03a Slides - Synergies

Mergers & Acquisitions – Slide Set Session 3
Synergies
Michael H. Grote
©Frankfurt–School.de 1
schedule
 synergies and value

 types of synergies
 foreigners pay most
 valuing synergies
 case: Unicredit - Hypovereinsbank
synergies and value
 there is no single correct price - the right price is relative
 Key success in buying another company is knowing the
maximum price you can pay synergy
value
value to
purchase acquirer
owners
price
value
gap
market
value value to
target
owners
intrinsic
value
source: HBR 1999
synergies and value
 intrinsic value
 most basic value, based principally on the net present value
of expected future cash flows
 completely independent of any acquisition
intrinsic
value
synergies and value
 market value
 on top of intrinsic value, the market may add a premium to
reflect the likelyhood that an offer for the company will be
made
 market value or „current market capitalization“ is the same
as the share price
market
value
synergies and value
 purchase price
 „anticipated takeout value“ - the price the bidder has to pay
to be accepted by the target owners
purchase
price
value gap: value
difference between gap
intrinsic value and value to
purchase price target
owners
synergies and value
 synergy value
 net present value of cash flows that will
result from improvements made when the
synergy
companies are combined value
 improvements above and beyond those value to
the markets anticipates each company would acquirer
make if the acquisition did not occur owners
total synergies announced
source: Deloitte 2017
announced synergies over time
source: BCG 2018

announcing synergies makes a difference
only in about half

the transactions
synergies are
announced
acquirers that
announce
synergies are
associated with
better share price
reactions
source: BCG 2018
which synergies to communicate?
What you aspire to achieve to create exceptional value
Ambitious stretch targets communicated to PMI teams
What you are confident you can achieve
High confidence internal targets from

valuation during due diligence
What you need to achieve
Public estimates of
targets, just high enough
to make deal credible to
capital markets
acquisition valuation
acquisition valuations are complex,

because the valuation often involves issues like synergy and
control, which go beyond just valuing a target firm
the motive behind the acquisition is important for acquisition

valuation
and has to be considered when estimating the value of the target firm
however, the valuation of an acquisition is not fundamentally

different from the valuation of any firm
although the existence of control and synergy premiums introduces

some complexities into the valuation process
the safest way to value a target firm is in steps, starting with a status
quo valuation of the firm as usual,
following up with a value for control and a value for synergy
basically one treats e.g., cost savings, as an additional cash flow

within a DCF analysis  savings are assumed to last forever!
synergies and market reaction
Revenue synergies (MUSD)

2,400 ... and even more synergies to
exceed investor expectations
produced by positive reaction to
2,000 the deal
1,600
1,200
An
acquirer's
bid included 800
a 3.5B USD
premium
400
0
150 200 250 300 350 400 450 500
Cost synergies (MUSD)
But the announced cost synergies of 250M
USD were insufficient to achieve the value ... requiring additional cost and/or
promised to shareholders ... revenue synergies to justify the
premium ...
Note: Diagonal lines indicate net present value (NPV) of total expected synergies at a given acquisition premium
schedule

 motives for m&a
 undervaluation, i.e., that firms that are undervalued by financial

markets, relative to true value, these firms will be targeted for
acquisition by those who recognize this anomaly
 diversification, with the itent of stabilizing earnings and

reducing risk
 managerial self-interest and hubris might be the primary, though
unstated, reasons for many takeovers
 in these cases:
value target firm as stand-alone entity – with no extra premium
Synergies and Value
there are five types of synergies:

cost savings, revenue enhancements, process improvements,
financial engineering, and tax benefits
cost savings
level of certainty quite high
savings from eliminating jobs, facilities and related expenses
economies of scale in purchasing (purchasing power)
savings are large when both companies are from the same industry
typical cost synergies (ordered roughly by size): people, operational

improvements, procurement, physical infrastructure, corporate and
shared services, IT & technology, sales & commercial, logistics &
supply chain, research & development
announced cost synergies
announced cost synergies differ across
industries, strong idiosyncracies remain

C&IP – Consumers and Industrial Products LSHC – Life Science and Health Care
E&R – Energy & Ressources TMT – Telecom, Media and Technology
FSI – Financial Services Industry
Synergies and Value
revenue enhancements
higher level of sales growth – distribution power, brand, marketing
hard to estimate (reaction of customer base, reaction of competitors)
gaining of „critical mass“ (e.g., new large projects are now feasible)
typical revenues synergies:

cross-selling via both distribution channels (e.g., selling acquirer‘s
products to the target‘s customers, markets, and geographical areas),
and new pricing strategies (e.g., higher pricing power, bundling
strategies)
announced revenue synergies
announced revenue synergies differ across
industries, wide dispersion

C&IP – Consumers and Industrial Products LSHC – Life Science and Health Care
E&R – Energy & Ressources TMT – Telecom, Media and Technology
FSI – Financial Services Industry
Synergies and Value
financial engineering
pooling working capital requirements
netting currency positions
refinance target‘s debt at acquirers more favorable boworring rate
process improvements
eliminating duplication, combining different strenghts from both
companies
transfer of best management practises (in either direction)
product development processes
Synergies and Value
tax benefits
placing shared services and central purchasing in tax- advantaged
locations
reorganizing to pool taxes
pushing debt into high-tax subsidiaries
in general: synergies are often easy to understand on a conceptual

level, but hard to estimate
partly due to horrendous conditions: time pressure, limited
information, confidentiality must be maintained
partly due to managers that just love that deal
schedule

Synergies and Value
 case study – differences in valuation

 sale of a medium-sized German pharmaceutical company
 production site in Germany

 r&d personnel
 large share of turnover with two products which it has
developed and on which it owns patents
 sales force / distribution network in Germany
 few smaller sales bureaus in Europe
source: P. Achleitner 2003
Synergies and Value
 case study
 potential strategic buyers
 big German pharmaceutical companies

 medium-sized German pharmaceutical companies
 EU pharmaceutical companies
 non-EU pharmaceutical companies
Synergies and Value
 big German pharmaceutical company

 will pay for…
 production site in Germany 

 r&d personnel ()
 large share of turnover with two products which
it has developed and on which it owns patents 
 sales force / distribution network in Germany 

 main rationale: rationalization, turnover growth
 conservative valuation
Synergies and Value
 medium-sized German pharmaceutical company

 will pay for…
 production site in Germany 

 r&d personnel

 sales force / distribution network in Germany

 few smaller sales bureaus in Europe 
 main rationale: achieving critical size
 aggressive valuation (but often not too much money)
Synergies and Value
 EU pharmaceutical company
 will pay for…

 r&d personnel 
 sales force / distribution network in Germany 

 main rationale: interested in German distribution network,
r&d cooperation, growth of product range
 very aggressive valuation
Synergies and Value
 non-EU pharmaceutical company

 will pay for…

 r&d personnel 
it has developed and on which it owns patents

 sales force / distribution network in Germany 
 few smaller sales bureaus in Europe 
 main rationale: access to EU, Germany
 extremely aggressive valuation
Synergies and Value
the more assets of the target can be used, the higher the price
market access is highly valued
golden rule: foreigners pay most
well-documented in literature
next slides: study on European takeovers from Rustige / Grote
Analysis on data-set of offer prices
Data and methodology
Sample composition... ...and premium calculation

1,931 Acquisitions from 1985 to 2009 where Target First offer
• Target is public and domiciled in Europe - share price @ 600
Acquirer may come from any country Offer

600
• Acquirer owns <50% pre-acquisitions and price
>50% post-acquisition
• Deal Value >10m €
40,5%
• Consideration is all cash, all share or 500
combination of both -30d -10d
• Successful match to Worldscope & Base
Datastream price
400
Acquisition prices extracted from SDC Ø 427

• "CONSID" text field information is used to
extract per share offer price 300
1 May 2000 1 Jul 2000
• Offer related to average target price
between -30 and -10 days prior to
announcement
Premiums in cross border acquisitions
are higher
Cross-border acquisitions show a ~10%- ...which is robust to deal

points "cross-border premium"... and target characteristics
% Bid Premium % Bid Prem ium Base Period Only Cash No Fin.Acq.
(1) (2) (3) (4)
Cross-Border 8.344 *** 10.091 *** 7.442 *** 8.613 ***

34.8% [6.7] [5.07] [5.66] [6.24]
LN Deal Value 0.461 0.716 0.363 0.543
10.4%*** [1.18] [1.23] [0.85] [1.29]
24.4% Tender offer 3.746 *** 5.366 *** 4.003 ** 4.036 **
[2.61] [2.77] [2.52] [2.5]
...
...
...
...
...
N 1,931 1,929 1,596 1,665
R² adjusted 20.9% 14.3% 23.3% 20.0%
F 0.24 *** 0.17 *** 0.26 *** 0.23 ***
Controls: Acq. stock return, Target RoA, LN Target Q,

Domesti Cross-
toehold, % sought, diversifying, amended, hostile,
c border
completed, Euro deal, Cash year dummies, target industry,
target country
What is special about cross-border acquisition compared

to domestic deals?
Note: *** significant at 99%, ** significant at 95%, * significant at 90%
What drives higher bid premiums in
cross-border acquisitions?
International acquisitions
 Synergies
should deliver better or
Market access, efficiency gains, equal returns to acquirers
internalization
Asymmetric Information Equity offers as well as

Foreign & unknown acquirers bear acquisitions by private
acquirers should demand
greater risks for incumbent owners
higher premiums
Management‘s private benefits

Cross-border premiums
Risk reduction through diversification,
should be higher in firms
lower risk of firing b/c higher complexity, with high managerial
higher prestige and salary due to size discretion
Private firms do not offer more abroad
Are they making more deliberate acquisitions?
Public acquirers pay 12.5 %-points more Results are robust in multiple
in cross-border acquisitions regression analysis
% Bid Premium Dependent variable: All Private Public
38.3% Bid Prem ium (1) (2) (3)
Cross-border 9.235 *** 2.451 9.005 ***

[5.75] [1.24] [5.48]
12.5%***
Private acquirer -5 ***
25.4% 25.8% [-3.05]
2.8% 22.6% Priv. acq _x_ Cross-Border -5.861 **
[-2.46]
...
...
...
...
N 1,931 702 1,229
R² 24.8% 19.6% 27.1%
R² adjusted 22.2% 13.3% 23.3%
F 8.466 *** 3.106 *** 6.763 ***
Private Public
acquirer acquirer Controls: Acq. stock return, Target RoA, LN Target
Domestic Cross Border
Q, LN Deal Value, % sought, % held before,
challenged deal, diversifying deal, subsequently
amended, Tender Offer, Hostile acquisition,
Completed, Euro deal, Cash payment,
Fixed effects: Year, target industry, target country
Analysis of public acquirers provides further
support for agency-hypothesis
Cross-border acquisitions yield ~1% ... the "cross-border premium" varies

lower announcement returns and... with proxies for managerial discretion
CAR[-1;1] (1) (2) (3) (4) Acquirer closely held shares

Cros s-border -0,007 * -0,011 *** -0,009 ** -0,009 ** • The closer held the company,
[-1,73] [-2,75] [-2,17] [-2,17]
the lower the cross-border
LN Acquirer Size -0,002 * -0,002 *
[-1,81] [-1,8] premium
Targe t RoA 0,000 • Shleifer/Vishny (1997)
[0,11]
LN Target Q 0,001
[0,3] Leverage (Disciplining effect of
debt)
...
...
...
...
N 1.028 1.028 952 952 • The higher the leverage, the
R² adjusted 1,8% 3,3% 2,2% 1,9%
stronger the external
F 1,80 *** 1,99 *** 1,62 *** 1,57 ***
monitoring
Controls: Acq. stock return, Target RoA, LN Target • Data: % liabilities to total
Q, LN Deal Value, % sought, % held at before, assets
challenged deal, diversifying deal, subsequently
amended, Tender Offer, Hostile acquisition,
Completed, Euro deal, Cash payment Cash-Holding
• The "cash-richer" the firm, the
Fixed effects: Year, target industry, country
higher the managerial
discretion
• Data: % cash to total assets
• Harford (1999)
Further robustness-checks
Is "private" a proxy for acquirer size?

