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How synergies drive successful acquisitions
As seen through the eyes of roundtable participants in:
Dallas
Albert Hoover, AT&T Douglas Glen, MetroPCS Harish Mysore, Perot Systems Barbara Papas, Texas Instruments John Rexford, Affiliated Computer Services Scott Thanisch, Sabre Holdings Luis Castellanos Torres, Wal-Mart
Silicon Valley
Mark Copman, 3M Kristina Omari, Adobe Jacob Sayer, Avago Craig Johnson, Cadence Sandeep Johri, HP John Zdrodowski, Intel Ross Katchman, LSI Kevin Kettler, McKesson Chris King, Medtronic Marc Brown, Microsoft J.R. Ahn, NetApp Brian Moriarty, Sun Charlie Rice, Symantec
Contents
Effectively realizing synergiesModeling
Synergy validation Negative synergies PwC point of view
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A note on the survey charts A short survey was conducted among the roundtable participants to better understand their approaches to synergies in the acquisition process. Some of the responses are shown in this report. Despite the small sample size, we view the survey results as an accurate indicator of the challenges associated with modeling, executing, and tracking synergies throughout the deal process, and they are presented here for that purpose.
The market rewards or punishes shareholders of a combined company depending on how well its management succeeds at establishing and, ultimately, achieving one primary objective: create value that exceeds the cost of acquisition.
Exploring synergies
When applied to deals and valuation theory, synergy means both companies win. The sellers shareholders receive an acquisition premium, and the buyer realizes shareholder value by capturing synergies above what is required to justify the deal premium. Because synergies are fundamentally the only tangible justification for making an acquisition, sophisticated and repetitive buyers must orient their acquisition processesfrom screening through post-integration monitoringto focus deal and business unit teams on identifying, quantifying, executing, and tracking synergies by deal, business unit, deal type, and across the portfolio of acquisitions. To provide business leaders opportunities to share best practices and learn from the obstacles and pitfalls their peers encounter in the acquisition process, PricewaterhouseCoopers (PwC) facilitated roundtable discussions in Dallas and Silicon Valley. Composed primarily of corporate development leaders, participants shared their perspectives and experiences related to synergies. A well-defined, disciplined, and transparent approach to synergies increases the probability of achieving them. Such an approach involves: 1. 2. 3. Modeling synergies: Conducting synergy and value driver analyses, including probability weighting of financial impact and success Executing synergies: Creating a detailed work plan that identifies dedicated and accountable resources Tracking synergies: Implementing robust approaches to synergy tracking and reporting
We hope you will find this summary of our roundtable participants conversations about synergies in the deal process informative and enlightening. We think it provides a practical perspective to some of the challenges and potential solutions facing corporate development professionals. Our thanks to all who added to the dynamics of each roundtable by generously and candidly sharing their valuable experiences and viewpoints. We are honored to be able to host such discussions and appreciate the opportunity to learn from our clients and friends.
To prepare a deal model, acquirers need information to validate deal-sensitive assumptions. In the context of a competitive auction process, the seller completely controls the abundance or relative scarcity of this information. Accordingly, identifying and validating value drivers need to be high-priority outputs of due diligence. This process can best be accomplished with a good starting point, which requires a focused playbook and the judgment and discipline to walk away in the face of what one participant described as toxic levels of uncertainty.
ultimately, to the diligence teams charged with validating the final investment thesis. One participant described how his company utilizes a proprietary database of synergies developed from dozens of past transactions by the functional and business unit diligence and integration teams. The deal modelers use this database as a source for initial synergy estimates and as a control to limit overly optimistic assumptions.
Discussions with target Analysis of target-provided information in due diligence Quarterly/annual filings 80%
100%
90%
70%
Analyst reports
60%
Note: Results represent the percentage of 10 survey participants that use the given input for their initial synergy calculations. Respondents could select more than one input.
A challenge many companies face is the way they approach diligence. Frequently, the diligence process revolves around a dense series of checklists used to unearth everything that could be wrong with the target company. Rather than trying to cover every possible variable or scenario, a more efficient approach breaks down the key value drivers and risk areas before diligence.
Its easy for the diligence team to get lost when theyre looking at everything instead of concentrating on the things that can potentially make or break the deal.
We apply the same large sledgehammer to all nails, regardless of size or circumstance.
Synergy validation
Before synergies can be realized from an acquisition, synergy assumptions must be accurately identified then validated by the functional units responsible for hitting the targets. When functional units own the numbers and they are vetted by subject matter experts, the accuracy of the synergy estimates increases. Panelists reported having more success with core acquisitions, such as consolidating a competitor or closely adjacent entity. Synergies in these types of core acquisitions typically are easier to model, integrate, and realize because the acquirer has a better understanding of the business and already possesses the systems and business process platforms in which to consolidate redundant activities and drive alignment around customer and product strategies. Panelists also reported more successful business combinations that relied on cost synergies as opposed to revenue synergies. One reason could be that cost synergiesheadcount reduction, elimination of surplus facilities, reduced overhead, increased purchasing power are more quantifiable and easier to identify and track. In contrast, revenue synergiesmarketing and selling complementary product sets, crossselling into a new customer base or channel, access to new markets, reduced competitiontend to involve a greater number of variables and rely on more subjective assessments to reach synergy goals. Revenue synergies also depend highly on the behavior of third parties including customers, resellers, and even competitors, and thus present variables that are challenging to model. Though large revenue synergy targets sound theoretically achievable, they are rarely fully met and generally require more time and cost more than anticipated, according to panelists. This increases scrutiny on revenue growth acquisitions with fewer cost synergies.
Weve had success in achieving synergies if the acquisition was closer to our core rather than going too far away from the core. If you go too far away, we typically discount all the synergies that the operating people put in the model.
Theres a certain type of acquisition that weve had a lot of success with, and it follows that pattern where we are consolidating a competitor. There are lots of cost synergies, and those are the things you can really count on. You feel a lot more comfortable about the synergy projections. However, when it comes to revenue synergies, weve missed so many. As a rule, we now automatically discount them by 20 percent or more.
Negative synergies
Our panelists uniformly warned that deal modelers who exclude negative synergies often do so at their own peril. Though most acquirers rely on a range of sources when conducting synergy analysis, negative synergies that are not accurately captured can prevent a deal from meeting expectations or, ultimately, cause a deal to crumble. Chart 2 shows the types of negative synergies panelists typically address and quantify in diligence.
Some negative synergies are obvious, such as overlapping customers with a preference for multiple suppliers or misalignment of compensation practices, but others can be more subtle and really require almost a separate thought process or work stream to truly uncover and quantify. A good example is something as simple as misalignment of accounting policies, which, while not affecting cash flows, can materially affect the operating margins of the business inside our organization. Weve been surprised enough to add a separate component to our evaluation scorecard that reminds business and corporate teams to specifically address the potential for downside.
Chart 2 Negative synergies typically addressed and quantified pre-announcement Negative synergies typically addressed and quantified pre-announcement
Negative effects of conforming accounting policies or practices differences Additional infrastructure or sales and marketing investments More generous employee benefits Revenueoverlap customers with multivendor requirements Revenue from competitors or competing channels Conflicting suppliers with more favorable pricing 30% 60% 70% 70% 80%
90%
Note: Results represent the percentage of 10 survey participants who address a certain type of negative synergy. Respondents could select more than one type of negative synergy.
2. Synergy validation and accountability If companies do not validate synergies with the respective functional owners during diligence, they face two major risks. First, inaccurate estimates are more likely to occur without validation from functional owners, who are best positioned to assess: a) the cost savings or revenue growth potential; b) the investments required; and c) the timing and probability of successful synergy realization. Second, the risk of a postdeal synergy shortfall increases without validation because the actual teams required to execute and deliver synergies have no stake in the goals they are being asked to achieve. For instance, a product development team may be excited about acquiring a product, but the sales team might not be aligned to reprioritize its efforts to meet the revenue synergies. It is critical to validate synergiesthe single biggest drivers of deal value and assign owners to drive post-deal accountability before you sign the merger agreement. This validation sets the stage for accountability during execution. Clear ownership and accountability for targets are essential to achieve synergies.
3. Negative synergies Negative synergies play a pivotal role in many transactions, but despite the high financial cost of the negative aspects of integrating an acquisition, these synergies often are overlooked and underestimated. Vetting the costs associated with any estimated negative synergies and incorporating these numbers into the overall valuation are crucial to creating a realistic model. For example, the costs and potential financial statement ramifications of converging two companies revenue recognition policies can be significant because of complex accounting rules and varying business practices. Accurately capturing these types of negative synergies can help companies avoid disaster by taking a deal off the table before they invest significant amounts of time and resources.
When strategic initiativesincluding acquisitionsfail to fully realize their expected outcomes, the most common reason is weak execution, not flawed strategy. On this basis, companies should focus on ensuring the essential elements of successful execution are in place. Otherwise, they jeopardize their ability to create shareholder value through acquisitions.
