Reading: Creating Value with M&A

The other element that directly affects the net synergy from a deal are the post-merger integration costs. EY conducted a survey about these integration costs. They asked participating firms to indicate their merger integration costs in percent of the value of the conducted transaction. The results summarized in the following graph are rather surprising.

The main takeaways are:

• According to the survey, the average merger integration costs are 14% of the deal value.
• Put differently, a $100 million acquisition typically costs about $14 million to integrate. Absent synergies, its net value would therefore only be $84 million.
• The average deal therefore needs to generate substantial synergies only to justify these integration costs! To see this, remember that the target company often captures a takeover premium of 30% or more. If so, the following example shows that the synergy potential will have to be as high as 50% of the target's stand-alone valuation to make up for the costs of the acquisition (takeover premium plus integration costs)!

Example:

Let us consider a hypothetical target firm with a stand-alone valuation of 100 million. An acquirer offers a takeover premium of 30% and faces merger integration costs of 15% of the deal value. What are the minimum expected synergies from the point of view of the buyer for the deal to make sense financially?

Based on the available information, the deal value is 130 million and the merger integration costs are 19.5 million: 

• Deal Value = Stand-alone Value × (1 + Takeover Premium) = 100 × 1.3 = 130 million
   
• Merger Integration Cost = Deal Value × Merger Integration Costs (%) = 130 × 0.15 = 19.5 million.

Consequently, the overall cost of acquisition will be 149.5 million, namely 130 million to purchase the company plus 19.5 million to integrate it. This is 49.5 million or 49.5% over the target firm's stand-alone value. Therefore, the acquirer must expect synergies or at least 49.5% of the target's stand-alone value just to break even! Generally speaking:
 

Minimum required synergy (% Target Stand-alone Value) = (1 + Takeover Premium (%)) × (1 + Merger Integration Costs (%)) − 1.

As another example, if the takeover premium is 40% and the expected merger integration costs are 12%, the acquirer's minimum required synergies are 56.8% of the target's stand-alone value (= 1.4 × 1.12 − 1).

This implies that a deal generally has to add a lot of value before starting to become valuable for the acquiring company!

Together, these two findings regarding the synergies and the integration costs can explain why creating value with M&A it is easier said than done. Managers and directors should therefore be particularly careful when proposing or agreeing to M&A transactions. Projected synergies should be very critically reviewed, keeping in mind than integrating a merger is almost always costly, and often costlier than expected.