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Power Sheet – May 24, 2016

The prospect of making a giant acquisition often seems to infect CEOs’ minds with delusions of glory. They envision themselves standing triumphantly atop a corporate colossus, commanding an empire that Alexander would have envied. Eventually they forget that their field is business, not global conquest, and that the definition of success is not closing the deal but rather benefiting shareholders. Signs suggest that Bayer CEO Werner Baumann has succumbed to this malady.

His $62-billion cash bid for Monsanto would create a vast, globe-girdling company, and he justifies it by projecting impressive synergies and cost savings. Monsanto has rejected the bid, as it wants an even higher price for its assets. Meanwhile, investors don’t seem to see the value. They’ve stampeded away from Bayer’s stock since rumors of the deal began circulating, sending it down to a 52-week low yesterday and reducing the company’s value by $25 billion. This, sad to say, is utterly typical when a company proposes a giant takeover. The stock of the target company, by contrast, typically leaps, and that’s just what happened; Monsanto gained $7.2 billion of value, hitting a 10-month high yesterday (before Monsanto rejected the bid this morning).

That is, investors expect this deal to be a value destroyer for Bayer shareholders and a value enhancer for Monsanto shareholders. The reason is surprisingly simple, and you’d think CEOs would figure it out more often than they do.

The value of a business is based on how investors expect its return on invested capital to exceed (or not) the cost of all the capital in the business. The result is what finance types call economic profit. It’s an elementary concept, yet most financial reporting doesn’t tell you much about it. So I turned to the EVA Dimensions consulting firm, which crunches the numbers needed to figure economic profit. Here’s what they show, using Bayer’s initial bid for Monsanto as a starting point.

If Bayer were to pay $62 billion for Monsanto, that’s $62 billion of new invested capital. The dollar cost of that capital for Bayer would be about $4.7 billion a year. So the Monsanto deal is a value creator for Bayer only to the extent it can bring in profit (net after-tax operating profit, if you’ll forgive the finance jargon) beyond that amount. What are the prospects of that happening? Well, by that measure Monsanto’s profit last year fell far short, at only $2.6 billion. Not encouraging, especially since the numbers would increase if Bayer ups its bid.

Maybe Baumann thinks he can make up the difference through synergies and cost savings. But Monsanto CEO Hugh Grant can calculate those potential economies about as well as Baumann can and is thus well positioned to extract most of them for his shareholders in the price negotiation. Or maybe Baumann figures he can get the returns up to the needed level in a few years; but of course future profits must be discounted back to the present at Bayer’s cost of capital (about 7.6%), so they lose value quickly as they get pushed out.

Even deals that make sense strategically turn into losers if the price is too high. Think of Boston Scientific’s disastrous purchase of Guidant in 2006 or Xerox’s deal for Affiliated Computer Services in 2009. This looks like another classic example. At least that’s what investors think, and CEOs need to stay focused relentlessly on investors, despite a big deal’s glittery allure.

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What We’re Reading Today

Viacom CEO sues Shari Redstone  

Days after being ousted as a trustee of Sumner Redstone‘s estate and removed from the National Amusements’ board, Viacom CEO Philippe Dauman has sued Redstone’s daughter. George Abrams, a Viacom director also removed from both positions, has joined the suit. They argue Shari manipulated Redstone, who doesn’t have the mental capacity to make such a decision. However, it creates an ever-growing messy situation, since Viacom’s CEO is suing the president of National Amusements, the company that owns 80% of Viacom’s voting shares.  USA Today

NFL’s attempt at dodging a brain study   

A congressional report has accused the NFL of trying to influence a major brain study on concussions by dictating who would conduct the research. Commissioner Roger Goodell and the NFL had provided the National Institutes of Health a $30 million unrestricted gift for research. When the NIH hired a researcher who has spoken out against the NFL, the league tried to have the researcher removed and replaced with members of its committee on brain injuries. When that failed, the NFL chose not to provide the unrestricted gift. The NFL has rejected the findings of the report. ESPN

Facebook tweaks Trending Topics policy

The social media site said that, after an internal review, its ‘Trending Topics” selection process did not lead to bias. However, it will remove the ability to select the importance level of a topic, and it will no longer rely on a list of outside outlets to verify a topic’s importance. Mark Zuckerberg‘s company has faced pressure from the political right, including an inquiry from Senator John Thune, as reports indicated Facebook suppressed conservative media. VentureBeat

Toyota recalls 1.6 million more vehicles… 

…due to faulty Takata airbags. The decision comes after Takata had announced earlier this month that it would need to recall 35 to 40 million more airbag inflators. That brings the total recall for Akio Toyoda‘s company to 4.73 million vehicles, while Shigehisa Takada continues to remain silent in his response to Takata’s crisis. Fortune

Building a Better Leader

Netflix’s efforts in hiring top talent includes… 

…developing a strong relationship between talent managers and recruiters. SHRM

The best advice Martha Stewart ever got…

…came from her father. He told her that she could do anything, but she would have to work for it. Fortune

Startup employees turn to obscure law… 

…to see how much their shares in the company they work for are worth. The Delaware law can force startups to share financial statements with employees who are also shareholders. WSJ

Dramatic Turns

Doubts grow over Anthem-Cigna merger

After reports indicted that Joseph Swedish‘s Anthem and David Cordani‘s Cigna are squabbling, investors fear that the $54 billion merger between the two could fall through. The two sides have bickered over information to provide antitrust regulators and an Anthem lawsuit against Express Scripts. Reuters

Men’s Wearhouse founder wants his company back

George Zimmer, the founder of Men’s Wearhouse, has been speaking with private equity firms to purchase the company from Tailored Brands. If his bid is successful, he would likely replace most of the management team. Zimmer and Tailored Brands went through a publicly hostile divorce. There’s no indication that Men’s Wearhouse would consider selling the company back to Zimmer. Fortune

Is a silent hand attacking Gawker?

Gawker founder Nick Denton believes that a private backer may be targeting the news site through lawsuits. Denton had started to speculate of such a nemesis during the three-year long legal battle with Hulk Hogan. Now, a series of new lawsuits attacking certain Gawker writers, all coming from Los Angeles litigator Charles Harder, has Denton questioning whether someone seeking revenge on the site is doing so by funding the lawsuits. NYT

Up or Out

Versace has tapped Jonathan Akeroyd as CEO, replacing Gian Giacomo Ferraris.  WSJ

The Transportation Security Administration removed security chief Kelly Hoggan from his post due to a $90,000 bonus he received in the middle of public outcry over the length of time flyers must wait in security lines.  Fox News

Fortune Reads and Videos

Ebay is expanding StubHub

It just bought Ticketbis, a Spain-based ticket hub that has a presence in 47 countries, which Ebay will wrap into StubHub. Fortune

The Best Workplaces for new grads…

…offer plenty of opportunities for young talent and sweet perks. Engineering firm ENGEO tops the list. Fortune

China’s richest man is in a fight with Disney

Dalian Wanda Group founder Wang Jianlin is turning his focus toward amusement parks and says Disney China would be unprofitable for at least 10 years. Fortune

The gig economy is a big drain on the IRS

Over two-thirds of gig economy workers make less than what’s required to report income to the agency. Fortune

Quote of the Day

“They wanted to look like the good guy, like they were giving money for this research…. But as soon as they found out that it might be somebody who they don’t like who’s doing the research, they were reneging on their commitment, essentially.” — U.S. Rep. Frank Pallone, Jr, the ranking member on the Energy and Commerce Committee, which investigated the NFL’s attempt to sway researcher selection in the NIH’s concussion study ESPN

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