A synergy arises in a merger or acquisition when the combined value of the two firms is higher than the pre-merger value of both firms combined. For example, if firm A has a value of $500M, firm B has a value of $75M, and the merged firm has a value of $625M, there is a $50M synergy for this merger. This guide will outline what you need to know about M&A synergies.
Synergies arise out of cost reductions, due to efficiencies in the newly combined firm. Alternatively, they may arise due to new net incremental revenues brought about by the merged firm.
There are different types of synergies. The two most common tangible types are cost savings and revenue upside arising out of the merged firm. However, there are other “softer” synergies that may also arise due to a merger. One example is a common corporate culture that will allow the merged firm to be more easily successful.
How are Synergies Estimated?
One approach to the way merger synergies are forecasted is by comparing like-transactions. In other words, comparable acquisitions are reviewed as a starting point for potential synergies. Initially, it may be difficult to quantitatively estimate synergies as the operations merge as the logistic intricacies are not yet known until post-merger. Thus, synergies may be first estimated qualitatively.
Another approach is to look internally at the two companies and perform as much analysis as possible. A bottom-up analysis should be performed to see how the acquiring firm expects the target firm’s assets and operations to line up and what cost savings can be made. This second approach is more detailed and possibly more accurate, however, it is very challenging for anyone outside of the deal to perform themselves.
10 Examples of Ways to Estimate M&A Synergies:
Analyze headcount and identify any redundant staff members that can be eliminated (i.e. the new company doesn’t need two CFOs).
Look at ways to consolidate vendors and negotiate better terms with them (i.e. purchase goods/services at lower prices).
Evaluate any head office or rent savings by combining offices.
Estimate the value saved by sharing resources that aren’t at 100% utilization (i.e. trucks, planes, transportation, factories, etc.).
Look for opportunities to increase revenue by upselling complementary products or increase prices by eliminating a competitor.
Reduce professional services fees.
Operating efficiency improvements from sharing “best practices.”
Human capital improvements from “top grading” exercises and potential ability to attract superior talent at NewCo.
Improve distribution strategy by serving customers with closer locations
Geo-arbitrage – Reduce labor costs by hiring in other countries if the target is in another country.
Hard vs Soft M&A Synergies
There are two main types of synergies, hard and soft. Hard synergies refer to costs savings, and soft synergies refer to revenue increases.
Risks for Synergies
Synergies are not effective immediately after the merger takes place. Typically, these synergies are realized two or three years after the transaction. This period is known as the “phase in” period, where operational efficiencies, cost savings, and incremental new revenues are slowly absorbed into the newly merged firm.
In fact, in the short term costs may actually go up as the integration incurring one-time expenses and a short-term inefficiency due to lack of history working together and culture clashes. If a culture clash is too great, synergies may never be realized.
Thank you for reading CFI’s guide to M&A Synergies. To keep learning and advancing your career in corporate finance we recommend these additional free resources to help you along your path: