This is the whole series of articles on Mergers and Acquisitions, make sure to check all other articles including:
Part 1: What Are Mergers And Acquisitions
Part 2: Synergies In M&A Deals
Part 3: Outline Of Business Valuation Techniques
Part 4: Quick Overview Of M&A Process
Part 5: Selling Business To Private Equity
Part 6: Selling Business To Venture Capital
Part 7: Letter Of Intent (or “LOI”) In Mergers And Acquisitions
Part 8: Due Diligence Process
Part 9: Principles Of Negotiating In Mergers And Acquisitions
Part 10: Sale And Purchase Agreement
Part 11: M&A Deal Closing
Essentially, synergies are a catch-all term for the benefits that arise when you combine two corporate businesses. Sometimes these are ephemeral, sometimes these are more imagined than real. You get the directors of one or both sides, producing long documents and press releases explaining the wonderful benefits of this business combination and why there will be all these synergies and some creative shareholder value created and what happens.
But synergies are much criticized because they are very often not realized, and so it is important to understand and be realistic about what the synergies are and where they can arise from.
So the question is, what are synergies, what does this term mean? There are two sides to it. There is the opportunity for revenue enhancement. And there is the opportunity for cost savings, and either of these obviously has a beneficial impact on the profitability of the company.
The first way of looking at it in the most general sense is that synergies can be achieved because there is more growth when you put two businesses together. You would expect the combination to provide more opportunities and for the two companies to grow faster and further as they both have a customer basis that they can address. Both companies got products and services and technology, and all these other things, so it should enable the combined company to grow faster and improve their profit margins. This is the broadest interpretation of synergies.
But we can be more specific.
Let’s start with competition. An acquisition or a merger can pre-empt a competitor from gaining the benefits of the same deal. So the acquisition can strengthen the competitive position of the buyer or of the enlarged entity, depending on whether you are talking about an acquisition or a merger.
The scarcity of targets in a hotly competitive sector can make this a really, really important factor, because if there is a particular technology or an expertise in a team or something like that, you can secure those people in that technology for your business, preventing a competitor from getting it and things like the Oculus Rift (acquired by Facebook), where a number of people could have bought that business.
Facebook jumped in this acquisition with a very big check and bought it preemptively before it really got going. And that was to capture the expertise in that business and stop other people getting it.
Market leadership can be achieved or enhanced by a business combination or an acquisition, and if you have market leadership, then you can start to set the strategy for the sector. You can dominate with your size and your scale, and that can lead to all sorts of additional benefits.
Of course, there are monopolies issues which are carefully regulated both in the US and in Europe and obviously elsewhere in the world. But market leadership can be achieved or a step towards it can be achieved through a business combination.
One of the tricks that US companies have been pulling up in the last decade or so is to acquire an overseas company, to capture benefits in lower tax jurisdiction. Corporate taxation rates in the US were some of the highest in the world and so US companies turned to be rather creative in sheltering some of its US domestic earnings through various perfectly legitimate tax avoidance schemes.
Economies of scale is a very real benefit. If you can harness it, essentially larger companies should be able to get better terms from their suppliers, they should be able to work to better margins. They should also be able to price more effectively and take a stronger position in the market, and therefore, they get benefits just from their scale.
This should of course impact the bottom line, but there are also benefits which are slightly more subjective, but nonetheless clearly identifiable through the acquisition, such as access to technology, or business process, or expertise, or intellectual property and patterns of skilled people.
These benefits are more difficult to quantify sometimes, but clearly they are there. If you are a growing tech company, and you need a group of technicians who are experts in virtual reality but cannot hire them individually, then snapping a team such as the one that Facebook snapped at Oculus Rift is a very good reason is to make the acquisition. And this is a clear synergy, you get the expertise you want very often, probably at a cheaper price, and an added bonus is a massive amount of technology.
Market reach and visibility is another obvious synergy in M&A deals. If the company becomes a market leader, and as its brand becomes better known, it makes it easier to find new customers as well as to improve marketing and distribution.
As one might expect, market leaders have more resources, they perhaps have more expertise in the marketing department. Whatever it is that can lead to new sales opportunities is what synergies are about. And indeed, larger companies also can benefit from access to capital because they are seen as less risky than smaller companies.
These are some of the synergies that can result from a business combination, a merger or an acquisition. It is a somewhat subjective subject of course, but it is always interesting when you see a deal announced to look through and see what synergies are being claimed, very often justifying an acquisition premium that is being paid to finance the deal.
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