20% or 30%, given its growth rate, at the time that you initiate the deal to be able to walk away with value added. Note that, much as I am tempted to do a riff about the wondrous benefits of bringing both Botox and Viagra under one corporate entity, I am deliberately keeping synergy out of the equation since it can justify a premium.
Read the full article as published in Forbes.
Aswath Damodaran is the Kerschner Family Chair in Finance Education.