Synergies, in a corporate or mergers and acquisitions setting refer to the benefits that a corporation expects to gain when it merges with or acquires another firm. Although these benefits are often referred to in financial terms, they may also be exploited in terms of employee cooperation or business practices such as sales or distribution.
A term closely related to this is control premium or acquisition premium. Acquiring firms must weigh up the benefits of making the acquisition, ie synergies, against the additional cost ie control premium they will be required to pay for the target firm in excess of the current market value.
Synergies and their benefits are a cornerstone of the M&A industry and often occur as the primary (or only) reason for the corporate action. Mature industries especially will look to cut costs as products mature and the industry stagnates. To maintain a profitable business, firms may choose to merge and exploit cost cutting opportunities. This is done by eliminating duplication amongst merging firms whilst retaining the combined sales. This concept is explained further in our article Horizontal Mergers with Examples – A Complete Guide.
Revenue Synergies
Revenue synergies however are much more difficult to exploit and implement. A study by McKinsey & Co. in 2018 stated,
… the majority reported that their company had fallen short of its aspiration for revenue synergies, with an average gap of 23 percent between goal and attainment … The executives we spoke to cited a number of difficulties: setting realistic targets, changing salesforce behavior, executing across functions, measuring financial impact, and getting the organization to focus on the right things.
This demonstrates the inherent difficulty in managing a successful merger and benefitting fully from the acquisition. Should these positive expectations not be met, the outcome may result in negative synergy. This is where the value of the combined entity is now LESS than the previous value of the companies when they operated independently. This is an all too common result if the merged firms experience the problems identified in the McKinsey report. Fortunately for a merger arbitrageur, the investment would already have been liquidated and would therefore no longer need to consider this aspect as an issue.
