valuing synergies

Question 1

what is the main idea of valuing synergies

Answer 1

*Main idea:
True synergies create value for shareholders that they would be unable to create on their own

Question 2

Synergy assessment is extremely important for four reasons:

Answer 2

1) Crucial for value creation (= fundamental aim of M&A)
2) Helps to predict investor reaction to deal announcement:

If Price < V Target, stand-alone + V Synergies means ARbuyer > 0
If Price = V Target, stand-alone + V Synergies means ARbuyer = 0
If Price > V Target, stand-alone + V Synergies means ARbuyer < 0

3) Helps analysts to disclose synergies to investor community
4) Is a foundation for post-merger integration

Question 3

Why is it so difficult to create synergies?
Market is sceptical about synergy creations for following reasons (4)

Answer 3

1) Stock prices of buyer and target already reflect anticipations of improvements
in the stand-alone value
→ To achieve synergy, you must beat that base case!

2) Synergies do not come for free: they require money and time

3) Competitors might easily replicate the benefits of the deal

4) Demands of integration can divert attention away from competitors
→ Company more likely to be under attack

Question 4

Synergies consist of two components:

Answer 4

V Synergies = V Synergies in place + V Real option synergies

Question 5

Types of synergies in place (5)

Answer 5

• Revenue enhancement synergies:
  Typically through cross-selling, critical mass, bundling
• Cost reduction synergies:
  Arise from economies of scale/scope, transfer of knowledge, buying power
• Asset reduction synergies:
  Arise from disposal of idle assets
• Tax reduction synergies:
  Combining loss-making with profitable firm, Tax Inversion
• Financial synergies:
  Arise from shifting the WACC (= coinsurance effect). Debatable

Question 6

Real options synergies

Answer 6

Real option synergies depend on some triggering event
to produce a payoff

*Some examples:
- Growth option synergies
E.g., R&D, access to network
Exit option synergies

Arise from increased flexibility in altering investment strategies

Question 7

Some rules of thumb for synergy valuation:

Answer 7

• Establish credibility of the synergy source
• Everything after tax

Question 8

Valuing synergies: Concluding remarks

Answer 8

*Not all synergies are created equal!
*Synergies tend to be highest in horizontal deals,
middling in vertical combinations,
and lowest in conglomerate deals.
*Apply rigorous analysis and adopt a critical attitude!
*Communication towards investors is very important
(see examples on next two slides).

Question 9

Valuing synergies: Mini-Case: AOL’s takeover of Time Warner
what were the deal characteristics
what was the outcome

Answer 9

*Deal characteristics:
When: January 2000
Acquisition premium: 56%
Projected cost synergies: $1 billion
No detailed overview of synergies provided

*Outcome:
AOL’s stock price declined by 15%
(or $25 billion) in the days following the announcement,
and the synergies had been discounted to almost zero
by the time the deal closed.

Question 10

Valuing synergies: Mini-Case: Pepsico’s Takeover of Quaker Oats

Answer 10

*Deal characteristics:
- When: December 2000
- Price: $13.4 billion
- Acquisition premium: 22%
- Detailed overview of expected synergies ($230 million):
$45 million from increased Tropicana revenues
$34 million from increased Quaker snack revenues
$60 million from procurement savings
$65 million from cost savings
$26 from eliminating redundancies

*Outcome:
Pepsico’s stock price rose by over 6%
(or nearly $4 billion) in the days following the announcement,
and has continued to outperform the shares of its
industry peers since the transaction closed in August, 2001.
Model of how it should be done!