Strategic M & A : Valuing Synergies

Strategic M & A : Valuing Synergies

Have you ever thought that 1 + 1 = 3 ?? Yes it happens in case of Strategic Mergers and Acquisitions where the entities work for the ‘synergies’. It is often believed that in a strategic M & A, combined entity is valued more than the sum of its all parts.

Combining two entities through merger/acquisition often considered as a business strategy adopted by the entrepreneurs to have an increased value through synergies.

• Revenue synergies – Revenue sources diversification due to the addition of product or service lines
• Operational Synergies – Increase in the production capacity as a result of acquisition of additional employees and facilities
• Financial Synergies – As a result of merger / acquisition there will be a decrease in the financial risk and reduction in the borrowing costs.

Strategic Mergers and Acquisitions take place mainly with the two motives –

• Saving Cost – Combined entities will save the cost by consolidating the positions and reducing the number of offices, closing the low performing lines and also consolidation the overhead costs and other small marketing and administration expenditures.
• Generating Revenues – The synergies will make the entity to perform more aggressively as a result of cutting cost products can get a very good competitive prices and the network will help to reach the broader market and the customers segment. Estimation of such revenues is difficult to quantify.

Sharing of wealth and Profit

It’s often said that synergies will be quite lucrative, so the sellers expects a synergic value from buyers during the negotiations. Buyers also will accept that by doing so to ease the integration process postmerger to assist in the transition process.  Sometimes sharing synergic value with seller might need a holistic understanding of the complete deal terms, sometimes seller may ask as share as a percentage of any specific synergy related profit over an agreed period on the top of sale price and in exchange for a lesser sale price.

Many of the strategic buyers find this offer pleasing as they can reduce the sale price which lowers the risk and also if the combined entity fails to save on the synergies, the strategic buyer will not be having any obligations towards the seller.

“Sharing synergic value with the parties is very beneficial for public companies as the investors can see that both parties have a stake in confirming smooth transition and revenue generation, which can boost the share price of the combined entity”

In case of Strategic Mergers & Acquisitions where the combined entity is focused on getting synergies, valuing them required a very depth analysis of each entity individually and the combined entity postmerger, their future growth factors and potentials, estimates in terms of cost reduction and revenue estimates in terms of reach.

Discounted Cash Flow (DCF) Method is commonly used in Mergers and Acquisition Transactions to value synergies and risks. Risk based adjustments will be made by considering the risk factors associated with the entities while valuing synergies.

Some Valuation Experts value synergies separately according to the risk associated with each of them and some experts use higher discount rates and adjust the risk associated with them by reducing the cash flows. The valuation approach depends on the nature and the risk factors with the combined entity.

“Valuation comprises various phases or stages in case of a business deal. Very important factor note here is that to evaluate the target company from a several different viewpoints to decide whether the company is sold or merged at a fair value”

• The very 1^st step is to understand from the stand alone of each party to the transaction
• 2^nd step in a valuation process of M&A is to observe and understand at the transaction values for the target company
• And the last step here is to analyse the transaction and evaluate its impacts and possibilities.

Deciding a proper valuation for an M & A transaction is not always easy. Something as simple as a spread sheet mix up can cause millions of dollors in way of fines and costs. The common errors on the buy side in determining the target company include –

Improper evaluation of Management team

Financial data miscalculation / Clerical errors

Lack of understanding / Misunderstanding on the competitors data

Missing some of key information during evaluation process

Financial Analysis during valuation process of M & A transaction is a very dynamic phase of evaluating the feasibility of a particular business deal. It requires to be equipped with right set of analyses and assumptions, and the lead negotiator needs to be well prepared with all the required knowledge on the proposed transaction to construct a deal that is meaningful to the shareholders and also creates value for the company.

 

HOW DEV MANTRA CAN HELP YOU?

In Strategic Mergers & Acquisitions when the parties have unrealistic expectations and potentials on the combined entity’s future performance, Valuing synergies can be a challenging work. A professional who understands the synergies and the risks can definitely make it a successful deal and give a right valuation to the synergies.

Write us to at unicornsgroww@devmantra.com