Vetting synergy assumptions requires input from all departments, including operations, finance, strategy, business development, sales and marketing, product development, IT, legal, etc.
70%
Functional groups
50%
Integration leader/function
40%
Other
10%
Note: Results represent the percentage of 10 survey participants who assign accountability for synergy targets among business unit leadership, functional groups, the integration leader, or another party. Participants could select more than one option.
Among our panelists, delayed integration and underestimated integration complexity are the primary drivers of unrealized synergies, followed by overestimated synergies and a lack of accountability (see chart 4). Also, most panelists companies will permit changes to synergy estimates without adverse consequences to compensation (see chart 5).
Note: Results represent which obstacles were chosen by the 10 survey respondents as possible challenges to realizing synergies. Respondents could select more than one obstacle.
Chart 5 For surveyed panelists, the majority did allow synergy estimates to be revised without adverse consequences in compensation or incentives. Changes to synergy estimates Changes to synergy estimates
12.5%
12.5%
75%
Talent retention
A significant amount of synergies are enabled through successful employee retention. However, participants expressed issues with retaining talented people. On average, companies generally use financial incentives to retain key personnel from one to three years post acquisition.
Essentially, depending on the company weve looked at, we may allocate 10 percent of the acquisition price to retain employees. Sometimes its pushed to 15 percent with a small company. Obviously, it depends in part on who is getting a paydayif somebodys getting too much (money) theres not a whole lot you can do to incent them to stay.
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3. Synergy life cycle framework During diligence, the synergies must be estimated and included in the valuation model. Post-announcement, a more detailed level of synergy planning is required. PwC uses a synergy life cycle framework that helps companies capture synergies through four phases: modeling; business case development; detailed project planning; and tracking. In the business case development phase,
PwC Synergy Life Cycle Framework PwC synergy life cycle framework
Synergy analysis Value driver analysis
synergy models are substantiated by high-level plans that identify resourcing, risks, and dependencies. The business cases should be prioritized to ensure the organization is not overwhelmed. The company should focus its resources and energy on the 20 percent of business cases that drive 80 percent of the deals value. These cases must then be supported by detailed project plans and resourced sufficiently.
Synergy model
Business cases
Workplans
Detailed project plan for each value driver initiative based on qualitative information from business cases; includes tasks, resources, dates, and deliverables
Outputs
Synergy tracker
Detailed business case for each value driver initiative, including qualitative and quantitative information based on extensive analysis and information
Due diligence
Integration planning
Integration execution
Tool used for tracking and reporting synergy achievement based on quantitative information from business cases
Timeline
Announcement
Deal close
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Our point of view is that revenue synergies are a very low probability. You ought to spend the time to measure cost synergies discretely to estimate them and track them. However, youre going to track them separately. The negative synergies, youve just got to have your eyes wide open because culture can cause a negative synergy.
Chart 6 Synergy realization Synergy realization
Revenue growthcomplementary product sets/cross selling Cost reductionhead count reduction Revenue growthaccess to new regional markets Cost reductioneliminate surplus offices Cost reductionreduced production overhead Cost reductionincreased purchasing power Revenue growthreduced competition 13% 38% 38% 75% 88% 100% 100%
Note: Results represent the percentage of eight survey respondents who reported realizing certain types of revenue or cost synergies.
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About PricewaterhouseCoopers
PricewaterhouseCoopers (www.pwc.com) provides industry-focused assurance, tax and advisory services to build public trust and enhance value for its clients and their stakeholders. More than 163,000 people in 151 countries across our network share their thinking, experience and solutions to develop fresh perspectives and practical advice. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.
For information about these or other PwC publications, please contact a Transaction Services professional listed on the back page.
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For a deeper conversation about capturing synergies in the acquisition process, please contact: Rob Fisher (408) 817-4493 rob.fisher@us.pwc.com Todson Page (408) 817-1223 todson.page@us.pwc.com Amity Millhiser (408) 817-7850 amity.s.millhiser@us.pwc.com Bryan McLaughlin (408) 817-3760 bryan.mclaughlin@us.pwc.com Dana Drury (214) 758-8245 dana.drury@us.pwc.com Gregg Nahass (213) 356-6245 gregory.d.nahass@us.pwc.com Mike Giguere (617) 803-6377 mike.giguere@us.pwc.com Marc Suidan (408) 817-7908 marc.suidan@us.pwc.com Todd Weissmueller (214) 754-7382 todd.weissmueller@us.pwc.com Debra Skorupka (312) 371-0137 debra.skorupka@us.pwc.com
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