When the buyer in a merger or acquisition estimates it can close redundant plants, cut headcount, centralize administrative functions, or realize other synergies post-transaction, it generally doesn’t want to share much of that potential value with the target company.
In fact, the standard thinking is that the buyer shouldn’t pay anything for the synergies it hopes to realize from a transaction. But, increasingly, acquirers have to give sellers a portion of the synergies, and sharing synergies can actually result in better reception of the deal from the capital markets, says Boston Consulting Group.
That was one of the findings in a recent BCG study, “Divide and Conquer: How Successful M&A Deals Split Synergies.” The study examines some of the expectations around M&A synergies.
Synergies are shared when the ultimate deal price falls between the stand-alone value of the target (the net present value of its future cash flows) and the sum of a) the stand-alone value and b) the maximum value of potential synergies.
An acquirer must leave adequate headroom in the premium it pays for the target so that some of the value from the deal accrues to shareholders of the buyer. If the buyer pays too much of a takeover premium (i.e., shares too much of the synergies), its share price could be crushed.
The seller, of course, is working toward a different goal: if it anticipates the buyer will be able to garner synergies, especially unique to the specific deal, it will demand a higher takeover price, that is, a larger share of the synergies.
The seller’s share of M&A synergies has risen in the past several years, according to BCG. On average, the seller collects about 31% of the synergies, and that number has been trending upward.
BCG says this is because sellers are more sophisticated at assessing the synergy potential of their assets. “I’ve been leading the M&A practice in Germany for 12 years,” says Jens Kengelbach, partner at BCG and lead author on the study, “and 12 years ago bidders and sellers were looking at synergies from a far less-sophisticated angle.”
Nowadays, says Kengelbach, targets do specific synergy assessments down to line items on a profit- and-loss statement and synergies from individual manufacturing sites. They do it to determine what kind of takeover premium a specific bidder might be able to put on the table.
It would be helpful to the acquirer if it could gauge – before negotiations – how much a seller will demand in the deal and to what level the buyer can share synergies without getting a negative reaction from its shareholders. But that requires digging.
There are some industries in which buyers expect a higher level of synergies. In those industries sellers will generally collect a larger cut. Sellers in markets outside Europe and the United States, for example, are getting a larger share of deal synergies. That’s because buyers are willing to give up more to gain access to so-called rapidly developing economies (RDEs) – China, India, United Arab Emirates, Malaysia, etc., says BCG.
For example, from 2000 to 2011, manufacturing targets, many of which are based in RDEs, captured 39% of the net present value (NPV) of announced synergies; oil, coal, and gas companies, also RDE concentrated, garnered 48%.
In contrast, telecom sellers have low synergy potential because they are so highly regulated. In the 10-year period sellers in telecom captured only 6% of the NPV of expected synergies.
In many cases, sharing synergies has a positive effect for the acquirer. BCG found a correlation between the percent of synergies captured by the target and the performance of the buyer’s stock around the transaction’s announcement: The greater the rise in the buyer’s stock price in the days around the transaction’s announcement date, the higher the share of synergies captured by the seller. Importantly, though, the buyer must explain the rationale for the deal in detail and explain where the synergies will come from and how they will be achieved.
It also helps if the buyer is a sterling performer financially. BCG found that the higher the acquirer’s EBIT (earnings before interest and taxes) margin prior to the deal, the more it can afford to give away in synergies to the seller’s shareholders. That’s because the markets believe that a well-performing buyer “can lift the performance of the assets they acquire,” says Kengelbach.
A well-performing acquirer “can afford to give more away and sometimes has to, because people expect it,” he says.
But companies can also go overboard, especially when M&A is booming and they are in a competitive situation with other bidders. In those cases, the acquirer may be able to increase the takeover premium by identifying less obvious synergies, such as the ability to optimize the seller’s tax situation. There’s a caveat to that, though: overpaying can be a recipe for shareholder revolt.