• Hypothesis: Conceivable that private acquirers are systematically smaller
than large acquirers
• Approach: Deal-Value as proxy for acquirer size
• Result: "Cross-border premium" is especially prominent for small deals –
little evidence that private is a proxy for size
Is free-rider problem (Grossman/Hart) less an issue in deals of private

acquirers?
• Hypothesis: private bidder may go for firms with cultural proximity (family
owned, majority owner), where free rider problem may drive down bid
premiums
• Approach: Acquisition process (tender/non-tender) as proxy for relevance
of free-rider problem
• Result: Private acquirers pay a small significant premium only in tender
offers, public acquirers in all settings
Conclusion: Cross-border premiums
Premiums in cross-border acquisitions are significantly higher

• Significant "cross-border premium" of ~10 percentage points
• Robust to deal, acquirer and target characteristics
Strikingly, this "cross-border premium" is not evenly distributed

• On average, only public bidders pay significantly more in international M&A
• Private bidders pay only insignificantly more
• Support of notion that premium is driven by agency aspects
Robustness checks further support agency hypothesis

• Public bidders' shares loose on average ~1% when buying abroad
• Cross-border premiums varies with indicators of managerial discretion
• Private bidders subject to cross-border premium only in tender offers, while public
bidders do so in all settings
While synergies play some role, managerial discretion and the pursue of
private benefits drive the higher bid premiums in international M&A
schedule

synergies might be elusive
 Harry Tempest, former CEO of ABN AMRO:
„We have a rule on the executive committee. When someone

says ‚strategic‘, the rest of us say, ‚too expensive‘.“
“Of one thing, however, be certain: If a CEO is enthused about a

particularly foolish acquisition, both his internal staff and his outside
advisers will come up with whatever projections are needed to justify
his stance. Only in fairy tales are emperors told that they are naked.”
Warren Buffett, 1997 Berkshire Hathaway annual report
repeat
based on DCF analysis

start with valuing firm as a stand-alone
basically one treats, e.g., cost savings due to an acquisition as
permanent cost reductions.  These reductions are assumed to last
forever!
revenue enhancements increase revenue growth – new base lasts
forever,
etc.
 forms of operating synergy:
 cost reductions as a percentage of sales and increase of

profit margins (= economies of scale)
 increase in future growth (increasing market power)
 longer growth period (increased competitive advantage)
 re-value the target firm with new estimates
 costs associated with the acquisition (integration costs) are treated

as usual costs – but with a defined life-span, usually not longer than
three years  important, but often underestimated!
 valuing financial synergy
 synergy can also be created from purely financial factors,

 excess cash (or cash slack)
 a greater tax benefit from accumulated losses
 increase in debt capacity
 cash slack
 when a firm with significant excess cash acquires a firm
with great projects but insufficient capital, the combination
can create value
valuing financial synergy
cash slack
managers may reject profitable investment opportunities if they have
to raise new capital to finance them
it may therefore make sense for a company with excess cash and no
investment opportunities to take over a cash-poor firm with good
investment opportunities (or vice versa)
the additional value of combining these two firms lies in the present
value of the projects that would not have been taken if they had
stood apart, but can now be taken because of the availability of cash
valuing financial synergy - cash slack

assume that Instagram had a severe capital rationing problem, that
resulted in approximately $500 million of investments, with a
cumulative net present value of $100 million, being rejected
Facebook had far more cash than promising projects, and had
accumulated $4 billion in cash that it was trying to invest – it was
under pressure to return the cash to the owners
by Facebook taking over Instagram, it could be argued that the value
of the combined firm would increase by the financial synergy benefit
of $100 million, the net present value of the projects possessed by
Instagram that can now be taken with the excess cash from
Facebook
 valuing financial synergy - tax benefits
 tax paid by two firms combined together may be lower than

