Financial Synergy

Refers to when two firms merge and their financial operations improve to a higher degree.

Christopher Ballesteros

Reviewed by

Christopher Ballesteros

Expertise: Consulting | Private Equity


September 25, 2023

What Is Financial Synergy?

Financial synergy is when two firms merge, and their financial operations improve to a higher degree than when they are functioning as independent organizations. It is a term synonymous with the context of mergers and acquisitions.

When two companies merge, the additional value they create is worth more than the value of them separated. This is when synergy occurs.

In this article, we will be discussing financial synergy.

Synergy can be categorized into three types that can occur in any transaction of mergers or acquisitions in varying degrees. The three synergies are:

  • Revenue Synergy

  • Cost Synergy

  • Financial Synergy

Combined, companies have a large consumer base, operations, capital, etc., thereby increasing their value.

Financial synergy usually indicates an improvement in the financial metrics of two companies when they merged from when they were separate entities. These metrics include lower cost of capital, taxes, increased capital sources, profitability, cash flow, etc.

Simply put, financial synergy indicates that the combined financial worth of two merged companies is greater than the sum of their separate values.

Benefits of financial synergy

Some of the benefits are:

1. Increased Cash Flows

Companies can use the large operations and market share achieved after merging to increase their revenue, thereby increasing their cash flow.

In addition, with improved debt capacity, companies can raise more funds from various financial institutions.

2. Reduced Taxes

Companies can use current tax regulations to get tax advantages, such as utilizing losses to reduce taxes. For example, if a profitable company buys a company that is not doing well, the former can reduce its tax burden.

Furthermore, one firm might reduce its tax burden by using the depreciation costs of another firm.

3. Improved Debt Capacity

When two businesses merge, their cash flows, sales, and profits become more stable. This strengthens their balance sheet, allowing them to take on additional debt or increase capacity.

In addition, the new company could negotiate higher interest rates and loan terms with the borrower.

4. Reduced Cost of Equity

The cost of equity may be reduced when a merger or acquisition leads to diversification. This usually occurs when a large corporation buys a small company or when a public company buys a private company that operates in a different industry.

Even within the same sector, acquiring rival firms lessens competition and increases market share and the customer base. All these may eventually lead to a cheaper cost of equity.

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Financial Synergy Examples

Financial synergies are improvements in a company's financial operations following a transaction. This usually entails a stronger balance sheet, a reduced cost of capital, tax advantages, and better access to financing for the merged company.

Given below are some acquisitions and mergers that are examples of financial synergy:

1. Facebook and Instagram

In 2012, Facebook (now Meta) purchased Instagram for $1 billion, an acquisition that was thought to be one of the most expensive purchases of the former at the time.

Facebook, at the time, was gearing up for its initial public offering, while Instagram was a small start-up with a mere 13 employees, 30 million users, and zero revenue. $ 1 billion was a high price for a company that was not earning any revenue.

Back then, Facebook provided an internet service like no other, but its users were moving towards phone-based apps. With the rise of applications like Snapchat, Facebook was already facing competition, and Instagram could’ve been another competitor.

This left only two options for Facebook to win. One, either Mark Zuckerberg’s engineers could make Facebook so interesting and helpful that it consumed an increasing amount of people's smartphone time.

Second, he could acquire, copy, or eliminate competing applications, ensuring that other firms had less opportunity to infringe on people's Facebook habits. With Instagram, there was only one option: buy.

Today, the acquisition of Instagram by Facebook has been one of the most successful. Instagram now accounts for about one in every four dollars of Facebook's yearly ad income, bringing in more than $1 billion every quarter, and has more than one billion active users.

2. Disney and Pixar

The two prestigious firms, Disney and Pixar, merged on May 5, 2006. Pixar was bought by Disney for $7.4 billion in stock and became a Disney subsidiary. It has since been praised as one of the most successful mergers in history.

Pixar specializes in animation, whereas Disney primarily focuses on producing animated films. Both businesses were in the same industry but functioning at different production phases.

By acquiring Pixar, Disney gained access to the former’s creative and technological talent. For Disney, this was going to be a huge addition. Disney and Pixar's combined efforts and resources could produce more movies in a year, resulting in added value for Disney.

For Pixar, merging with Disney aided them with distribution and funding and provided a better market position against competition like DreamWorks, Universal, etc. 

Disney owns assets such as theme parks and has business experience in the animation sector. It would also aid Pixar in increasing its private equity ratio.

