Dow, S&P Find Small Gains As Technology Suffers From Facebook Drubbing

Synergy - the bonus that is achieved when things work together harmoniously.
Mark Twain

Couples are famous for having difficulty working together in cars. Often, a guy is driving the vehicle and finds a way to, shall we say, momentarily lose the proper direction. The lady decides it might be good to get some guidance and seek out a person who knows how to get back on course. When I convey this, clearly I have a little bit of personal experience here, so if a guy is intelligent he will ultimately give in and find someone to help. An even better event, though, is when you know the correct path to your ultimate destination, and on the way you can accomplish an additional task because it fits nicely into your route. Essentially, you are finding a situation where one plus one equals three, not two. In the business and finance world, the term used for this is synergy, as Mark Twain so elegantly noted. So why is synergy an important idea to understand and look for if you are an investor?

The longer you are involved in financial markets, the more you realize that deals can have a trans-formative impact on how an industry evolves. We have seen it over and over again in the last decade. In the deal world, investment banks lie at the center of the universe. When mergers and acquisitions are negotiated and then executed, the synergies of a deal become an important aspect to consider. Synergies can take the form of potentially greater revenues, or reduced costs. The simplest explanation is if you take two companies in the same industry, and you merge them, you now have two different marketing, sales, finance, legal, human resources, and corporate staffs serving one company. Clearly, not everyone is going to survive so the duplicate costs get cut out when analyzing what the leftover company will be. On the revenue side, usually what takes place is a larger company buys a smaller company to plug needed products into the larger footprint. By filling a needed void into a larger distribution system, the larger entity keeps all the revenues and profits by having and also owning the new product (versus not having it and paying some other entity to get it). Deals like the Amazon.com Inc (NASDAQ:AMZN) - Whole Foods acquisition, Google (NASDAQ:GOOGL) buying You Tube, Microsoft (NASDAQ:MSFT) landing LinkedIn (NYSE:LNKD), and maybe Walt Disney Company (NYSE:DIS) getting the prime Twenty-First Century Fox Inc (NASDAQ:FOX) assets, are examples of situations where entire industries can be dislocated because of the great fit between two companies. There are many academic studies about how most mergers and acquisitions are value destroying, something like AOL-Time Warner being the most obvious. However, synergy is a real economic value that astute investors pay attention to when deals are announced. If they are real, over time, the impact can be dramatic and enormous.

In the markets this week, the forward guidance of reduced operating margins by Facebook (NASDAQ:FB), from mid forties to mid thirties, shaved a cool 100 billion of the value of the company in one day (greatest one day loss ever). Twitter also took it on the chin when their monthly average users disappointed because they took steps to get rid of fake accounts. On the positive side in the tech area, both Google and Amazon (NASDAQ:AMZN) wowed investors with their top line growth, and in Amazon’s case, an emerging advertising business which has fabulous margins. You have to think both management teams realize they will increasingly be butting heads with each other when going after more market share. In the energy domain, Shell (LON:RDSa), Exxon (NYSE:XOM), and Chevron (NYSE:CVX) disappointed on the upstream side because of turnaround (scheduled maintenance) activity, though all are spending heavily to buy back stock. Clearly the higher oil price helps fund those purchases.

In the macro area, second quarter US GDP growth came in at 4.1%, a tad below the expected 4.2%. President Trump decided to take a bit of a victory lap about it, imagine that. His administration believes the 3+ number is sustainable, with consumer confidence and spending robust. In combination with the US agreement with the European Union on reducing tariffs in a few selected areas, dollar strength will continue if the three plus GDP numbers have any staying power. China continues to take measures to add liquidity in their market, and the Yuan drifted lower versus the dollar. Looking at next week, Apple (NASDAQ:AAPL) is the biggest name to look at as they report Tuesday after the bell, although the action will be hot and heavy as there will be a full slate of releases over the next five days. You can bet that some of the results have been greatly influenced by past deals and the synergies that took place with them.

Yale Bock, Y H & C Investments, its clients, and the family of Yale Bock have positions in the securities mentioned in the blog, Investing in securities involves risk and the potential loss of ones principal. Past performance is no guarantee of future results. All investment decisions should be considered with respect to ones risk tolerance, return objectives, liquidity needs, tax considerations, and one's overall financial situation. The fact that Yale Bock has earned the right to use the Chartered Financial Analyst in no way means or guarantee performance better than market indexes.