Why timing of synergies is as critical as capturing synergies in deal making?

Introduction

  1. More companies are using M&A as a tool to capture higher growth by increasing market share and drive higher revenues.One of the underlying assumption when doing a M&A transaction is that the combined value of the target and acquirer post deal would be more than the value of the standalone companies pre-deal.This is termed as Synergy and is critical input while arriving at the final purchase price for the deal.
  2. The final purchase price takes into account of the future cash flows generated by the target company standalone and the synergistic cash flows arrived as a result of this acquisition.In order to derive the final purchase price, the acquirer needs to identify and quantify the synergies opportunities present in the deal.This process of identifying synergies happens during the due diligence process.
  3. Post due diligence, the buyer arrives at the final bid price that takes into account the standalone value of the target along with synergies.If the target has more than one bid, then the acquirer can mark up the purchase price above the enterprise value of the target but below the combined enterprise value and total synergies value arrived.This is termed as takeover premium.
  4. Once the target agrees to the final bid price, the deal is announced.It is important that the buyer clearly communicates the deal rationale to the investors along with synergies identified and the synergies values that the acquirer intends to realize during integration.If the synergies break up along with timing of synergies realization are shared with investors, then it is likely that investors would give a thumbs up to the deal even if the acquirer has paid a premium to the seller.

Why Synergies are win-win proposition for both acquirer and target?

  1. In M&A transaction, even though the acquirer buys the seller, the presence of synergies in the deal is a win-win proposition for both buyer and seller.
  2. Due to the synergies identified which is then quantified by the buyer during the due diligence process, the buyer pays a premium to the seller above its standalone enterprise value.
  3. It is also important to note that the identifying synergies and realizing synergies are different.The acquirer in most cases also overestimates the synergies that can be realized during the pre-deal phase in order to get approval from its board.

Types of Synergies

Most M&A transactions classify the synergies into three major categories

  • Revenue Synergies
  • Cost Synergies
  • Financial synergies

When the acquirer provides the synergy estimates to investors during the deal announcement, it would invariably share the cost synergy estimates.This is because the cost structures of both the entities are known before hand and also cost savings are easier to implement by eliminating duplicate functions, overheads and excess resources/systems.
In case of revenue synergies, there is lot of uncertainty involved in selling additional products/services to existing customers.It highly depends on customers whether they wish to buy bundled/cross-sell offerings of buyer.

Timing and Capturing of Synergies post deal

  1. Once the deal is announced, the acquirer shall immediately build an integration team to realize the synergies targets that were proposed during the pre-deal phase.
  2. The integration team should not immediately rush on the synergy targets that are proposed during the due diligence process.The integration team should do it’s own diligence with the available information of both buyer and seller to validate if the synergies targets set during the due diligence are achievable.In many cases, the due diligence team would have over estimated the synergy targets.Hence the integration team should come up with a revised synergy target.The synergy target to be taken by the integration team would be 20-30% more than the synergies targets announced by the acquirer to its investors.
  3. The revised synergy target should be further split into synergy targets by Cost and Revenues along with timing of synergy realization.It is extremely critical for the integration team that it is able to come up with a timeline when synergies shall start to be realized.

Important steps in Synergies Realization

  1. Once the integration team identifies and validates the synergies targets along with the timing of synergies realization, it has to build a detailed integration plan to realize those synergies.
  2. Before that, the existing revenues source of both buyer and targets needs to be protected.It is extremely important that the Day1 integration is seamless where all the important stakeholders including customers, employees and suppliers are communicated about the deal rationale and how the proposed acquisition shall benefit everyone.This stabilization phase is required to ensure that all the important stakeholders agree/ reconcile to the acquisition and are motivated to success of the acquisition.
  3. Post the stabilization phase, where the existing revenues are protected, the integration team should look at executing cost synergies to realize the savings. This could include closing of excess plants/factories, supplier consolidation, centralization of backoffice functions and removing excess employees to improve the productivity. An integration plan for each of the cost synergies needs to be built and tracked to ensure that the synergies targets are realized.Generally the cost synergies should be executed within a year of deal closing. The integration team needs to ensure the synergies savings pass on to the P&L statement so that it is communicated to the board.
  4. Revenue synergies are generally more difficult to execute compared to cost synergies.These synergies can be implemented in cases where acquirer and target business is complementary.This can result in cross-selling and bundling combined services to existing and new customers.For revenue synergies to be successful, the sales team plays a very important role as they would be responsible for selling additional products/services to customers.
  5. Hence before executing the revenues synergies targets, the Salesforce of both the buyer and target needs to be communicated the importance of deal rationale and any changes to their compensation/quota/accounts owned/territory as a effect of this deal.Once the sales team understands the deal rationale and is clear on their targets/compensation, it would be easier to implement the integration plans to achieve synergy targets.The sales team should also be given training on the new products/services that they need to sell to the customers.In case of joint accounts, clear account planning is required along with identifying the owner for the joint account.Generally the revenues synergies start to realize between 1st and 2nd year of deal closing.
  6. It is also important that the cultural integration between the buyer and seller is executed seamlessly in areas like way of Working, gaps in processes and different cultures between employees . Once the employees of both entities are aligned to each other and on the overall targets, it would be easier to achieve the revenues targets.
  7. Financial synergies plays an important role in the purchasing power of the combined entity.The combined entity post acquisition will have a high borrowing power at lower cost of capital to raise funds for investments.In case of acquisitions involving small target and a large buyer, the target can leverage the balance sheet strength of the buyer to make additional investments/expansion to new markets.Any synergies that can be realized due to financial leverage should be taken into account. The timing of such synergies to realize shall take more than 2 years.

Conclusion

  1. Identifying, quantifying and realizing the synergy targets forms the genesis of a M&A transaction involving a strategic buyer.
  2. To what extent should the purchase price be increased to take into account the synergies opportunities is critical for the deal team to focus at.
  3. The timing and implementation of synergies targets post closing is extremely important to arrive at the success of the deal
  4. The integration team should also have a detailed metrics driven reporting process that tracks the synergies targets all the way till it flows into P&L statement.
  5. The progress and success of the deal should be communicated periodically to all the stakeholders including the investors.


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