3. Pfizer and Allergan

Pfizer Inc, the maker of Viagra, Lipitor, and the Pfizer-BioNTech Covid-19 Vaccine, had proposed to buy Allergan Plc, the maker of Botox, in 2016 for $160 billion. Allergan Plc is an Ireland-based pharmaceutical company that enjoys low tax rates. 

This acquisition would have allowed Pfizer to shift its headquarters to Ireland in a so-called "inversion," which would reduce its tax rate.

As it is commonly known, the US charges 35 percent tax to corporations, one of the highest in the world, while Ireland charges only 12.5 percent.

However, in April, what could have been the biggest-ever deal in the health sector collapsed as the US government changed certain rules. These rules prevented the New York-based Pfizer from reducing its tax rates by shifting its headquarters to Ireland, thereby shutting down the deal.

How to maximize the synergy of the deal

Mergers and acquisitions are unique investment decisions as the entire price must be paid upfront, whether in cash, stock, or both. Managing a synergy in many ways is similar to managing a complex new company.

The following should be avoided during mergers and acquisitions to utilize the full potential of the deal:

1. Straying Too Far

Very few businesses can enter and manage themselves in multiple industries successfully. As a result, the temptation to stray into unrelated areas that appear attractive and favorable is often strong.

However, the reality is such onsets are risky and should only be initiated after proper analysis and research of the prospects.

2. Leaping before Looking

Sometimes companies fail to investigate the business that they want to acquire. The problems that could be faced later on might include:

Hence, the company must thoroughly assess the other company before the proposed deal.

3. Integration Failure

Poor implementation of the deal conditions may sabotage even the strongest approach. The appropriate post-acquisition or post-merger integration of the two firms is a requirement for the success of a merger or acquisition.

A clear and coherent strategy must be formulated to enable the buyer company to improve its prospect of creating value.

The following must be kept in mind for the same:

1. Focus on Right Targets

The main idea is to focus where there is potential to create value. If the buying company is best in operations or has unique sales channels, it will look to merge or acquire those companies lacking in such areas.

For example, by acquiring Pixar, Disney accessed its creative talent pool of original animated content creators. At the same time, Pixar got access to Disney’s distribution channels worldwide and expanded its reach.

2. Estimate Proper Values of Synergies

The valuation of a company should not be clouded by wishful thinking or debased by an obsession to acquire the target company.

And most importantly, the valuation of a company must not be exaggerated by considerations of the so-called ‘synergistic benefits that may be more elusive than real.

3. Disciplined Negotiations

Even when synergies are properly estimated, acquirers may be tempted to overpay. This is because negotiating acquisitions is notoriously susceptible to rising commitments.

This is why two teams should handle the acquisition analysis and negotiation task.

The task of acquisition analysis must be handled from a strategic, operating, and organizational point of view. A game plan should be ready to improve the overall performance.

The task of negotiations should be handled from a financial and legal point of view. Therefore, the second team should be entrusted to carry out the negotiations.

4. Plan and Control the Integration

During acquisition, sometimes differences may arise in visions, strategies, values, culture, production methods and standards, accounting systems, administrative procedures, etc.

A thoughtful attempt has to be made to think through the implications of the merger, anticipate problems that may arise, understand the nature of these problems, and hammer out a sensible and mutually acceptable way to handle these problems.

Synergies are typically easy to spot but difficult to realize, so it is important to remember that even after the transaction is closed, much work must be done to realize the recognized advantages.

The merger and acquisition synergy for a particular transaction must be assessed at every process stage.
To ensure a smooth integration, the post-closing synergy work must be planned and carried out for months, if not years, after closing the deal.

Key Takeaways

  • Financial synergy happens when two firms merge, and their financial operations improve more than when they function as independent organizations.
  • It usually indicates an improvement in the financial metrics of two companies when they merged from when they were separate entities. These metrics include lower cost of capital, taxes, increased capital sources, profitability, cash flow, etc.
  • Managing a synergy in many ways is similar to managing a complex new company. First, a clear and coherent strategy must be formulated to enable the buyer company to improve its prospect of creating value which must include:
    • Focus on the right targets.
    • Estimating the proper value of synergies.
    • Disciplined negotiations.
    • Plan and control the integration.
  • The synergy of a deal must be assessed at every stage of the process, and post-close synergy work must be planned ahead of time and carried out accordingly after the deal is closed.
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Researched and Authored by Aqsa WasifLinkedIn

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