Timing of Synergies

What is Timing of Synergies?

The timing of synergies refers to when the synergistic effects are expected to occur or be most apparent.

M&As - and many other business activities - are highly dependent on the business cycle. Profitable M&A deals occur during periods of expansion (also called economic boom). During economic developments, the unemployment rate decreases while company sales increase because of consumer purchasing and bull stock markets.

As a result, companies and investors are more willing to invest in other companies because of successful sales and higher expectations of higher post-merger returns on investments.

Hence, M&A transactions during this period are very profitable.

The timing of synergies also depends on the type of synergy they produce. In some cases, synergies may be immediate, while in others, they may take time to develop.

For example, if two companies merge and the combined entity can streamline operations and reduce costs, the synergies from the merger may be realized relatively quickly.

On the other hand, if the merger is expected to create new revenue opportunities by combining the strengths of both companies, the synergies may not be realized until later, as it takes time to develop and capitalize on those opportunities.

Hence, the timing of synergies will depend on the specific actions being taken and the goals being pursued. 

Synergies are quite an important concept in finance - the primary reason companies and investors enter mergers and acquisition deals. Timing of synergies is especially important, too, because not all mergers and acquisitions produce synergies. 

What is Synergy?

To understand what timing synergies mean, we should first figure out what synergy means.

The dictionary definition of synergy is the interaction or cooperation of two or more organizations, substances, or other agents to produce a combined effect more significant than the sum of their particular products. “One plus one is greater than two” is a common statement regarding synergies.

In business, synergy is the estimated cost savings or incremental revenue arising from a merger or acquisition, which buyers often use to rationalize higher purchase price premiums (the percentage by which a product's selling price exceeds or falls short of a benchmark price). 

This means synergy describes the increased efficiency or effectiveness achieved when two or more companies or entities merge or work together.

It is most often used regarding mergers and acquisitions (M&A). In short, synergy is the extra benefit you get when you merge with another company. 

For example, a merger between two companies may be described as creating synergy because the combined resources and expertise of the two companies are expected to create greater value than each company could achieve on its own.

Synergy can be defined as the potential financial benefit achieved through mergers, which is the incentive for companies to enter into M&A deals.

Synergies Realization

Timing of synergies can sometimes also mean the timing of synergy realization.

Synergy realization is the capitalization of potential synergies - it would be a disaster if the deal only looked good on paper and not real life.

The timing of synergy realization and duration are often overlooked. The notion of integration, a process required in an M&A deal, implies that synergy gains take time to materialize into actual profits, and if synergy is realized, gains should eventually diminish. 

A Wharton study argued two general propositions:

1. The greater the post-acquisition integration required by the combination of financial activities, assets, and relationships associated with a certain synergy type, the longer companies will realize that value from the synergy type.
2. The greater the post-acquisition control the merged company has over its financial activities, assets, and relationships associated with a specific synergy type, the longer the gains from that synergy type will persist. 

Hence, evaluating synergy is essential, but the realization of synergy cannot be overlooked. 

No formula or go-to guide can help companies overcome this challenge, so they must do their best to stick to their goal and take all the necessary actions to materialize their potential gains.

Types of Synergy

In business, several types of synergy can be achieved through mergers, acquisitions, partnerships, or other forms of collaboration.

Synergies can be mainly divided into three different categories:

1. Cost Synergies 

These occur when two companies merge and can reduce costs by eliminating duplicative functions, consolidating operations, or negotiating better deals with suppliers.

2. Revenue Synergies 

These occur when two companies merge and can increase their revenue by cross-selling products or services to each other's customer base, expanding into new markets, or introducing new products.

3. Financial synergies 

These refer to the ability of a combined business to achieve a stronger financial position, such as through lower borrowing costs or improved access to capital.

There are also lesser-considered synergies, such as:

1. Strategic Synergies 

These occur when two companies merge and can achieve strategic goals that would have been difficult to accomplish independently. 

2. Cultural Synergies 

These occur when two companies merge and can create a positive and productive corporate culture by aligning their values, goals, and practices.

