As we discussed in a previous HighPoint HighLights article, Top 3 Strategic Rationales for Mergers & Acquisitions, there are many reasons a business may want to merge with or acquire another – with the ultimate goal of a combined entity that is more market-leading, more effective, more efficient, and more valuable than the standalone companies themselves.
But what about the synergies – the fruit of that M&A labor – that contribute to increased value?
Is your firm screening and considering potential target companies? If yes, analyzing a variety of synergy scenarios and their estimated impact on the value of the new entity is a critical step in ensuring you’ve chosen the right company and established the right acquisition price. This will, in turn, help you assess whether your intentions for this undertaking are likely to be realized.
While the list of hard and soft synergies is long, we summarize typical sources of synergy below.
- Cost Synergies
The following efficiencies can result in savings through a reduction in organizational and operational expenses.
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- Supply Chain: Supply chains during the global pandemic have experienced enormous disruptions in their pipelines, with inflation in the cost of goods (COGS). By merging with a firm that has a more stabilized, automated, and diversified supply chain, this synergy can take a business with fragmented or unreliable delivery to one that is more high-performing, technologically advanced, responsive, and efficient. Additionally, scale can improve terms throughout the supply chain’s value chain partner list.
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- Overhead / Compensation: Functional redundancies typically result in material efficiencies related to efficiencies in salaries, wages, healthcare, and other benefits. They can also provide productivity increases, where firms select top-talent from both entities, and ensure they retain the best talent to lead the combined functions forward.
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- Overhead / Outside Spend: As important as internal compensation, a firm should gain importance with vendor partners, and create greater leverage around that spend to realize unit efficiencies in a broad variety of categories.
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- Information Technology: When two or more separate companies have established Information Technology operations, software licenses, and infrastructure, and cloud relationships, determining the go-forward integrated enterprise architectural roadmap and merged partner approaches can result in significant productivity and efficiency improvements.
Other cost-savings synergies may include proprietary technology or research.
- Revenue Synergies
Revenue synergies may take longer to realize than other kinds of synergies, yet often present the most significant strategic and dollar returns.
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- Bundling: Also referred to as cross-selling, this kind of synergy is the most common. It allows the acquiring company to offer its products or services to the target’s customer base. Conversely, it also allows the target company to sell to the purchasing company’s customers, a bidirectional win-win.
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- New Markets: If a company would like to enter a new geographic market, targeting a company that offers immediate access to that market can often yield faster, more efficient results than entering the market organically, while also providing the local regulatory, capability, and relational access that would otherwise take years of mistakes to build.
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- Distribution Channels: If, for instance, a brick-and-mortar retailer would like to jumpstart its e-commerce offering, or vice versa, joining forces with an established business in the desired channel can provide an accelerated path.
- Capital Synergies
Financial synergies are named thusly because they impact cash flow and balance sheets. While these synergies can provide a third major lever of value creation, they are also one of the more difficult to evaluate and realize.
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- Tax Benefits: There are a variety of tax benefits inherent in M&A, including a reduced tax burden due to higher depreciation gains, carrying forward any operating losses, new geographic domains, and any new tax structure.
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- Cost of Capital Benefits: The combination of companies can make lower-interest-rate debt more accessible because of a more favorable capital structure and increased cash flow. This is especially helpful for a firm that may have been challenged by sub-investment grade liquidity and rate structures.
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- Diversification: A company that acquires a target firm in a different, more cash-favorable industry can reap the rewards of a broader base of customers and enhanced cash flow. However, diversifying M&A brings other competency and management challenges, which are not addressed in this synergy review.
Synergies must be more than a math exercise. Any diligence lead or valuation modeler will assess synergies in each M&A transaction; the challenge is knowing the scale, probability, and realization timeline of each opportunity for relative prioritization. With that prioritization in hand, diligence and operational teams can then collaborate on deeper, kick-the-tires assessments before a deal decision is finalized.
Looking to strengthen your strategic position in the marketplace?
The consulting team at HighPoint Associates has both the operational chops and industry expertise to successfully and rapidly execute each aspect of M&A planning and integration. We’ve led significant M&A activities internally, and understand firsthand each endeavor is a high-stakes event that integrates complex assets, cultures, processes, and IT systems. Contact us to learn more about HighPoint’s mindful approach to mergers.
