The Intelligent Investor

The Danger Zone Pick: 9/11/12

Check you the latest Danger Zone interview on a company employing misleading merger accounting.

Check you the latest Danger Zone interview on a company employing misleading merger accounting.

Per the well-documented high-low fallacy, one of the biggest misconceptions in the investing world is that the merit of an acquisition should be judged by whether or not it is “earnings accretive”. The impact of an acquisition on a company’s accounting earnings is not indicative of its value to shareholders.

From Hologic’s (HOLX) 8/1/2012 press release announcing the close of the Gen-Probe deal: “the transaction delivers a strong growth profile with attractive economics and is expected to be $0.20 accretive to Hologic’s non-GAAP adjusted earnings per share in fiscal 2013 and significantly more accretive on a non-GAAP basis thereafter.”

Now for the economics of the deal. HOLX paid $3.7 billion for roughly $90 million in annual after-tax cash flow (based on Gen-Probe management’s guidance for 2012 earnings). That equals a return on investment of about 2.4%. In other words, HOLX just allocated capital that, without synergy, earns somewhere between a 10yr and 30yr treasury bond, which is far below the company’s weighted-average cost of capital of about 7.2%. Not so good for investors. And it is a sign that more write-downs are in the company’s future.

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David Trainer

Trainer brings insight and transparency to research on stocks, ETFs and mutual funds.
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