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Valuation: Avoiding the Winner's Curse

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Why did more than 50 percent of the major mergers and acquisitions in the United States completed in the 1990s erode shareholder value? And why did more than 77 percent of those transactions not earn a rate of return at least equivalent to the cost of the capital necessary to finance them? The answer to both questions is often the same: overestimation of target firm value.
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The Quaker Oats Company— The Significant Cost of Valuation Errors

The Quaker Oats Company's $1.7 billion purchase of Snapple in late 1994 stands as one of that decade's worst acquisitions. With Snapple's poor operating performance dragging the consolidated operating results down, Quaker's stock price stagnated while the Dow Jones industrial average moved up by more than 70 percent. So now that Quaker has sold the beverage company, should Quaker shareholders celebrate?

Mourning would be more appropriate. The price Quaker paid for its soft-drink misadventure goes well beyond the $1.4 billion in losses directly associated with the sale of Snapple to Triarc Company for just $300 million. In addition, Quaker absorbed more than $100 million in cash losses and charges related to Snapple from 1994 to 1997. And since the deal damaged its balance sheet, Quaker's credit rating suffered, raising its cost of capital.

Another cost: Quaker helped pay for the acquisition by selling its petfood and candy businesses that had given it a larger scale, steady earnings, and international reach. It also paid punishing capital-gains taxes on those sales.

The total losses associated with the Snapple acquisition may well exceed the original acquisition price.

Adapted from G. Burns, "What Price the Snapple Debacle?" Business Week, 14 April 1997, 42.

Why did more than 50 percent of the major mergers and acquisitions in the United States completed in the 1990s, according to Business Week magazine, erode shareholder value? And why did more than 77 percent of those transactions, according to Forbes magazine, not earn a rate of return at least equivalent to the cost of the capital necessary to finance them? The answer to both questions is often the same: overestimation of target firm value.

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