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CORPORATE DEVELOPMENT & FINANCE, M&A AND DIVESTITURES

The Real Deal on M&A, Synergies, and Value

NOVEMBER 16, 2016
By Decker Walker , Gerry Hansell , Jens Kengelbach , Prerak Bathia , and Niamh Dawson

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"Synergies” have been used to justify some of the worst and best M&A transactions in history.
M&A is supposed to be about value creation, and for many deals, synergies are cited as the
primary means to that end. But relatively few companies provide hard numbers to support these
claims. Even seasoned executives and M&A advisors use the term in varying ways that engender
different interpretations. And empirical evidence on the role of synergies in determining M&A
outcomes is hard to find.

This article aims to set straight the role of synergies in M&A value creation.

A DEFINITION

Start with a straightforward definition: synergies are the source of the tangible expected
improvement in earnings (calculated at an annual run rate) that occurs when two businesses
merge. In our analysis of almost 300 recent significant M&A transactions, we found that the
acquiring companies paid an average of $3 billion—a 34% premium—to gain control of their
targets. What sorts of synergies did these acquirers really get in return for their investment? How
did they know—or did they know—whether they were overpaying for those synergies? From the
viewpoint of acquiring shareholders, what were the predictors of value-creating synergies?
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We found that, when it comes to synergies, value-creating acquirers are different from others in
the way they do three specific things:

• They limit the control premium that they pay on the basis of a rigorous assessment of the
synergies that they expect to achieve.

• They are candid with their investors about their synergy expectations, publicly describing
explicit synergy commitments when they announce a deal.

• They practice rigorous postmerger integration (PMI) to capture synergies fully and rapidly,
and they are transparent with investors about their progress.

THE DATA

Not all M&A is pursued in the name of achieving synergies; for example, sometimes an asset
simply may be perceived as undervalued and therefore a good deal. In other cases, companies
want to acquire a critical technology or capability that they lack. But most deals do involve
synergies (or so investors are told). To examine the role that synergies play, BCG analyzed 286
major acquisitions. The deals, spanning a dozen industries in North America, were conducted
from 2010 through 2015. Each transaction was valued at more than $500 million, involved two
public companies, and was a significant deal for the acquirer, meaning that the total deal value
was greater than 30% of the acquirer’s market capitalization.

For each deal in our sample, we asked the following questions:

• How much did the acquirer pay (in the control premium) relative to the announced synergy
targets?

• Did the acquirer disclose the synergy expectations publicly?

• Did the acquirer report on the progress relative to the initial synergy targets within 12 to 18
months of the acquisition?

As part of the analysis, we developed a simple metric that we call the P/E of synergies. It is the
control premium paid (the absolute-dollar amount, using share price data 30 days before
announcement) divided by the pretax synergies (the absolute- dollar amount at the expected
annual earnings run rate). For example, if a company pays a control premium of $3 billion and
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expects $300 million of pretax earning synergies, the P/E of synergies is 10x. Dealmakers often
focus on the control premium they need to pay to get a deal done. Since the P/E of synergies
compares the control premium with the deal’s effect on earnings power, it is a more powerful
indicator of whether the transaction is likely to create value for investors. (See the sidebar “The
P/E of Synergies: A Key Metric for M&A Success.”)

THE P/E OF SYNERGIES: A KEY METRIC FOR M&A SUCCESS 

The P/E of synergies is a complementary valuation indicator to the more traditional measure,
overall percentage of the control premium paid. It also appears to have clear predictive ability to
estimate how well a deal is likely to be received by investors.

For the 167 companies in our data set that announced expected synergies, the average premium
paid was 34% and the average P/E of synergies was 8.6x. But in the retail sector, for example, the
average control premium was 45.4%, while the average P/E of synergies was only 5.1x. It is not
surprising that retail acquirers that announced synergies achieved a 20-day relative total
shareholder return (rTSR) of 4%. On the other hand, energy companies paid a lower-than-average
control premium of 25.5% and a higher-than-average P/E of synergies of 12.7x. The median rTSR
for the companies announcing synergies was –5.7%. High-tech acquirers paid an average control
premium of 40.1% and an average P/E of synergies of 7.1x, 1.5 percentage points below average.
Those announcing synergies received a 20-day rTSR of 1.65%. (See the exhibit below.)

