In these days, investors are in the habit of paying a high premium for companies involved in a merger, in the belief that a merger would strengthen the competitive position of the companies.
Actually whether or not a merger will work out depends on a lot of things. To say that every combination of companies will be a good thing is tantamount to saying that every marriage will have a happy end.
A "combination" is likely to succeed in cases of carefully planned mergers of firms with compatible or complementary product lines; otherwise, more often than not, mergers result in such things as poor digestion and incompatibility.
Throwing businesses together merely for the sake of aggrandizing corporate structure only swells volume with a shrinking profit margin is the worst thing that can happen to a business.
The acquisition of Continental Electronics Manufacturing by Ling-Altec Electronics provides us with an excellent pattern for analyzing other mergers and acquisitions. According to Ling's President, James J. Ling, this acquisition will increase Ling's backlog by a staggering 425 percent and sales by 85 percent. And that's not all.
The real beauty of the situation, say the experts, lies in the price Ling-Altec paid for the massive backlog, sales and earning power of Continental: $3.5 million cash, a $125,000 straight note and a token 10,000 shares of common stock. Each share of Ling-Altec common before the combination was expected to generate about $26 in sales for 1960.
On the other hand, each of the 10,000 shares relinquished to Continental will return nearly 3,000 sales dollars to Ling-Altec; a genuinely dilution-free acquisition.
In their eagerness to diversify into electronics, some aircraft companies have paid as much as three sales dollars of their own business for every one of the concern to be acquired, or traded per-share earnings of $1.50 for per-share earnings of 5O cents.
The result is, of course, common-share earnings dilution, the very opposite of what a merger is supposed to accomplish, since earnings is the most important single reason for anybody to enter into any business.
It may be justified to pay a high premium for an electronics concern, which eventually would increase per-share earning power. That, however, does not change the fact that the merger is hampered by a high initial cost. It would be a lot better if no initial premium were paid. It would be better still if below-the-average cost should be paid for a concern
which has not just a touch of electronics, but operates, as Continental Electronics, in one of the most exciting electronics areas today high-power transmission equipment.
The subsequent dramatic price appreciation of the Ling common over-the-counter should come as no surprise, especially to those who knew how the earnings potential of this Ling-Altec-Continental combination had been sharply elevated.
These are the things to look for in a merger situation. Before jumping into one, you should ask at least one question. How will the merger affect per share earnings? This is, of course, not all that you should know; however, it will save you a lot of trouble if you get the answer before getting into any merging stocks.