Even though Northrop usually refrains from publicizing revenue synergies, it runs all those numbers internally to ensure that it values deals correctly. Noski says it pays special attention to data collected from the division and business-unit managers closest to the acquired company's market, because those divisions will often be responsible for integrating and running the new, acquired divisions.

"The people in the business sector have to be an integral part of understanding the numbers," he says. "You don't want to say to them after the deal is done, 'OK, you're running this new business and you have to hit these numbers,' and then have them ask, 'What numbers, and where did they come from?' There has to be an engagement and understanding of how we came up with the synergies."

Keep Those Products Coming
Other executives concentrate on revenue synergies and not cost synergies. Dick Heckmann, CEO of Carlsbad, California-based sporting-goods company K2 Corp., for one, says he has based his aggressive acquisition strategy on revenue synergies since taking the helm two years ago. He developed the method as CEO of U.S. Filter, where he helped orchestrate 260 acquisitions in nine years. (U.S. Filter was sold to Vivendi SA in 1999, which sold it off in chunks between 2002 and 2004.)

"If you buy companies and start driving cost synergies, all you end up with is a pissed-off organization," he says. "You demotivate people from acquisitions." That's why "we never base a merger on cost synergies, [although] we go after them if we find them." (Heckmann says that he approves only acquisitions that are accretive to earnings and based on advantageous revenue synergies.)

But like Northrop, K2 relies heavily on its operating groups to familiarize themselves with synergy prospects in acquisitions. Indeed, K2's six business divisions bring Heckmann proposed deals for approval, he says, because the divisions are in a better position to evaluate acquisitions in their markets. "For corporate to look for an acquisition in our fishing division is insanity," explains Heckmann. "What does a guy at corporate know about fishing?"

K2's divisions also are held accountable for the valuation research — including revenue-synergy projections underpinning their acquisitions. A group that fails to meet postmerger budget targets doesn't get its bonuses. (At the corporate level, however, K2 does do quarterly evaluations of how its mergers are progressing.)

The tactic of restraining the pursuit of cost synergies draws some fire in the investment community. "I am criticized each quarter by analysts," says Heckmann. "They want to know why our SG&A as a percentage of revenue isn't declining with the acquisitions." His answer: increased research-and-development spending is needed to keep K2 ahead of retailers, which often create less-expensive private-label versions of brand-name products they stock on their shelves. "You have to keep coming out with hot products," explains Heckmann.

The level of research that K2 and Northrop both use in determining acquisition values helps them avoid the kind of corporate criticism that flows from McKinsey's study of 160 mergers, which found top-line forecasts particularly "rife with inflated estimates."

Says Noski, "It would surprise me, in a post-Sarbox world, if companies were making those numbers up." Still, "some companies might say, 'I can only absorb so much earnings-per-share dilution on the deal, and in order to achieve that threshold I need this much synergy.' "

Kris Frieswick is a senior writer at CFO.

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