The Survival Instinct

When cornered, businesses will overpay for assets they really want.

Last November Hewlett-Packard wrote down the value of Autonomy by a staggering $8.8Bn, after buying it for $11Bn just over a year earlier. HP also acquired EDS for $14Bn in 2008 to help it to transform, from a commodity pc and printing player, into an enterprise storage, network and software business. Acquisition based transformation is alive and well in this sector, just look at, possibly soon to go private, Dell, and its recent acquisition trail. Arguably, both companies had no other options but to go buy established businesses.

Why did the Autonomy deal go so horribly wrong? Is it just that, in the fast-moving technology sector, it is harder to judge what businesses are worth than in other, more pedestrian, industries? The Facebook IPO fiasco showed us just how hype and greed can lead to over-paying for a relatively unproven business. Maybe that explains it? My guess is that, to some extent at least, the Facebook and Autonomy valuation mistakes can both be put down to a bit of a technology valuation bubble; the enthusiasm and greed that confuses the thoughts of even the most level-headed investor, as he dreams about the riches the future holds in store.

But just how do you explain today’s news from Rio Tinto? It has just announced another $10Bn write down on its ill-judged acquisition of Alcan in 2007, a deal worth about $44BN at the time. To date, total “impairments” on this deal are reported to be $20Bn! The financial crisis may not have helped but, it paid twice as much as it now appears to be worth. Not content with that, the outgoing CEO, who rather obviously accepts that the buck stops with him, was party to  a coal deal in Mozambique, just two years ago, that has also been written down to the tune of $3Bn. Incredible as it might seem, Rio only paid $3.7Bn for the business, net of cash, in 2011. That’s a write down of over 80% in less than two years.

In total, Rio has now made new write downs amounting to about 14% of what the whole business is worth today. That its share price only dipped a few % points perhaps shows that it was only management, and not investors, who ever thought it was worth that much. The Alcan write down appears to have been expected, but the coal one not. Apparently, it was “the wrong sort of coal” the less valuable stuff; it expected something else, metallurgical coal, whatever that is. Oh, and it assumed it could export the coal down the Zambezi River, but the government said no, so it would have been forced to build a railway line. All this is rather hard to believe, isn’t it?

To my mind, the fascinating connection, between these apparently different sets of heroically poor decisions, is that they were both forced by desperate attempts to diversify.  Like HP, Rio is very keen to diversify too, in its case away from Western Australian iron ore, where it makes most of its profits.  It really wants to be a global player like its rivals, but not like this. I think it’s all rather straight-forward really, when cornered, human begins will grab at more risky options, in order to save themselves, and it seems that it also applies to CEO’s with cornered businesses too. The more they are cornered the bigger the risks they will be prepared to take and with rising risk the greater the likelihood of mistakes like these. Beware of a cornered CEO, they can be unpredictable; unless of course you have something she wants and then you can ask any price you like, it seems, so that she can at least survive in her job that little bit longer.


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