Introduction
In the last 10+ of my professional career, I have had exposure to over 40 transactions.
I have had two distinct roles in these transactions:
- As a M&A services vendor (i.e., Big 4 management consultant) and;
- Within a corporate team (i.e., Petco corporate development integration;
If anything this has been an interesting last 10+ years and I think it’s worth talking about some of the basics of M&A deals I have learned.
This article will review some basic buy-side M&A concepts with a focus on value creation, or in deal speak ‘Synergies’.
Definitions
Synergy — the expected cost savings, growth opportunities, and other financial benefits that occur as a result of the combination of two companies. Typically strategic partners realize these synergies but financial sponsors with a similar company in its portfolio could also benefit from cost or revenue synergies
Acquirer — the legal entity, business unit or company acquiring the Target
Target — the legal entity, business unit or company being acquired or considered for acquisition
Horizontal acquisition — acquirer buying another direct target / competitor
Vertical acquisition (transactions) — acquirer buying a target within the same supply chain
Financial sponsors — typically hedge funds, private equity firms; essentially pools of money holding equity investments in portfolio companies
Strategic partner — typically a company operating in the same or similar industry as the target company (“Target”) offering the same (or similar) goods and/or services as the “Target”
What are the key sources of synergy (i.e. value creation)?
- Increases in revenue
- Decrease in operating costs
- Decrease in taxes paid
- Decrease in working capital requirements
- Decrease in required capital expenditures
Primary synergy types sorted from easiest to hardest to realize
- (Operating) Cost synergies are less speculative and therefore easier to realize because repeated functions within merging firms are realistic examples of cost savings. Additionally, economies of scale are proven to impact costs especially in horizontal acquisition (same industry, same production stage).
- Revenue synergies are more speculative because the probability of additional sales growth is substantially lower (than rationalizing redundant functions).
Revenue synergy
- Ability to sell existing product or service in new distribution channels. The newly merged entity e.g., the acquirer operates in the U.S. and target operates in China, the new combined entity is now able to sell existing products (and services) in China, in addition to the U.S.
- If both acquirer and target share the same (or similar) customer bases, sales cannibalization is a key risk (as products/services displace each other due to customer preferences to diversify their purchases)
- Ability to sell new product or service in existing distribution channels
Operating cost synergy depend on the type of transactions
- For a horizontal acquisition, companies can eliminate redundancies and leverage existing infrastructure for better pricing
- For vertical acquisitions (transactions), the cost savings are much harder to realize as quality and efficiency are in focus rather than cost
Working capital synergy
- The savings originate from the amount of liquidity a business needs versus the amount it actually has on hold. The goal is to lower the investment required for working capital requirements. Recall the net working capital formula and analyze:
- Net Working Capital = (Accounts Receivable+ Inventory + Prepaid Expenses and Other Current Assets) less (AP + Accrued Liabilities + Other Current Liabilities)
Tax synergy
- There are numerous strategies to save on taxes whether it involves utilizing the new tax shield of acquisition debt, moving headquarters from a higher corporate tax region to a lower one, or acquiring operating loss carry forwards. An example is a Canadian entity acquires an Irish target and moves their headquarters to Ireland
- Tax synergies remain one of the most sought after goals for M&A
Conclusion
This article is intended to be the first part in a two part series. In the next article, I will provide specific deal context — where I can — to further clarify the above mentioned. Stay tuned!
