Where do you find growth in a low-growth economy? If Wall Street projections are correct, the about-to-close third quarter of 2016 will show a 2% year-over-year drop in earnings for the Standard & Poor’s 500 companies–the sixth consecutive quarterly drop in year-over year earnings. Forecasts call for a 2.6% year-over-year increase in sales. Which would be the first year-over-year increase in revenue since the fourth quarter of 2014.
Yep, we’re in what I’d call an earnings recession and sales growth isn’t all that robust either.
In this environment companies are scrambling for revenue and earnings growth using any strategy they can think up. A few companies, with superior products or sales networks or with an opportunity to take advantage of a competitor’s mis-steps (but how many companies can expect to have a competitor’s smartphone batteries set themselves on fire?) have been able to achieve organic sales and earnings growth even in this environment. Others have adopted a strategy of cutting costs early and often. But many of these companies have wrung most of the improvements to earnings (not sales) that they can get out of that strategy. Other companies have gone for a strategy of buying growth through acquisitions.
This search for any strategy that might deliver growth poses some unusual challenges to investors. What happens, for example, when a company that has been good for years at generating organic growth from research and development decides that it has to rely more strongly on a strategy of growth through acquisition? There’s no real guarantee that a company good at executing one kind of growth strategy will be equally or even minimally good at executing another kind of growth strategy. And in fact that company may stumble badly when switching to a new strategy for generating growth.
Which brings me to Abbott Laboratories (ABT.) Abbott Labs has a growth problem. Analysts forecast that revenue will growth by just 3% in 2016. Not exactly what you look for in a company whose stock trades at a trailing-twelve-month price to earnings ratio of 27.5.
Actually the drug, device, and nutritionals company has several growth problems. For example, slow growth in the developing world has cut into growth in Abbott’s pediatrics and nutritional business.
But maybe the biggest growth problem is in the company’s diagnostics business where growth has been extremely modest and threatens to slow even further in 2016-2020 from what it was in 2011-2015.
Part of Abbott’s plan for attacking that problem has been based on a strategy of acquisitions that would bring established streams of revenue to Abbott’s diagnostics business and also give the company access to new markets that would juice organic revenue.
That’s not an exceptionally original solution but so what? Other companies have proved that it can work if the acquiring company can handle the complicated issues involved in finding a suitable acquisition, negotiating a decent deal, and then integrating the new company with existing operations.
Abbott’s most recent big acquisition, that of Alere (ALR) a provider of point-of-are diagnostics with sales of $2.5 billion, however, does call into question in my mind whether the company can execute a growth by acquisition strategy–in a way that’s successful for investors.
In January 2016, Abbott agreed to acquire Alere for $5.8 billion or $56 a share. At the time Abbott estimated that the Alere deal would add 21 cents a share to earnings in 2017 and 29 cents share in 2018. Those aren’t insignificant boosts to earnings since Credit Suisse estimates that Abbott will earn $2.20 in 2016.
But apparently someone at Abbott missed something in due diligence. In March Alere received subpoenas from the U.S. Department of Justice in an investigation into the company’s sales practices and charges of bribery in order to secure sales.
Alere is pressing for the deal to close and Abbott seems to be looking for a way to back out. The deal looked like it was headed to court, but now looks like it will go to mediation.
Even the possibility of the deal heading to litigation raised questions for me about Abbott’s ability to execute a growth by acquisition strategy. Abbott has claimed, in what looks like an attempt to kill the deal, that Alere has denied it access to information crucial to moving ahead with the deal. Alere has, in response, claimed that it has fulfilled its obligations to provide data to Abbott. Unfortunately the merger agreement itself is rather vague on the issue of access to information. It requires Alere to provide “reasonable access” to officers, employees, agents, properties, books, contracts and records.
Who negotiated this thing?
These questions wouldn’t matter so much except that Abbott announced a second, even bigger acquisition, while the Alere deal was getting bogged down in wrangling.
In April Abbott agreed to acquire device-maker St. Jude Medical (STJ) for $25 billion (or $85 a sure) in a mixed cash and share deal. The deal wasn’t especially over-priced at about 17.7 times EV (enterprise value) but the difficulties with Alere and the company’s attempt to do two deals at once, opened the door to an attack by short sellers. A research report from a cybersecurity company MedSec Holdings, which initially looked like it came from an outside party but where the outside party turned out to have approached short seller Muddy Waters, claimed that St. Jude’s home monitoring equipment, which is used to send information from a patient’s pacemaker or defibrillator to a doctor, did not have standard security technology on encryption and authentication and could be hacked and was vulnerable to denial of service attacks that would drain the devices batteries. The truth seems to be that the U.S. Food & Drug Administration is concerned about the security of all medical devices and has been working with companies to improve security. St. Jude has denied MedSec’s conclusions and raised serious questions about some of its assumptions.
I’d call the short attack a consequence of the less-than-flawless execution of the Alere deal. Once a deal has opened a company management to doubts about its ability to execute complex deals, it’s very hard to put those doubts to rest.
So investors in Abbott Laboratories, and the stock is a member of my Jubak Picks portfolio, have to ask themselves two questions here.
Is management going to be able to execute its growth by acquisitions strategy? I’d say the jury has doubts but is still out. Certainly the deal struck on Friday to sell Abbott’s eye-surgery equipment unit to Johnson & Johnson (JNJ) for $4.33 billion is evidence in management’s favor. It makes sense to sell a non-core business (and use the money on deals such as the St. Jude acquisition) rather than spending big to try to catch up to the sector leaders. My judgment at this point doesn’t call management’s basic competence into question, but so far I wouldn’t call this one of the top grow by acquisition teams in its industry either.
Which brings me to my second question: If Abbott is, like many other companies, adopting a growth by acquisition strategy is an investor getting the best execution of that strategy, the one mostly likely to make the most money for that investor? Here the answer largely comes down to a question of Can an investor find a better alternative in this space and using this strategy? My answer is “Yes.” So I’ll be selling Abbott out of my Jubak Picks portfolio tomorrow and using the cash to buy a company that owns a better mousetrap when it comes to profiting from acquisitions. I have a 95.3% gain on my position in Abbott Laboratories since I added it to the portfolio on September 24, 2010. That gain does not include dividends.