Wednesday, September 8, 2010

Sanofi-Aventis: How Not to Spend $18.5 Billion

Here's a Barron's article from this past weekend on the Sanofi-Aventis (SNY) attempt to acquire Genzyme (GENZ). Sanofi is paying 36 times Genzyme's 2010 estimated profits and 20 times 2011 estimated profits.

Sure seems like more than a full price. Sanofi is selling at 7-8x earnings these days. With its ~$ 10 billion/year of FCF it could quickly add to existing shareholder value by simply buying shares at current market prices (or even higher).

The article makes the point that the $ 18.5 billion (Sanofi's market value: $ 78 billion.) could be used instead to buy back stock. It would be meaningfully accretive to earnings per share and Sanofi's shares would naturally trade at something like six times earnings at the same price.

Sanofi does have a difficult patent expiration problem in the coming years but the buyback math still works. Corporations like Sanofi with healthy FCF can borrow these days at low cost and take that money to buy their own 12-14% earnings yield. The difference goes into remaining shareholder pockets at relatively low risk. Better yet, don't borrow that much and just rely on the company's FCF to buy back as long as the shares are cheap or until a more favorably priced acquisition comes along. Even if Sanofi has to shrink its size somewhat in the coming years before resuming growth it works out pretty well for shareholders. This can be a bit counterintuitive (and I'm well aware that this way of thinking can be anathema to many investors). Pursuit of growth is fine but it has to make sense relative to the capital being allocated.

To me, the question is whether your goal is to quickly build a business (or in Sanofi's case quickly offset the expiration of key drugs) even if it is at a high cost to shareholders or whether you want to transition steadily over time through prudent capital allocation. Sometimes that means allowing a company to initially become a bit smaller while pursuing more capital friendly growth and higher overall returns for shareholders.
(ie. if Sanofi shrinks for a few years that doesn't have to be the permanent trajectory. Capable management can eventually build the company off of that smaller base while wisely allocating capital throughout the transition process)

Instead, CEO's often impatiently buy something for "strategic" reasons burning up capital in the process. The company does end up bigger but the shareholders end up poorer than they would otherwise ex-acquisition. Pursuit of growth for its own sake at a high cost to shareholders happens frequently. It's not an easy sell (and certainly does not feed one's ego) to say "We will use excess capital to buy our undervalued stock in order to increase per share value until a shareholder friendly deal comes along". Comes across as lacking ambition. A tough sell for a CEO but often the right thing to do.

What concerns me is the Sanofi CEO Chris Viehbacher's view of corporate buybacks more than the specifics of the Genzyme deal itself. According to the article, when asked on a conference call about buybacks he blasted analysts and said:

"I personally don't believe that buybacks add any shareholder value."

The article provided a quote from one big investor who was critical of drug-company CEOs:

"For these types, buybacks are a pejorative, a 'going out of business strategy' equated with no growth or ambition. Of course, the ambition to grow value per share instead of all the other stuff seems to escape many of them. I wonder how it's possible that so many well-educated people can be so ignorant of some pretty basic math."

That Viebacher thinks this way may seem somewhat amazing but unfortunately his view is not uncommon enough among CEO's. Here's a quick revisit of Buffett's take on buybacks from the 1980 shareholder letter (included in this recent post):

One usage of retained earnings we often greet with special enthusiasm when practiced by companies in which we have an investment interest is repurchase of their own shares. The reasoning is simple: if a fine business is selling in the market place for far less than intrinsic value, what more certain or more profitable utilization of capital can there be than significant enlargement of the interests of all owners at that bargain price? The competitive nature of corporate acquisition activity almost guarantees the payment of a full - frequently more than full price when a company buys the entire ownership of another enterprise.

Quite the contrast with Sanofi's CEO. It's too bad that so many CEO's see buybacks as "a perjorative" left only to those with not enough ambition.

Considering that Berkshire Hathaway owned ~$ 2 billion of Sanofi Aventis at the beginning of this year it makes you wonder whether Buffett is actually the "one big investor" quoted in the article. Who knows.

He was quite vocal in his dislike of the Kraft's (KFT) deal to buy Cadbury and this one looks much more expensive.

Adam

Long SNY and KFT

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