Expense Synergies in Merger Models (20:31)
In this expense synergies lesson, you’ll learn why expense synergies matter, what they consist of, how they impact M&A deals.
Why do Synergies matter? And what are they exactly?
Put simply, they’re cases where 1 + 1 = 3 in mergers and acquisitions.
You combine 2 companies, and get MORE revenue than just the Buyer’s revenue plus the Seller’s revenue…or you get LESS in expenses than just the Buyer’s expenses plus the Seller’s expenses.
Revenue Synergies are tough to estimate and are very error-prone… but sometimes they matter and can be calculated more precisely.
Expense Synergies are more grounded in reality, because you look at what both companies are spending and decide what can be cut – at the very least, it’s based on actual expenses incurred by both companies.
Synergies matter because some deals require synergies to look good on paper (i.e., be accretive).
And some deals are motivated primarily by synergies, such as this one with 2 very similar men’s retailers merging.
BUT… a lot of people get it wrong in 3 main areas when it comes to expense synergies in merger models:
Oversight #1: More Granular Estimates / Checks
Lots of models – even very complex ones – will just say something like, “$100 million in synergies per year!”
This is NOT ideal.
It’s better to break out the synergies by specific functional areas, if not by specific employee counts, building rents, anticipated discounts on inventory purchases, and so on.
In real life, as a banker, you don’t really know enough to do this – need the input of both companies’ CFOs and finance departments to make estimates.
Oversight #2: It Takes Time to Realize Synergies
No matter how evil the combined company is, it can’t just take the “Death Star” approach and blow up entire divisions / buildings all at once… it takes time to realize synergies, even if you’re simply laying off employees.
And something like consolidating buildings or inventory purchases / processes takes even more time.
Here: The company makes it easy in their investor presentation, since they give us the expected amounts that will be realized each year.
Oversight #3: It Takes Money to Realize Synergies
It’s not just “free” to consolidate buildings or factories or shuffle people around… there are costs associated with all of that.
Often labeled “Restructuring Costs” or “Integration Costs” or similar names.
Could show up on the Income Statement or on the Cash Flow Statement or both… depends on the deal and
the type of expenses.
Here: The company makes it easy for us with its estimate of $100 million in Integration Costs “over the next 18 months” – so we allocate that over the first 2 years of the model.
How Does All of This Impact the Deal, Accretion / (Dilution), and So On?
If you factor in the time and money required, it always makes the deal less accretive or more dilutive… because it pushes the Combined Pre-Tax Income lower in earlier years due to:
a) Some percentage less than 100% of synergies will be there; and
b) CFS expenses will push down the company’s debt repayment ability, thereby increasing interest expense from debt in the earlier years.