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Sunday, 21st April 2024
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Acquisitions: synergies must be realised, not assumed Back  
Bryan Evans writes that a disciplined process helps companies be part of the minority of acquirors which capture value by acquisitions
The creation of value for its shareholders is fundamental to the success of any business. Recent years have seen growing recognition of the fundamental principle that a company only adds value for its shareholders when the business earns returns on its equity that are greater than the true cost of that equity. Adherence to this principle has led many companies to consider special dividends and share buybacks as they do not perceive that there are acquisition or other growth strategies currently available on terms which will enhance shareholder value.

Mergers and acquisitions activity is booming with the number and size of deals in Ireland, the United Kingdom and the United States at or reaching for record levels. There are several reasons for this, the primary one being that the cash rich companies are looking for other profitable outlets.

Unfortunately for acquirors, the success rate for acquisitions and mergers remains disappointingly low. More than 50 percent of all deals fail to achieve the intended benefits. Only 17 percent of transactions result in significant increases in value, while some 50 percent actually destroy value. In reality, many acquirors have found that the overall growth and cash flow profile of the acquired company was simply not very good and that expected synergies could not be fully realised. Clearly, there is much scope for companies to improve their acquisition processes so as to increase the odds on completed transactions working out to the benefit of the acquiring companies’ shareholders.

The acquisition process may be divided into a number of stages, some of which overlap. There are key factors which can make the difference between success and failure.

Strategy

Acquisition is one of a number of different ways in which a company can meet its strategic objectives. Thus, the starting point of any acquisition programme is a clearly defined business strategy. This will identify the competitive position of the company and its goals: for example, geographic expansion; product diversification; increased productivity. The strategic plan should specify the role of acquisitions in seeking to achieve such goals, including key constraints such as available financial and managerial resources.

Acquisition criteria

The next step is to establish specific acquisition criteria. This is an exercise which warrants careful attention as the criteria form the basis for subsequent search activity by and on behalf of the company and also provide the framework for screening identified targets. Well thought out criteria will focus the search effort and reduce management time on the evaluation of weak prospects. While acquisition criteria must be tailored to the specific objectives of the company, they are likely to include consideration of certain core issues: market sector; products and services; geography; minimum revenues; minimum profitability; management strength; attitude to turnarounds; purchase price.

Target evaluation

This is a critical phase in the acquisition process and it is where many acquirors underperform. The first requirement is to make a preliminary determination as to whether the proposed transaction can create value for the purchaser’s shareholders. It is necessary to build up an estimate of the stand-alone value of the target company, on a discounted free cash flow basis and of the acquiror itself on a similar basis. The next step is to assess the effect of synergies likely to accrue, usually in the form of cost savings and income generation opportunities. Incorporating these synergies, it is possible to reach an overall estimate of what sort of value the combined group should be able to achieve, after allowing for costs.

This analysis enables a preliminary assessment of financing alternatives. The aim will be to finance the acquisition at the lowest appropriate cost of capital, recognising the relative cheapness of debt over equity but also the additional risk to equity holders if debt levels are excessive. Along with tax planning, such financial engineering to maximise the efficiency of a company’s post acquisition structure can be a key part of the transaction value map.

Negotiations

The foregoing model, incorporating the combined value of the enlarged group after realising the benefits of synergies and financial engineering, establishes the parameters for price negotiation. Alternatively, it enables bidders to assess the implications of the likely purchase price in terms of shareholder value.

Typically, negotiation is a dynamic process with a number of different agendas being played out and new information emerging throughout the process. For the shareholder value conscious acquiror, it is important to assess all developments and proposals against the transaction value map.

Due diligence

Those companies that apply best practise see due diligence as being far more than just a quick run through of various legal, regulatory and accountancy issues. Most particularly, they see it as an opportunity to test assumptions made at the evaluation stage, both quantitatively (confirming the likely synergies available) and qualitatively (general timing and integration compatibility).

Post acquisition planning

By the time due diligence is completed, the acquiror should have prepared a detailed plan for the post acquisition integration phase, focusing on delivery of the assumed operational synergies within the assumed timescale. Takeovers, as already noted, do not always succeed. With acquirors being required to pay significant premiums for target companies, the risks of failure are heightened. The rewards are potentially great and will flow to those who conduct the acquisition process with an eye always on the creation of added value and who act on the principle that synergies must be realised, not assumed.

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