by Tom Allen
Find me on LinkedIn
We’re all familiar with the statistics – approximately 50% percent of M&A deals fail to be accretive or result in increasing shareholders’ returns. What’s even more interesting is that this figure hasn’t changed substantially in over 30 years (Figure 1). On a positive note, we believe that acquirers can take action to significantly improve the odds of M&A delivering value. Accordingly, we’ve partnered with BTD and written a guide to provide a comprehensive framework intended to help M&A teams extract the most value from their deals across a number of key areas. There’s no rocket science – just a collection of best practices we’ve seen some of the most successful acquirers follow.
Source: Institute of Mergers, Acquisitions and Alliances
A wealth of market data and independent research suggests a multitude of reasons behind M&A failing to deliver: poor strategic fit, failure to highlight risks and issues in due diligence, cultural differences, an inability to implement change in the new organization, poor program management, exogenous market conditions… all of which typically lead to a failure to deliver synergies.
Shifting the Focus to Value Creation
The term synergy is regularly overused in the M&A lexicon, especially by some investment banks, deal brokers and consultants, all promising them in abundance and easily delivered – provided you don’t worry too much about the details. Nevertheless, adding value to a combined business is usually the point of M&A and senior executives regularly – and rightly – cite challenges delivering financial synergies as one of the key reasons for M&A not delivering.
Despite conventional wisdom regarding the need to focus on operational stability on Day One, value creation (i.e. taking positive steps to capture value from a deal) is the number one thing that deal makers say they should have focused on (see Figure 1).
Source: Strategy Business.com, June 2019
A Primer in Synergies
For the uninitiated, synergies can be thought of as improvements that companies party to an M&A deal would not have achieved as standalone entities. These can be categorized in terms of the financial statements they impact (e.g. P&L, balance sheet, cash flow). Onetime or ongoing financial synergies are associated with cost savings or revenue increase (mainly impacting the P&L) while capital synergies typically relate to one-off or ongoing improvements in financial/capital performance such as working capital cycles and borrowing costs (mainly impacting the balance sheet and cash flow statement).
Synergies might be – in fact, often are – overestimated, take too long to deliver or are not delivered at all, while the costs to achieve synergies are often underestimated or overlooked. Additionally, “negative synergies” – those cases in which ongoing operating costs go up, not down post-close (e.g. due to the need for additional headcount in accelerated growth areas) – are all-too-rarely considered. Whatever the exact reason, the outcome is often the same: M&A deals that under-deliver value.
It’s easy to overestimate synergies – perhaps to justify an aggressive deal price or incorrect valuation assumptions caused by a lack of reliable data gathered during due diligence. However, the reality cuts both ways: many companies are not only overestimating synergies – they are also failing to fully comprehend the full potential of synergies available from a deal.
When you pause to think, it’s not surprising that some synergy sources are going untapped or are overlooked. The nature of today’s deal making has evolved greatly from the days of M&A purely for scale and revenue growth. Rather, today’s M&A may be predicated on the basis of companies seeking to become market leaders; access to new organizational capabilities, products, services, technologies and IP; access to increasingly affluent consumers in emerging markets, de-risking/diversification of a group, and even securing key talent in the market (just think of the acquihires prevalent in Silicon Valley). Accordingly, companies need to widen the net beyond simply economies of scale and look further afield to drive value from their deals.
A Framework for Value Creation
Working with one of our strategic partners, BTD, we’re pleased to announce the release of a 50-page guide – Synergies in M&A: A Framework for Value Creation, which sets out a comprehensive framework for maximizing the odds of creating value from M&A. Some of the key takeaways from the guide are listed below. Download the 50-page guide here.
1. Consider Levers for Value Creation
When it comes to value creation via synergies there are three main levers a company can pull: cost, revenue and capital.
- Cost Synergies are associated with ongoing cost savings achieved via eliminating duplicate functions, rationalizing spend, reducing relative headcount and driving overall cost efficiencies through operations, etc.
- Revenue Synergies contribute to top-line revenue growth – for instance, via cross-selling of products/services, price increases, or new channels such as a customer demographic or geography, etc.
- Capital Synergies target one-off or ongoing improvements to the financial statements – namely the balance sheet and cash flow – such as through enhancements to the working capital cycle, realizing value from surplus/idle fixed assets, avoidance of planned investment and reductions in borrowing costs/cost of capital.
2. Value Creation Strategy
- Developing your value creation strategy at the start of target evaluation and detailing and refining it through the pre-deal exercise is a critical activity which should be used to drive both the deal process and integration design and planning.
3. Start Early
- Begin developing your synergy map and financial model early in the deal process, and refine it during due diligence, using due diligence to test your assumptions and uncertainties – can they be realistically delivered?
4. Don’t Ignore Costs to Achieve
- Value creation is not cheap. Large costs might accumulate as a result of value creation activities. It’s critical to consider and accurately estimate the costs to achieve your upside synergy targets and so to arrive at a net synergy number/target.
5. Don’t Overestimate
- Further to the above, for a deal to achieve a satisfactory return for the business and its shareholders, the value created must exceed all costs involved in the acquisition and subsequent integration, all as calculated on a time-discounted and risk-adjusted basis. A common occurrence is to underestimate costs and to overestimate value potential – therefore resulting in a deal that doesn’t “pay back” over time and is not accretive. This is sometimes referred to as the ‘synergy trap’.
6. Plan, Execute, Track, Report
- Plan – the starting point to capturing synergies is to prioritize value drivers (the factors underpinning synergies ‘lower down’ the synergy map) in preparation for execution and synergy capture.
- Execute – once initiatives have been defined, the synergies that will sit under these initiatives are understood, and Day 1/Change of Control has taken place, the business will need to deliver everything mapped out in the planning phase.
- Track – tracking the progress of synergy capture across an integration program ensures accountability of workstreams and individuals assigned to specific tasks and can help ensure that an acquirer is on track to achieving the intended deal outcome.
- Report – actively measuring and reporting on performance during the integration process is crucial to driving performance and maximizing the chance of value creation. As part of reporting pay attention to the cadence of reporting and key deliverables.