The Value of Synergy

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The Value of Synergy


“Many acquisitions and some large strategic investments are often justified with the argument that they will create synergy”

 

There are various types of Synergies like financial synergy and operational synergy. We then examine how best to value synergy in any investment and how sensitive this value is !!!

 

Synergy can be quoted as an increase in value that is generated by combining two entities to create a new and more valuable entity, which is the magic ingredient that allows acquirers to pay billions of dollars as a premium in acquisitions.

 

Operational synergies:

Operating synergies are those synergies that allow firms to increase their operating income from existing assets, increase growth, or both.

Eg. Economies of scale, Greater pricing power, Combination of different functional strengths, Higher growth in new or existing markets, etc.

 

Financial Synergy

Financial synergy leads to either higher cash flows or a lower cost of capital.

Eg. Debt capacity can increase, Tax benefits, Diversification, etc.

 

How to value synergy?

Here are 3 steps:

1)      First, we value the firms involved in the merger independently, by discounting expected cash flows to each firm at the weighted average cost of capital for that firm

2)      Second, we estimate the value of the combined firm, with no synergy, by adding the values obtained for each firm in the first step

3)      Third, we build in the effects of synergy into expected growth rates and cash flows and we revalue the combined firm with synergy. The difference between the value of the combined firm with synergy and the value of the combined firm without synergy provides a value for synergy

 

 

 

 



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