the taxes paid by them as individual firms
 (1)
 if one of the firms has tax deductions that it cannot use
because it is losing money, while the other firm has income
on which it pays significant taxes, the combining of the two
firms can lead to tax benefits that can be shared by the two
firms
 the value of this synergy is the present value of the tax
savings that accrue because of this merger
 valuing financial synergy - tax benefit
(2)
the - tangible - assets of the firm being taken over may be written up
to reflect new market value, leading to higher tax savings from
depreciation in the future
example: LBO by Congoleum Inc., a diversified firm in 1979 by the
firm's own management
after the takeover, estimated to cost $400 million, the firm would be
allowed to write up its assets to reflect their new market values, and
claim depreciation on the new values
the estimated change in depreciation and the present value effect of
this depreciation, discounted at the firm's cost of capital of 14.5% and
based on a tax rate of 48% is shown on the next slide:
 valuing financial synergy - tax benefit - Congoleum
tax rate: 48%
PV of tax
savings
approx.
10% of
overall
price
 valuing financial synergy
 debt capacity
 if the cash flows of the acquiring and target firms are less
than perfectly correlated, the cash flows of the combined
firm will be less variable than the cash flows of the
individual firms
 this decrease in variability can result in an increase in debt
capacity, so the combined firm may be able to borrow more
(have a higher debt ratio) than the individual firms
 which could increase the value of the firm
 sometimes it is the bondholders that gain most: they find

themselves lending to a safer firm after the merger - but
receive interest rates on the riskier premerger firms
 discounting future synergies
 the appropriate discount rate used to discount future synergies is

controversial:
target firm‘s rate?
acquiring firm‘s rate?
combined entity‘s rate?
 best is to use the discount rate of the part of the firm where the
synergies take place
 synergies take place at the target: target‘s rate, etc.
 but: debated – needs to be discussed in any case
acquisition valuation - summary
motive valuation specials
undervaluation value target firm as stand-alone entity:

no extra premium
diversification value target firm as stand-alone entity: no

extra premium
operating synergy  value the firms independently

 value the combined firm with the
operating synergy
 synergy is the difference between
the latter and former
 target firm value = independent
value + synergy
acquisition valuation - summary
motive valuation specials
financial synergy tax benefits: value of target firm + present

value of tax benefits
debt capacity: value of target firm +

increase in value from debt
cash slack: value of target firm + NPV of

projects/ target
control value of target firm run optimally
manager’s interest value of target firm: No extra premium
schedule

case: HypoVereinsbank and Unicredit
1998 – Vereinsbank merges with Hypobank

(first significant bank merger in Germany)
1999 – Problems with bad mortgage loans surface
2000 – Hypovereinsbank merges with Bank Austria
(market leader in Bavaria, Austria, Central &
Eastern Europe)
2003 – IPO of 22.5% of Bank Austria
2004 – continued problems with bad loans
2005 – Hypovereinsbank bought by Unicredit
(largest cross-border banking merger)
mid 2005: strategic options limited
synergy calculation
Global Banking Services: €310 million cost synergies
migration to one single IT platform (nor further development of

different IT platforms)
outsourcing software development
improved productivity in IT operations
rationalisation of international branch network
combination of back-office operations
Retail: €170 million cost synergies
improving cost/income ratio in Germany and Austria

exporting Unicredit’s management model to Germany
synergy calculation
Multinationals & Investment Banking: €140 million cost

synergies
integration of investment bank activities

creation of “centers of excellence” in selected product areas which
can be levered at a pan-European level
Private Banking and Asset Management : €110 million (2/3 cost

synergies; 1/3 revenue synergies)
economies of scale thanks to creation of a single investment and risk

management platform
leveraging existing Unicredit presence in Ireland
pricing realignment vs. industry average (leveraging Pioneer brand
recognition)
synergy calculation
Corporate and SMEs: €90 million (40% cost synergies; 60%

revenue synergies)
broadened product range allowing for revenue enhancements, e.g.

cross-selling
rationalisation across business areas and functions
creation of common product factory platform
total synergies: € 985 million per year
91% cost synergies; 9% revenue synergies
net synergies
restructuring charges estimated to be €1350 million

fully expensed in 2005 P&L
estimated synergies are 0.5% of combined 2004 revenues

or 7.4% of combined 2004 costs
HVB’s existing tax shield is used for calculations
tax benefit on restructuring charges not used in estimation

benefits of reduced funding costs not considered
net synergies
cost-synergies are to a large extent driven by

lay-offs (always)
total workforce-“right-sizing”: 7% i.e. ~ 9,200 people
CEE: 9% (of regional workforce, ~ 5,400 people)

