March 2018 Issue
Dealmaking has reached several unprecedented highs in recent years. As trade barriers have fallen, technology has improved and globalisation – though currently under threat by recent geopolitical developments – has taken hold, markets have become increasingly integrated, creating uniform standards, norms and procedures.
Much of this drive for globalisation stems from the desire to protect or improve a company’s position in an industry or a particular market, or the desires of chief executives or other key stakeholders who may wish to enhance a company’s reach.
Behind all this is the key driver of deal activity: the desire to generate shareholder returns. And one of the most important factors in that process is unlocking synergies, the potential financial benefits that can be achieved by combining companies. Successfully capturing synergies can give companies an important competitive advantage.
Synergies can be difficult to realise, however. Indeed, synergies, particularly revenue synergies, can be hard to project as they are often a source of conjecture. Projected synergies must be carefully considered prior to any transaction. However, many companies fail to do this adequately. According to McKinsey & Company, in M&A due diligence, companies frequently fail to develop an adequate roadmap to identifying synergies and then capturing them to create value. As such, more must be done, particularly in the due diligence phase of an acquisition, to identify synergies and the opportunities they represent.
For the most part, synergies can be categorised in three ways. The most prominent is revenue synergy. In most M&A transactions, revenue synergies are expected to play a significant role in achieving deal value. In fact, more than half of all deal synergies are expected to be derived from revenues, according to Deloitte. Revenue synergy sees a combined company, as a result of an acquisition, able to generate more sales than the two companies would separately.
To identify revenue synergies, acquirers must be able to access reliable data and deploy a dedicated integration team. Relevant, accurate information from structured data sources can assist companies in planning and executing their revenue synergy initiatives. Such synergies can take many forms, such as cross-selling, marketing and distributing complementary product lines, sharing distribution channels and reducing competition, among others. Revenue synergy can provide attractive economics. Sellers can generate a significant premium when the revenue synergy that the selling company provides is unique to the buyer. Buyers are able to pay a substantial premium for the target, satisfied that the increase in revenue post-close will account for the additional cost of the deal.
The second type of synergy companies can achieve is cost synergy. This allows two companies to reduce costs by combining, typically achieved by eliminating or streamlining redundant processes. Headcount reductions, lowering administrative and overhead costs and increased purchasing power, can all have an impact.
Significant cost synergies may also be identified in the research and development (R&D) department. Given that R&D projects take years to produce tangible, value-generating results, merged businesses can shorten the cycle. An M&A implementation plan should attempt to identify issues such as similar products in development across the merging companies. Looking at these processes logically can generate cost synergies.
The third form of synergy is financial synergy, which can be achieved by improving the financial metrics of a combined business. Debt capacity, cost of capital and profitability are all areas where financial synergy can be found. By achieving financial synergies, companies may reduce their interest payments on borrowing, for example. They may also take advantage of numerous tax benefits.
For companies that are able to achieve synergies, it is beneficial to publicise those results. According to a 2017 McKinsey report, between 2010 and 2017, investors typically responded well to acquirers disclosing the sources of value in their deal announcements. Share prices, for the large part, increased whenever companies disclosed the sources of synergies. Unsurprisingly, those deals where the value of synergies was greater than the premium paid by the acquirer were viewed favourably by the market.
Clearly, M&A can be a key driver of value for organisations; however, it is imperative that companies identify synergies in their due diligence if they hope to generate full value post-close. Synergy-capture should form part of the wider due diligence process, helping acquirers discover where specific revenue, cost and financial benefits may be achieved. This can help justify valuations and drive early alignment around the new operating model for the combined business.
If synergies are to be achieved post-close, the bulk of the work must be done at the outset; however, realising synergies will always create uncertainty for acquirers, since so much of the process is a matter of conjecture. Yet if companies are to secure a competitive advantage, opportunities must be planned for and identified, with new financial models drawn up, to identify synergy opportunities and ultimately prosper.
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