Synergy Valuation – How do you calculate them during M&A?

Synergy Valuation during merger and acquisition

Companies go through mergers when they are able to increase the value of their company known as synergy. The synergy valuation depends on the types of merger. The common types of mergers are:

• In horizontal mergers:  synergy is created from economies of scale which reduce costs, or from increased market power which increases profit margins and sales
• In vertical integration:  synergy comes from controlling the chain of production much more completely 
• In functional integration:  When a firm with strengths in one functional area acquires another firm with strengths in a different functional area,  the potential synergy gains arise from exploiting the strengths in these areas.

To calculate synergy value, follow these steps:

1. the firms involved in the merger are valued independently, using discounted cash flow method
2. the value of the combined firm, with no synergy, is obtained by adding the values obtained for each firm in the first step. 
3. The effects of synergy are built into expected growth rates and cashflows, and the combined firm is re-valued with synergy. 

Synergy Value = Value of the combined firm, with synergy –  Value of the combined firm, without synergy

Operational Evidence on Synergy Value

1. McKinsey and Co. examined 58 acquisition programs between 1972 and 1983 for evidence on two questions
   • Did the return on the amount invested in the acquisitions exceed the cost of capital? 
   • Did the acquisitions help the parent companies outperform the competition? 
   • They concluded that 28 of the 58 programs failed both tests, and 6 failed at least one test.  
2. KPMG in a more recent study of global acquisitions concludes that most mergers (>80%) fail – the merged companies do worse than their peer group. 
3. Large number of acquisitions that are reversed within fairly short time periods

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