Germany: 7% (of regional workforce, ~ 1,800 people)
Austria: 7% (of regional workforce, ~ 900 people)
Italy: 2% (of regional workforce, ~ 900 people)
Internat.: 33% ( ~ 200 people)
during presentations total numbers were never mentioned
calculating synergies
an atypical success story
marketing required
marketing required…
…and successful
newly-weds
in line with empirical findings
 Houston et al. (2001) find that the primary source of management’s

expected merger-related gains is cost savings
 revenue enhancements are far less important: estimated revenue
gains account for 7% of the total valuation gains implied by
management’s estimates on average (median: zero)
 while valuation estimates of projected cost savings are positively
related to the combined stock market returns of the bidder and
target,
 valuation estimates of projected revenue increases are
negatively related to stock market returns around announcement
Houston J.F.; James C.M.1; Ryngaert M.D. (2001), Where do merger gains come from? Bank mergers from the
perspective of insiders and outsiders, Journal of Financial Economics, Vol. 60 (2), pp. 285-331
likely board questions for the CEO on synergies
What are the stand-alone expectations of the acquirer

and target?
Where will performance gains emerge as a result of
the merger?
Are the projected performance gains in line with the
premium being paid?
Synergies and
What are the milestones in a 12-24 month Realization
implementation plan?
What added investments will be required to support
Source: based on Sirower / Sahni 2006

the plan?
Who are the key managers responsible for
implementing the plan?
Mergers & Acquisitions – Slide Set Session 3
-- END OF SESSION 3 --
Michael H. Grote

03a Slides - Synergies

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03a Slides - Synergies

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Mergers & Acquisitions – Slide Set Session 3

 synergies and value

source: HBR 1999

source: Deloitte 2017

source: BCG 2018

only in about half

source: BCG 2018

What you aspire to achieve to create exceptional value

Ambitious stretch targets communicated to PMI teams

What you are confident you can achieve

High confidence internal targets from

What you need to achieve

acquisition valuations are complex,

the motive behind the acquisition is important for acquisition

however, the valuation of an acquisition is not fundamentally

although the existence of control and synergy premiums introduces

following up with a value for control and a value for synergy

basically one treats e.g., cost savings, as an additional cash flow

Revenue synergies (MUSD)

 synergies and value

 motives for m&a

 undervaluation, i.e., that firms that are undervalued by financial

 diversification, with the itent of stabilizing earnings and

there are five types of synergies:

typical cost synergies (ordered roughly by size): people, operational

source: Deloitte 2017

source: Deloitte 2017

typical revenues synergies:

source: Deloitte 2017

source: Deloitte 2017

in general: synergies are often easy to understand on a conceptual

 synergies and value

 case study – differences in valuation

 production site in Germany

source: P. Achleitner 2003

 big German pharmaceutical companies

 big German pharmaceutical company

 production site in Germany 

 medium-sized German pharmaceutical company

 production site in Germany 

 production site in Germany 

 non-EU pharmaceutical company

 production site in Germany 

golden rule: foreigners pay most

Sample composition... ...and premium calculation

Acquirer may come from any country Offer

Acquisition prices extracted from SDC Ø 427

Cross-border acquisitions show a ~10%- ...which is robust to deal

Cross-Border 8.344 *** 10.091 *** 7.442 *** 8.613 ***

Controls: Acq. stock return, Target RoA, LN Target Q,

What is special about cross-border acquisition compared

Asymmetric Information Equity offers as well as

Management‘s private benefits

Cross-border 9.235 *** 2.451 9.005 ***

Note: *** significant at 99%, ** significant at 95%, * significant at 90%

Cross-border acquisitions yield ~1% ... the "cross-border premium" varies

CAR[-1;1] (1) (2) (3) (4) Acquirer closely held shares

Is "private" a proxy for acquirer size?

Is free-rider problem (Grossman/Hart) less an issue in deals of private

Premiums in cross-border acquisitions are significantly higher

Strikingly, this "cross-border premium" is not evenly distributed

Robustness checks further support agency hypothesis

 synergies and value

Cross-Border 8.344 * 10.091 * 7.442 * 8.613 *

Cross-border 9.235 * 2.451 9.005 *

Note: * significant at 99%, significant at 95%, * significant at 90%