If you've ever dreamed of owning an oligopoly, Goldman Sachs has a few tips to share.
Step one: Look at mature, commoditized industries, beset by cut-throat competition and where consolidation delivers a competitive advantage. They believe cable companies, cement producers, generic pharmaceutical firms, hospitals, food staples and trucking firms fit the description.
Step two: Reap the benefits. No, the gains aren't coming from a company getting taken out at a handsome premium, but rather the longer-term benefits from operating within an industry that has fewer players.
The Goldman Sachs analysts took a look at several industries where mergers and acquisitions created what they call "disruptive consolidation" – a series of big deals over a brief period that grabs investor attention and drives share prices higher. According to their figures, deals representing about 10 per cent or more of an industry saw the remaining stocks in that industry outperform by double-digits over the next 12 months.
"M&A is often assailed as a risky or value-destroying endeavor – e.g., management teams 'empire building', joining incompatible cultures or overpaying for growthy bolt-ons, to name a few common objections. Our work suggests, however, that in situations where relatively undifferentiated product offerings are joining forces or taking out excess industry capacity, consolidation is well correlated with improvement in sector margins and return on capital."
They provide a few examples. After American Airlines announced a merger with U.S. Airways Group Inc. a year ago, U.S. airline stocks outperformed the S&P 500 by 178 percentage points.
After InBev concluded a deal $60-billion (U.S.) with Anheuser-Busch in 2008, global beer stocks outperformed the global stock market by 33 percentage points. Operating margins have improved, costs have been cut and pricing power has returned to what was once a fragmented industry.
Even container-board stocks have delivered returns. After International Paper merged with Weyerhaeuser in 2008, the shares outperformed by 15 percentage points a year later. They outperformed by another 12 percentage points after International Paper hooked up with Temple-Inland in 2012.
Investors should keep this trend in mind when they look at Comcast Corp. The U.S. cable company announced a deal late Wednesday buy Time Warner Cable Inc. in a $45-billion deal, giving the combined entity close to a 30 per cent share of the pay television market in the United States.
On Thursday, Comcast shares fell 4 per cent on the news. One caveat here: The share price has risen 125 per cent since the start of 2012, outperforming the S&P 500 by 80 percentage points. As well, Goldman Sachs points out that even with consolidation, the cable industry still faces competition from online and satellite providers.
Here are the thoughts from Goldman Sachs analysts on the other industries ripe for consolidation.
"Over the course of the construction downturn, the aggregates industry has continued to move toward a rationalized market structure with Vulcan Materials, Martin Marietta, Lafarge, Texas Industries, and others participating in asset swaps that have improved individual market structures."
"There are two key driving forces behind future consolidation in the generic space. First, the generic drug industry is mature, with the largest opportunities (blockbuster small molecule drugs going off patent) having already passed into the background (e.g. Lipitor and Zyprexa in 2011, Lexapro in 2012, Cymbalta in 2013). Second, the generics industry is transitioning to specialty branded pharmaceuticals (e.g. urology, dermatology, women's health, gastrointestinal medicine) where drugs/formulations are more difficult to make thereby creating more pricing power, higher barriers to entry and longer product cycles."
"Key drivers for the increase in M&A activity in the hospital space include reimbursement pressure, benefits of economies of scale and higher penalties for low-quality delivery of care. In addition, we expect healthcare reform to accelerate consolidation moving forward, and this could lead the way for more nontraditional alliances."
"We have seen a scarcity of large assets coming to market which limits the likelihood of needle-moving acquisitions for large-cap firms. However, there have been a plethora of small transactions that have proven to have material accretion potential for SMID-cap firms,"or a blend of small-cap and mid-cap companies.
"The less-than-truckload industry is highly consolidated at the national level, with the top 20 carriers representing approximately 80 per cent of the market in 2012, up from 67 per cent in 2005. On a regional basis, the space is more fragmented with many small players vying for business. Industry dynamics have made it more difficult for local carriers to operate, which has stimulated further consolidation."