The main reason for the restructuring of companies in the form of mergers and acquisitions is the desire to obtain and strengthen the synergistic effect. In this article, we will consider the merger and acquisition synergies, and how to evaluate them.
Synergy effect in M&A deals
Mergers and acquisitions (M&A) are one of the development strategies of any enterprise. Every successfully functioning company in the process of evolution is faced with the decision of which development strategy to choose – an organic growth strategy or another investment strategy, such as growth through an M&A deal.
M&A synergy is an increase in the economic activity of an enterprise as a result of the merger of individual parts or entire companies into a single system. Main sources of synergy include:
- increasing revenues by expanding sales markets, an assortment of goods, offering new products;
- reducing costs by reducing the share of fixed costs and variable costs;
- improvement of processes through the use of more advanced management methods;
- financial savings by increasing the market value of the enterprise and tax benefits.
Despite optimistic estimates, numerous M&A studies show that most deals do not achieve their goals. Many scientists, analysts, and consultants question the wisdom and effectiveness of such transactions. According to analysts, the majority of deals (about 70%) on acquisitions are assessed as mediocre. The expected synergy that influences positively is observed only in 30% of transactions.
Why does synergy have such poor efficiency? The answer to this question lies in several reasons:
- The first reason is that a synergy deal is an expensive undertaking. The reasons for unsuccessful synergy can be: different strategies of the company; cultural and social differences in companies; overstating the real value of the company.
- The second reason is the low efficiency of transactions on large-scale synergies and unjustified high expectations.
Cost synergies approach
Synergy effects are designed to provide a recurring stream of benefits, so it is necessary to analyze their distribution over time. The total flow of additional benefits is assessed through the prism of compliance with the return required for investment risk by discounting at a barrier rate, for which an analysis of risk factors and the cost of equity costs, also associated with financial synergy, is carried out. As a result of the assessment of synergy effects, the investment value added by them will be obtained. Expected synergies are based primarily on increased revenues and reduced costs.
In some cases, the synergy effect is assessed based on the cost approach as an increase in the value of the property complex as it is completed with created or acquired tangible and intangible assets until the ability to produce cost-effective products in demand arises. The synergistic effect, in this case, is manifested in increasing the value of assets.
Often a business is bought, not a set of assets, therefore, the cost synergies approach is of limited use, since it does not take into account the intangible assets inherent in the business as a whole and is not available for each asset. Therefore, the synergy effect estimated based on this approach will be significantly underestimated.
As a result of the merger, the consolidated company usually has a higher variety of assets compared to the companies participating in the transaction, which allows, while maintaining the same level of risk, to achieve a higher return on assets. Thus, if the asset portfolio review is carried out optimally, it is possible to create an additional source of synergy.