- December 11, 2019
- Posted by: Ramkumar
- Category: Mergers And Acquisitions
Synergies in Mergers and Acquisitions
The word synergies in mergers and acquisitions get frequently abused in the M&A vocabulary, notably by some investment banks, deal brokers, and consultants, all assuring them in excess and quickly delivered.
We’re all accustomed to the data– traditionally, around 50% of M&A transactions fail to be accretive or succeed in increasing shareholders’ gains. What’s even more intriguing is that this number hasn’t altered extensively in the past 30 years. On a promising note, we think that acquirers can take decisive action to improve their odds of success in delivering value to M&A. An abundance of business data and objective analysis hints a plenitude of causes behind M&A disappointing to deliver. Some reasons are a poor strategic fit, failure to underline risks and concerns in due diligence, cultural differences, an incapacity to execute change in the new company, lousy program management, and external market position. All these reasons usually head to a failure to fulfill synergies.
Nonetheless, supplementing value to a consolidated business is customarily the point of M&A and senior managers. These executives always indicate challenges in achieving financial synergies as one of the critical reasons for M&A not delivering.
For the inexperienced, synergies are reforms that firms gathering to an M&A transaction would not have succeeded as standalone entities. These get classified in terms of the financial statements they impact (e.g., P&L, balance sheet, cash flow). Onetime or continuing commercial synergies get correlated with cost savings or revenue addition (primarily impacting the P&L). Capital synergies link to ongoing improvements in financial/capital execution, such as working capital cycles and financing costs. These synergies are fundamentally affecting the balance sheet and cash flow statement.
Synergies regularly are – exaggerated, take too long to fulfill, or are not produced at all, while the costs to realize synergies get frequently miscalculated or neglected. Additionally, “negative synergies” – those situations in which ongoing operating costs go up, not down post-close (e.g., due to the requirement for added headcount in accelerated growth sectors) – are seldom recognized. Whatever the specific reason, the consequence is often alike: M&A deals under-deliver value.
It’s obvious to overrate synergies – possibly to support a competitive deal value or inaccurate valuation premises produced by a lack of robust data collected during due diligence. Several companies are not only exaggerating synergies – but they are also neglecting to thoroughly understand the full potential of synergies achievable from a deal.
The characteristics of today’s deal-making have significantly evolved from the eras of M&A solely for scale and revenue growth. Instead, today’s M&A get signified based on businesses attempting to become market leaders; reach to current organizational abilities, products, services, technologies, and IP; access to frequently wealthy consumers in developing markets, diversification of a product/service, and also acquiring essential talent in the market.
There is a need to concentrate on operational stability on Day One – value creation (i.e., exercising decisive actions to obtain value from a deal).
Synergies in Mergers and Acquisitions – Levers for Value Creation
Thoroughly managed, financial synergies should add to a business value exceeding the sum of the elements of two firms. The added value can be new revenue channels, entrance to new geographies, cost rationalization, streamlining of operations, divesting of residue assets, and realignment of market positioning.
The task of setting high-level “in principle” synergies is inadequate as a justification for M&A unless one explicitly define each synergy and how it will get achieved up-front, pre-close. Recognizing and evaluating synergies demands a thoughtful and systematic approach. However, even seasoned acquirers can be enthusiastic in their assessments of the value that can be obtained by a deal. Therefore, the path to recognizing and evaluating synergies should be one of reality, with a focus directed on preserving existing operations to maximize the possibility of a deal being accretive.
When it arrives to value creation through financial synergies, there are three primary tools an acquirer can draw: cost, revenue, and capital.
Cost synergies get linked with one-time or continuous cost savings realized by eliminating duplicate functions, rationalizing spend, decreasing relative headcount, and accelerating overall cost efficiencies through operations.
Revenue synergies add to top-line revenue growth – for example, through cross-selling of products/services, price rises, or new channels such as customer demographics or geography.
Capital synergies’ objective is one-off or continuous enhancements to the financial statements. These improvements are reflected in the balance sheet and cash flow – such as through improvements to the working capital cycle, obtaining value from surplus/idle fixed assets, delay of planned investment, and decreases in borrowing costs/cost of capital.
Classifying Synergies in Mergers and Acquisitions
An initial difficulty confronted in the pursuance of value creation is the exact identification and evaluation/ quantification of synergies. In terms of identification of synergies, in the initial stages of a deal, an acquirer would be smart to analyze the four value levers (cost, revenue, capital, and capability). Then the acquirer should examine themselves, which bars offer the potential for synergies. The pertinence of a synergy lever will depend on the type of the deal. While all of these levers typically have a part to play, not all of them will star to the same level from one transaction to the next.
Potential synergies will become visible in the process of studying a target in the early steps of discovery (and undoubtedly before due diligence).
Still, it’s essential to note that synergies recognized in the early period of a deal should be viewed as speculative only. The various methods of evaluating synergies can generate a wide range of potential valuations for the merged organization.
Thus, acquirers must obtain inventive methods to discover how a target could be accretive. They must also accept that it is not till later in the due diligence process when things become more explicit (and typically, only thoroughly transparent post-close!). Classifying synergies can be particularly challenging given the reality of “dis-synergies” – where the combination of two companies can be dilutive.
Moreover, post-close integration difficulties and business confusion can drive quickly to brief synergy underperformance. For example, as a consequence of higher than predicted customer attrition, decreased employee urge, or the absence of a definite strategic objective post-close. When two businesses in the same industry merge, consolidated revenues may initially dwindle to the amount that operations overlap – with some customers becoming side-lined or deciding to go away. For a transaction to serve shareholders, realizable cost-saving possibilities should exist to negate any such revenue losses. In other words, the synergies arising from the merger must surpass the value initially lost.
It is not likely to comprehend with absolute certainty the degree to which acquisition will be accretive till the transaction has closed and post-merger integration gets started. Nonetheless, a thorough knowledge of synergies and how they link to each other at the most initial outset of the acquisition process is crucial. This understanding is necessary to warrant the integration planning is consistent and directed, to restrict overpaying for a target, and to assure that “bad deals” are discarded early in the discovery process. A robust synergy review confirmed through detailed integration design and planning pre-close supports successful acquirers do less – but better – transactions.