Synergies are all interrelated - most of the time, when you achieve one, you will likely achieve another due to how businesses function. However, regardless of the synergy in an M&A deal, the end goal is to improve a company's development and profit.

Since cost, revenue, and financial synergies are the three main benefits M&A deals look for, we will focus on understanding those three.

Cost Synergies

Reducing costs is an efficient way for companies to develop and expand. They can direct funds that were supposed to go to their expenses into areas where companies can better invest their money.

Companies can find cost synergies in the:

1. Information Access

Shared information access allows both companies in an M&A deal to increase the information technology and data they have access to. That way, companies do not have to spend extra money for increased access and instead gather their pool of information.

2. Supply Chain 

Companies often merge because they are at different stages of a supply chain. By joining forces, they can streamline supply chain processes and save money by having a more efficient process and removing unnecessary parties. 

3. Sales & Marketing 

Companies merge to improve both companies' sales and increase marketing channels. By doing so, they can take advantage of each company's strong suit and be more efficient.

In addition, when companies merge, they can save costs by consolidating their marketing budget to market one brand instead of spending money individually to market each of their business.

4. Research & Development 

A merger allows both companies involved in the deal to capitalize on each other's investments in R&D, which can help them cut R&D costs and improve the team's overall knowledge.

5. Staff and Salary Optimization 

Mergers allow companies to also streamline their teams, just like supply chains. A joint team means fewer members involved - there is no need for two CEOs, two CFOs, etc. - which results in fewer salaries while keeping the best members. 

This may also mean there will be a better division of labor, which allows companies to take on more work, offer more products and services, be equipped to expand, etc.

6. Equipment 

Both companies in an M&A deal have access to each other's equipment - heavy machinery, office supplies, etc. 

This allows them to save costs when they merge because they would obtain access to new equipment owned by the other company and dismiss the need to purchase additional equipment.

Revenue Synergies

Increasing revenue helps companies by increasing the amount of money that the company is bringing in. By bringing in more money, the company can fund operations, pay expenses, and potentially make a profit. This can help the company to grow and be more successful in the long run.

Companies can find revenue synergies in the:

1. Increased Demographic 

When companies merge, they also merge each company's demographics, which allows them to expand their reach and engagement. 

Increased demographics can mean an increased volume of their current target audience or a new set of target audiences. 

In both situations, a company has access to more people to invest or purchase their product or services, resulting in higher revenues.

2. Optimized Production 

Like the staff and salary optimization and equipment mentioned under cost synergies, access to new employees and equipment allow merged companies to streamline their production processes, creating more efficiency and increasing output (higher revenue).

3. Increased Products and Services

Companies that enter an M&A deal are usually different but relevant. This means companies provide each other with new or an increased volume of products or services that will improve a company's revenue.

4. New Customers 

When companies merge, they get additional customers. This new solidified customer base can improve sales and return, resulting in increased revenue.

5. Intellectual Property 

Merged companies receive each other's intellectual properties - namely patents, trademarks, etc. In this case, they can often produce more competitive offerings and obtain higher revenues.

Financial Synergies

Outside money, such as loans or investments, can be beneficial for businesses because it allows them to access additional financial resources that can be used to fund expansion, hire new employees, invest in new technology or equipment, and otherwise support the growth and development of the company.

In addition, outside money can help a business to improve its financial stability and reduce its reliance on internal financing. This can provide a buffer against financial challenges or uncertainties, giving them the flexibility they need to weather economic downturns and other challenges.

Obtaining outside funding can also be viewed as a sign of credibility and help establish the business as a serious and viable player in the market.

Companies can find financial synergies in the:

1. Borrowing Loans 

Related companies can merge to improve their credit and present higher revenue to obtain financing and business loans.

2. Loan Repayment

It is more cost-efficient to repay one big loan than two separate loans because they pay less interest. In addition, merging can increase their revenue to repay the loan faster. 

Where is Synergy Reflected?

A firm's synergy is reflected through a company's financial statements, such as the goodwill account, income statement, and balance sheet.

As a quick refresher, goodwill is an intangible asset presented on a firm's balance sheet. Its value is found in a firm's good name and recognition value, such as

• brand recognition,
• intellectual property, and
• good customer relationships. 