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SYNERGIES AND SHAREHOLDER VALUE

We also reviewed each acquirer’s relative total shareholder return (rTSR)—its stock price
performance relative to an industry index—to determine which deals did and which did not
create value. Not only did we find consistent outperformance in value created by companies that
accurately valued synergies, paid appropriately, and delivered on their projections, we also found
that the market consistently penalized less disciplined acquirers. (See the exhibit, “A Disciplined
Approach to Synergies Leads to Superior M&A Value Creation.”)

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Acquirers in our data set that paid less than the average P/E of synergies outperformed by about 5
percentage points of rTSR those that paid more than the average. Those that paid more than the
average P/E of synergies were penalized with a negative rTSR. Moreover, the acquirers in the
cheapest quartile (those that paid a median P/E of synergies of only 1.5x) outperformed those in
the most expensive quartile (those that paid a P/E of synergies of 17.6x) by 4.8 percentage points
of rTSR. The data is consistent. The second quartile outperformed the third quartile by 3.1
percentage points. To put this in context, consider that an acquiring company with a $30 billon
market capitalization could expect to see more than $1 billion of market capitalization added (or
subtracted), depending on how it handled its valuation and disclosure of synergies.

PREPARATION, CANDOR, AND DELIVERY

The research shows that acquirers should do their homework: they must be in a position to
publicly announce the synergies they expect to result from the combination. Yet only 58% of
acquirers in our sample (167 out of 286 companies) announced synergies, and the percentage
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varied by sector. For example, 69% of high-tech and 59% of energy acquirers announced expected
synergies while only 38% of health care companies and 45% of materials companies did the same.
Investors bid down the shares of acquirers that did not announce synergies. In the 20 days before
and after the announcement date, the TSRs of these companies averaged –3.1%, which translates
into almost $300 million of lost value per transaction.

Of the acquirers that initially announced synergies, only 29% then saw fit to follow up with
investors on their progress against their targets. Those that did were further rewarded by
shareholders, outperforming those that did not by a median of 6 percentage points nine months
after their deals closed. Moreover, those that did not follow up saw positive rTSRs at the time of
the announcement turn negative (a median rTSR of –1.4%) nine months after their deals closed.

There is good reason for these discrepancies, and it’s not only that investors generally appreciate
management transparency. In our PMI work with more than 1,000 companies worldwide, we have
observed that most successful acquirers go after a significantly larger synergy number than they
publicly announce, and they achieve the synergies much faster than they project publicly. The
thinking is simple: if we can’t get the synergies within 12 to 18 months, they are not likely to
happen. Management teams that put themselves on the line do so secure in the knowledge that
they plan to outperform—a good strategy for management and shareholders alike. (See the
sidebar “Outperforming on PMI.”)

OUTPERFORMING ON PMI 

Acquirers project two types of synergies: cost and revenue. Very few of the companies that
announce their synergy expectations break out the two, but they do tend to track each one
internally.

On the basis of our work with more than 1,000 PMI projects, BCG has built a database that tracks
the PMI results of some 200 transactions over the past decade. Our data and analysis show that
companies’ internal synergy expectations are significantly higher than the targets they provide
publicly: on average, they are 15% higher for cost synergies and 21% higher for revenue synergies.
In addition, companies that practice particularly rigorous PMI, holding firm to the accountabilities
outlined below, substantially exceed even their internal targets. These companies boost cost
synergies by another 15% (so the total achieved exceeds the announced synergies by 32%) and
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revenue synergies by 25% (for a total of 51% over announced expectations). (See the exhibit
below.)

Delivering on Promises

These are big gains even if one factors in some conservative downplaying of initially announced
expectations. So how do successful companies do it? In our experience, they practice four
subdisciplines, all of which are related to accountability within the organization.

• Bottom-Up Accountability. Smart companies don’t leave synergy projection to the bankers
and the M&A team; early on, they involve the line managers who will be responsible for
achieving the targets. These line managers play a part in setting their targets.

