Are Buyers Fudging the Synergies of M&A Deals?

Although acquisitions frequently fail, acquiring companies are ballyhooing their financial benefits as transaction prices steadily rise.
David McCannSeptember 18, 2018

Current M&A trends are heading in a disturbing direction for buyers, a new report from The Boston Consulting Group (BCG) suggests. Here’s why:

First, acquisition multiples have been hitting record highs each year, according to the report. The median transaction multiple in 2017 was 14.2 times EBITDA. That was a 4.6% hike from 2016 and in line with the average annual increase of 5% since 2009.

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Perhaps to justify the rising cost of deals, acquiring companies are making increasingly bold projections about the financial benefits — or “synergy value” — of business combinations.

BCG examined the 100 largest public-to-public deals by corporate non-financial buyers for each of the past 10 years. The consulting firm found that there were announced synergy estimates for roughly half of the transactions in the 1,000-deal data set.

While the 10-year average synergy estimate was 1.6% of combined sales, a new high has been established each year since 2013. The 2.1% average estimate in 2017 was almost twice the 1.1% average estimate in 2011.

That puts synergies squarely in the spotlight. “Synergies have [historically] almost always served to augment the case for an acquisition,” BCG wrote in its report. “In the current environment, they move to center stage, becoming the ‘make-or-break’ element of the buy-side case.”

For the average deal in the sample, the one-percentage-point climb in announced synergy value over the past seven years translates into an increase in the targeted “synergy run rate” for pretax operating income of more than $200 million a year, the report states.

Applying the 10-year average EBITDA multiple of 12, this constitutes an implied increase of more than $2.4 billion in enterprise value, according to BCG.

Are such rosy projections plausible, considering the bulging library of research showing that a majority of M&A deals fail to achieve expected synergies and fail to boost shareholder value?

Actually, markets generally welcome the announcement of synergies, the BCG report notes. Among the 1,000 deals that BCG studied, when acquiring companies announced expected synergies, cumulative abnormal return (CAR) — the difference between the expected and actual returns on a security — averaged 0.1% during the three days before and after a deal announcement. That compared with -0.9% for deal announcements not accompanied by synergy announcements.

However, that effect has diminished over the past five years. The difference between CARs for deals with announced synergies and those without fell from 2.9% in 2013 to -0.3% in 2016, before rebounding somewhat to 1.5% in 2017.

“The decline since 2014 appears to reflect investors’ increasing skepticism about companies’ ability to deliver on the higher synergies they announce,” the BCG report says.

Perhaps even more alarming for acquirers, to afford their deals they’ve been giving away a greater share of total synergy value, in the form of higher transaction prices.

“Historically, buyers have kept two-thirds of the value of expected synergies — their reward for bearing risk and shouldering responsibility for realizing the synergies after closing,” the report says. “In today’s seller’s market, buyers are keeping less than half the synergy potential, with the remainder going to targets’ shareholders at closing.”

There are three categories of synergies for combined businesses, BCG notes:

  • Revenue synergies, derived from cross-selling, pricing, additional distribution, and innovation
  • Cost synergies, in areas including general and administrative costs; procurement and cost of goods sold; sales and marketing costs; and research and development costs
  • Balance sheet synergies, stemming from inventory reductions, financing terms, better capital allocation, elimination of duplicate capex, and tax optimization