A merger master's playbook: there is a time to buy and a time to sell, and always a time to do right for the shareholders.

Ed Note: J.B. Fuqua (1918-2006) built a small manufacturer of bricks into a multibillion-dollar collection of businesses known as Fuqua Industries. This self-made entrepreneur who never went to college (but became a major benefactor to Duke University, which named its business school after him) was renowned in the M & A community in the 1970s and '80s for his savvy dealmaking. In 1984, a few years before he sold his controlling interest in the Atlanta-based company, he authored "Size vs. Strength: The Making of Stockholder Wealth," an article for DIRECTORS & BOARDS that laid out some of his fundamental value-creating principles. An excerpt follows. He died in April 2006 at the age of 87.

I BELIEVE THAT stockholder wealth is the most important ingredient in our capitalistic system. In top management we often sit around figuring out how to buy out another company. Actually, what we ought to do is figure out how to increase the value of the stockholders' interest. In my company, I concentrate on that to a greater extent than executives in many public companies, perhaps because I am a significant stockholder myself.

The idea that bigger is always better just isn't true for all corporations in our economic system. I did a little exercise many years ago, which I recommend. I had my associates do a thorough study of what happens with acquisitions in major, acquisition-minded companies. From that study I can tell you that it is hard to justify many of the acquisitions most of us have made. Often, the only ones who win are the stockholders of the acquired company.

We've restructured Fuqua Industries in view of the cycle we've been through, where economic conditions were bad, and we've strengthened the company not by increasing its size but by decreasing it. We had built Fuqua through acquisitions until, in 1979, we had sales of over $2 billion. For 1983, we are down to about $750 million. That shrinkage was done intentionally, and the company is stronger than ever.

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In mid-1980 our company was selling for around $15 per share, well under book value despite the fact that 1979 was one of the best years we ever had. In determining ways to enhance the stockholders' investment, we didn't start by saying, "Let's see what we can acquire to make the company bigger." We said, "Let's see what we can do to increase the value of the stock."

Certain well-known economic fundamentals came into play. There is a time to buy and a time to sell, particularly in a conglomerate. We went over every subsidiary to determine which units might ride through a recession and continue to give us a good profit. Even though they were profitable, those that looked like they might have a problem in the coming recession were sold, and then we redeployed the money.

In 1980 we were in the trucking business with a company we bought in the early days. We had built it up to a $350 million (revenues) transportation company, and it was separately financed. That year we just spun it out to the stockholders. Last year it lost $15 million. If we had that trucking company in Fuqua Industries today the value of our stock would be a great deal less, perhaps half of what it is. Our action did not harm anyone; the company was able to operate on its own, and we relieved ourselves of what we thought would be a problem, and indeed it did develop into one.

Divestitures are not necessarily made because companies are unprofitable. We used to always sell a company when it became unprofitable; now we sell for a number of other reasons. One of the basics in economics is that if a business is worth more to someone else than it is to you, it is to the benefit of your stockholders to sell the business. In 1980 we sold all of our television stations--sold them for 27 times earnings. There was no way in a conglomerate we could justify owning something that valuable to someone else.

Another economic fact of life is that when your return on equity is less than your cost of equity, the stock is going to sell below book value. When the return on equity is about the cost of capital, the stock will sell for more than book value, and will sell for an amount that will reflect market conditions in the stock market at a given time.

Influencing the stock price

Now I don't say you can determine what the stock is going to sell for; that depends on the particular timing in an absolute sense. But relative to the rest of the market, I believe that you can influence it to some extent: If you reduce the equity and have the same earnings, you can increase return on equity. Return on equity is really what the stockholder is looking for, and what the market responds to.

As you go through your portfolio of businesses, identify those that produce a low return on investment and determine what your minimum rate of return on investment is. (This will vary from one management to another, from one company to another, and from one industry to another.) Then determine the lowest return on investment you can accept to maximize stockholder wealth, and get rid of those businesses that cannot be expected to meet that minimum requirement.

It is so much easier to sell a business now than it used to be. In the early days, if I made a mistake in an acquisition, it was quite a project to sell it off. But now it is no problem.

The leveraged buyout business is something new to someone my age. Frankly, I grew up in the era when banks wanted you to pay the money back; they wanted to look at the cash flow, and you had to demonstrate how you were going to pay it back. They don't do that anymore. In 1982 my company sold $50 million worth of assets to one of the major New York banks. I say "sold it to the bank" because the principals had virtually no capital. In effect, we sold it to the bank. Thank goodness that kind of thing is going on now. For the banks, as they equate their lending policies, these were good deals, although some observers are starting to question whether banks are in trouble with all these leveraged buyouts taking place now.

Another factor making divestitures easier than I have ever seen is that it is often easier for the seller to arrange financing than it is for the buyer. As have many other companies, we've sold some business units to management, and helped make the financial arrangements. In fact, we can almost give a business to management and say, "Here it is, it's your business." That is a big advantage.