Another place to look for business synergy in financial statements is in the income statement. If combining two businesses leads to increased sales or cost savings, this will typically be reflected in the financial statements through higher revenues and profits.

Another area to look for business synergy in financial statements is the balance sheet. Suppose the combination of two businesses leads to more efficient use of assets or the creation of new investments. This may be reflected in the balance sheet through higher asset values or a stronger overall financial position.

Even though synergy is reflected through a firm's financial statement, it may not have a monetary value; for example, it could be seen in reducing costs or increasing profit margins. However, the bottom line is synergy must bring a more significant benefit to affect that value.

It may be necessary to analyze the financial statements of the individual businesses before and after the merger or collaboration to understand the impact of business synergy fully. We will expand on this later when we learn about the timing of synergies.

Example of Synergy Calculations

Let's look at how synergy can be calculated through an example. Imagine there are two healthcare companies: Wall Street Partners and Oasis & Co. Both Wall Street Partners and Oasis & Co. generate $250M per year in revenue.

One day, the two companies merged to form Wall Street Oasis Inc. They now generate $750M per year in revenue.

Calculating revenue synergy can be challenging, as it requires forecasting future revenues and estimating the potential impact of the combined efforts of the two companies.

We can calculate the revenue synergy by subtracting the forecasted revenues that would have been generated by the two companies working separately from the forecasted revenues that are expected to be generated by the combined efforts of the two companies.

The resulting number represents the revenue synergy expected to be achieved through the combination.

In this case, we estimate

• the revenue of Wall Street Oasis Inc. is $750M, and
• the sum of revenues generated by Wall Street Partners and Oasis & Co. is $500M.

As a result, there is a $250M revenue synergy generated from this merger.

This is the extra simplified version of calculating synergies. 

Real-life Example of Synergy

In 2006, Walt Disney acquired Pixar, which benefited both companies.

Before the acquisition, Disney generated about $34B in revenue. After the acquisition, Disney's revenue increased by nearly $41B five years after the deal. Despite S&P 500 dropping at the time, Disney's stock price increased.

However, it is essential to note that not all M&As give rise to synergy. For example, Quaker Oats' acquisition of Snapple is one of the most famous failed M&A deals. 

In 1993, Quaker outbid Coca-Cola and other interested parties for Snapple at the cost of $1.7B. Barely under two years, Quakers sold Snapple for only $300M, a price most investors and observers found generous.

It was logical at first thought that Quaker and Snapple should not be that terrible of a deal. Yet, it is not the case if you analyze the firms more closely. Quaker and Snapple sold on distinctly different sales channels, and their branding and target markets differed.

Unlike Disney and Pixar, Disney and Pixar had similar target markets and products, so their deal reduced competition. In addition, the acquisition gave Disney access to Pixar's technology, allowing for synergy.

Now that you know what synergies are, let's talk about the timing of synergies. This is crucial because M&A deals are time-sensitive, given the volatile nature of financial markets. 

Procter and Gamble Example

Procter and Gamble's (P&G) acquisition of Gillette is an example of a successful M&A deal.

P&G acquired Gillette, a leading personal care and grooming product manufacturer, in 2005 in a deal valued at approximately $57 billion. 

The acquisition allowed P&G to expand its personal care and grooming product portfolio and gain access to Gillette's strong distribution network. The acquisition has also allowed P&G to expand its presence in the men's grooming market and offer consumers a wider range of personal care products.

In their case, P&G's value of its broad product line and favorable payment terms combined with Gillette's return on investment and trade terms and incentives that P&G had never implemented before allowed the company to create an integrated - and better -trade terms model.

However, the gains did not occur automatically; the mutual gains from the integrated trade terms with its customers took time to materialize. The COO of P&G had said: “over time, it became apparent that Gillette was best in class at a lot of things that P&G wasn't good at.” 

The emphasis on the time it took to materialize the gain from the M&A deal reflects the challenge many other companies going through M&A deals have to face. 

Researched and authored by Alisa Zhu | LinkedIn

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