m&a synergies

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Synergies

M&A Analysis

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January 12

Synergies - Outline

Introduction: Definition and classification of synergies Required level of synergies Classification of Synergies Measurement of Synergies Using Macro Statistics Measurement of Synergies Using Detailed Analysis Reference: Studies of Merger Savings Reference: Examples of Synergies

M&A Analysis

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January 12

Basic Success in M&A and Synergies

Recall that synergies drive the success of M&A for Buying Companies Same or Related Industry Know how to manage costs Can possibly reduce competition

Acquiring Company has Higher ROIC Acquiring company can use best practices to reduce costs

The implications of this finding is that synergies come from imposing best practices and improving cost efficiency of the target company and if there is a possibility to increase prices in a merger.

M&A Analysis

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January 12

Introduction to Measurement of Synergies Focus on measurement rather than strategic theory There are virtually no textbooks that discuss the mechanics of how to measure specific synergies. Instead, there is a general discussion of strategic behavior and extending products or expanding market coverage. In measuring synergies, the calculations must account for how the synergy can actually be achieved for example, if there are staff reductions, will the reductions come from voluntary reduction, attrition etc. Given, the problems with no generic formulas for synergy, the discussion includes: Definition of the synergy Examples of the synergy estimation Formulas for measuring the synergy

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Real World Problems in Measuring Synergies There is no template or simple formula The academic literature uses strategic theory and statistical analysis of market power. There is virtually no literature on how to measure cost savings in practice. General points on measuring related to measuring synergies: The synergy measurement depends on specific knowledge of the business and industry Synergies and their measurement is specific to a company or an industry and the computation is also specific to the company or industry Data is very limited when evaluating a transaction not only do you not have little data on the target, but your own staff cannot evaluate the data (e.g. you may not be able to ask your IT staff to evaluate cost savings.)

M&A Analysis

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January 12

Definition of Synergies

M&A Analysis

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January 12

Synergy a Quest for Holy Grail

Definition: the increase in performance of the combined firm over what the two firms are already expected to accomplish as independent firms. Popular definition: 1 + 1 = 3 PV (A+B) > PV(A) + PV(B) Roundabout definition: If am I willing to pay 6 for the business market-valued at 5 there has to be the Synergy justifying that More technical definition: Synergy is ability of merged company to generate higher shareholders wealth than the standalone entities Efficiencies based upon the close integration of specific, hard-totrade assets owned by the merging parties. If cost savings or revenue enhancements can be obtained without a merger, synergies do not exist.

M&A Analysis

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January 12

Types of Synergies and Value Allocation If synergies do exist, then the next issue is whether the buying company or the target company achieves the synergies (recall the formula fundamental equation that synergies > premium). The allocation depends on the relative bargaining power. Universal: Value to Target Company in Premium Available to any acquirer. Examples are administrative costs, eliminating obvious value drains and cutting waste Endemic: Value to Target or Buyer Available to a few acquirers. Generally in the same industry and/or geographic area. Examples are economies of scale and redundant sales force Unique: Value to Buyer Available to only one buyer (co-ownership of plant). Combination of geographic, industry and product lines.

M&A Analysis

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January 12

Operating Synergies Marketing gains Advertising Distribution network Product mix Strategic benefits Market power Under-managed target Efficiency gains Economies of scale, economies of scope, critical mass Opportunities for restructuring Sell unproductive assets that are retained by management who cannot or will not shed such value destroying businesses

M&A Analysis

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January 12

Negative Synergies

Competitive response to sales force reductions Competitor response when integration is occurring High integration costs and limited savings Overoptimistic appraisal of market potential and synergies (e.g. assume that product markets for acquirer will turn around or unrealistic vision about the value of corporate strategies) Poor Due Diligence (over looking problems because of deadlines, in-experience or ignoring bad news)

M&A Analysis

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January 12

General Valuation Issues

Synergies should be: After tax Discounted at a rate that reflects risk Risk free synergies for things like contract adjustments Venture capital type discount rate for speculative revenue increases

Account for the lifetime of the synergies and terminal valuation Account for cost to achieve

M&A Analysis

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January 12

Required Level of Synergies

M&A Analysis

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January 12

Sirower Formula

Investors pay what a firm is worth. Therefore, the value of playing the acquisition game is NPV = Synergy - Premium

If you believe a firm is mis-valued, just buy shares in the company on the market. Synergy > Premium : Success 0 > Synergy < Premium : Failure Synergy < 0 : Disaster

M&A Analysis

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January 12

Basic Valuation Formula in M&A

Added Value From Acquisition = Value of acquirer and acquired firm after the acquisition Value before

Acquirer Value = Value Added - Cost Cost = Transaction Cost + Acquisition Premium Investments can be made without acquisition Paying a premium means there must be expected synergies that more than off-set the premium

M&A Analysis

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January 12

Synergy a Quest for Holy Grail

Paying unjustified premiums is tantamount to making charitable contributions to random passers-by, never to be recouped by the buying company no matter how long the acquisition is held. SIROWER: Suppose you are running at 3 mph, but are required to run 4 mph next year and 5 mph the year after. Synergy would mean running even harder than this expectation while competitors supply a head wind. Paying a premium for synergy that is, for the right to run harder is like putting on a heavy pack. Meanwhile, the more you delay running harder, the higher the incline is set. This is the acquisition game.

M&A Analysis

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January 12

Synergy Puzzle

Why do executives, investment bankers and consultants so often recommend that acquiring firms pay more for a target company than anyone else would pay. Over-bidding for Synergies (in the heat of the deal; can find benchmarks that justify the valuation; the winners curse) Post-Acquisition Integration

M&A Analysis

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January 12

Exercise Find Premium and Required Level of Synergies Relative to Reported SynergiesWhat was premium Share price x shares x premium percent

What was the reported level of synergies pre-tax Present value of synergies Subtract cost to achieve Compute on after tax basis to compare to premium

How do the level of synergies compare to the premium Net value of merger

See slides below

M&A Analysis

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January 12

Comparable Synergy Analysis

M&A Analysis

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January 12

Comparable Synergy Analysis

M&A Analysis

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January 12

Premium in BP-Amoco Merger

Morgan Stanley reviewed eleven selected comparable merger transactions and compared the implied premium to the relative market capitalization of the smaller entity. This analysis evidenced premiums in a range from 5.0% to 15.0% based on closing share prices on the day before the announcement of the transaction. The implied premium received by Amoco Shareholders upon receiving 40.0% ownership of the combined entity is 13.3%, also based on closing share prices on the day before announcement of the transaction. The premium received by Amoco Shareholders when measured over different time periods similarly matched the premiums indicated by comparable transactions when measured over the same time period.

M&A Analysis

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January 12

Classification of Synergies

M&A Analysis

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January 12

Classification of Synergies Free Cash Flow Based

Attempt to classify synergies into categories to discuss measurement EBITDA Capital Expenditures Cost (Operating Expenses and Capital Expenditures) Economies of Scale Best Practices Capacity Utilization

Revenues Price Increases Volume (Growth) Increases

Risk Reduction

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January 12

Classification of Synergies Economies of Scale

Definition of economies of scale reduced average cost per unit when the total production increases. No matter how small a company, need billing systems, accounting, basic treasury etc. These are fixed costs that can be spread over larger output with a merger. Often referred to as duplication or redundant costs Include purchasing economies t

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