• Individual Accountability. Managers are assigned individual responsibility for their specific
targets and held accountable for meeting them by the project management office (PMO) and
top leadership. Furthermore, targets are hardwired into managers’ budget and performance
objectives, eliminating any ambiguity about what is required.

• Leadership Accountability. Top management leads from the front throughout the PMI
process. It actively supports the PMO and stays the course until target realization is well
underway.

• Public Accountability. Individual managers are held publicly accountable for meeting their
targets. “Heroes” are acknowledged and rewarded (often with meaningful leadership roles in
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 the acquired company); managers who come up short must answer to their peers as well as
the boss.

In addition, companies that excel at PMI move fast, especially with respect to revenue synergies.
One highly effective technique that enables companies to hit the ground running the day after a
deal closes is the establishment of a so-called clean team that gets a jump-start on planning for
revenue synergy execution. The clean team is a group of outside advisors or soon-to-retire
managers who can work with confidential customer data from both companies during the period
between contract and closing without running afoul of anticompetition laws or regulations.

Realizing Elusive Revenue Synergies

Identifying cost synergies is a relatively straightforward exercise, and achieving them is largely a
matter of accountability and discipline. Revenue synergies present bigger challenges in both
quantification and realization. This may be one reason why relatively few companies (only one-
third of those that announce any synergies) announce revenue synergies in advance and investors
are skeptical of those that do. Acquiring companies in our database received virtually no market
benefit increase for projecting revenue synergies.

That said, in our experience, many frequent acquirers have become adept at realizing these
synergies. They demand the same level of rigor that they require when they go after cost synergies
precisely because revenue synergies are so difficult to project and execute. Best practices from
best-in-class acquirers include the following:

• Using detailed account mapping and allocation to identify precisely the opportunities for
increased revenues

• Quantifying cross-selling quotas and linking associated compensation and incentives to

achieving them

• Clearly articulating future sales models (such as reselling and referral) and implementing
sales force enabling programs (such as new training)

• Moving quickly to capture key-account upside potential and to protect against major account
loss, not waiting to identify top cross-selling targets or key accounts at risk while IT systems

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 are being integrated, and using manual solutions to address the greatest upside opportunities
and downside risks.

PUTTING IT ALL TOGETHER

In the competitive bidding market for corporate assets, many acquisitions transfer all, if not more
than all, of the synergy value from the acquirers’ shareholders to the seller’s shareholders. (See
Divide and Conquer: How Successful M&A Deals Split the Synergies, BCG Focus, March 2013.) This is
why more than half of all deals destroy value for investors.

Value-creating M&A requires discipline in the assessment, valuation, and delivery of synergies.
Take the example of Martin Marietta and TXI. The two companies announced a $2.7 billion
merger in January 2014 to “create a market-leading supplier of aggregates and heavy building
materials, with low-cost, vertically integrated aggregate and targeted cement operations.” The
combined company had a market capitalization of about $9 billion. The announcement
highlighted the expectation of significant synergies: “The transaction is expected to generate
approximately $70 million of annual pretax synergies by calendar year 2017.”

Martin Marietta paid a P/E of synergies of 5.8x, which is lower than our data set average of 6.5x
for the materials industry. Investors reacted to the deal with a 20-day rTSR of 18.7%. Martin
Marietta followed up on its synergy estimates on February 11, 2015, indicating that the company
expected to exceed its original estimates by 40%. Nine months after closing, the company’s TSR
had outperformed the industry index by 8.3 percentage points.

M&A is risky business—especially for the shareholders of acquiring companies. To be sure, many
factors that contribute to M&A success or failure are beyond management’s control. But acquirers
can tilt the odds strongly in their favor by consistently applying discipline to how they assess,
value, and deliver synergies from their acquisitions.

CONTACT THE AUTHORS

Decker Walker
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Managing Director & Partner
Chicago

Gerry Hansell
Managing Director & Senior Partner
Chicago

Jens Kengelbach
Managing Director & Senior Partner
Munich

Prerak Bathia
Partner
Chicago

Niamh Dawson
Partner and Director
London

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