- - Thursday, March 31, 2011


As part of keeping up with my existing thematic viewpoints and working on new ones, I constantly read news stories, magazine articles and other publications from around the world. Over the past several months, there have been more features on the topic of consolidation, across several different industries: From mining and biotech, to industrials and technology, to fertilizers and equipment companies.

As someone who got started in the investing business by looking at cyclical stocks and later migrated into technology, the predictable pattern of strong growth, followed by slower growth as an industry matures, then eventual consolidation is not a surprise. Rather, it is to be expected. I suspect most people can name the top few companies — market share leaders — in more than a few industries. Not surprising, since the 80/20 rule applies with 80 percent of the market share held by the top few companies, and the balance spread across the remaining players.

In order to understand where in the life cycle an industry is, it is important to understand what the typical stages are in an industry life cycle:

• Early stages phase — Alternative product design and positioning, establishing the range and boundaries of the industry itself.

• Innovation phase — Product innovation declines, process innovation begins and a “dominant design” will arrive.

• Cost or shakeout phase — Companies settle on the “dominant design”; economies of scale are achieved, forcing smaller players to be acquired or exit altogether. Barriers to entry become very high, as large-scale consolidation occurs.

• Maturity — Category growth is no longer the main focus, market share and cash flow become the primary goals of the companies left in the space.

There are a number of industries, such as mobile phones, TVs, agricultural and construction equipment, autos, beverages, insurance, banking, media and more that rest between the cost/shakeout phase and maturity.

As with most aspects of investing (and according to an ogre like Shrek, onions as well!) there are layers that need to be considered as an industry consolidates. I tend to think of it more as ripple effects, similar to when you skip stones in a pond — once the stone skips on the water, a ripple shoots across the top of the water, thereby affecting the water nearby it.

This same ripple effect takes place when a company starts to consolidate its industry and ripple effects can bee seen across the industry’s food chain of companies. As other companies respond to the consolidation wave, merger & acquisition (M&A) activity heats up, and in some cases becomes a feeding frenzy, which may or may not result in sensible deals a few years later. Much like the game of musical chairs, a company is left standing alone when the consolidation music stops and may very well be left out of the rest of the game. While AT&T Inc. makes its move on T-Mobile USA, what does it mean for competitors like Sprint-Nextel Corp. and Leap Wireless International Inc., or suppliers like Alcatel-Lucent, American Tower Corp. and the like?

The point is as investors we need to proactively contemplate industry evolution as part of our investing homework. Yes, it’s a chess game of sorts but it’s important to understand strategic gaps, product holes and other issues that companies we are investigating must deal with through either organic growth (internal solutions brought to the market) or by acquiring a company to fill that competitive deficiency. As the saying goes, let the buyer beware or be aware in this case.

There also are M&A deals that deliver far less than expected, and in some cases investors have to wonder what the strategic imperative was behind such deals to begin with, at least from a consumer perspective. Examples include AOL acquiring Time Warner, which were later split apart, and Sprint acquiring Nextel. Sprint acquired Nextel for $35 billion in 2005 and recently announced that it would begin shutting down the Nextel network in 2013 as it unburdens “itself of having to operate two incompatible services.”

Given corporate cash balances and the M&A outlook, it appears the strong M&A activity in first quarter of 2011 is poised to continue.

What makes me say this? Cash now accounts for more than 13 percent of corporate assets, the highest since 1984 according to Standard &Poor’s. The 13 biggest cash-hoarders among companies in the Standard & Poor’s 500 had stockpiled more than $300 billion in cash by the end of last year. Among them: Cisco Systems with $40.2 billion cash on hand, Microsoft with nearly $40 billion and Google with nearly $35 billion. At the same time, the fourth annual M&A survey conducted by Brunswick Group LLC finds that 92 percent of top bankers and lawyers polled think that the level of deal volume will continue to rise this year following a strong first quarter in M&A volume. This view is reinforced by PwC Transaction Services, which sees key conditions in place for deal making to surge.

Stay tuned.

Chris Versace, the Thematic Investor, is director of research at Think 20/20, an independent equity-research and corporate-access firm in the Washington, D.C., area. He can be reached at [email protected] At the time of publication, Mr. Versace had no positions in companies mentioned; however, positions can change.



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