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M&A

What is synergy in M&A?

M&A practitioners must conduct meticulous due diligence to justify successful deal execution. Capturing deal synergies is a key part of this practice.

Ongoing market instability has fueled consolidation amid opportunistic companies and private equity firms looking to increase revenue through acquisition and drive inorganic growth. As companies face profit declines and valuations tumble, resourceful investors are taking advantage of a discounted dealmaking environment—with many placing bets on M&A deals in the middle market.

“The motivation and investment strategies have shifted slightly in this environment. As it becomes harder to find larger buyouts, corporations and firms are looking to restructure through carve-out divestitures and identify smaller companies for add-on opportunities.”

Jinny Choi, PitchBook Private Equity Research Analyst

Those deals will be encouraged by ample dry powder reserves and cash-rich corporates. According to our Q2 2023 Global M&A Report, the amount of dry powder that has yet to be invested by sponsors stands at $1.35 trillion, just 9.7% shy of its all-time high, with an even larger cash pile for corporations.

As M&A activity is expected to continue its upward climb, we examine synergy – a key motivator for all M&A deal execution. This article will focus on the most common types of synergy, forecasting synergies, and how PitchBook helps clients enhance their M&A strategy.

What is synergy in M&A, and why does it matter?

Whether on the buy or sell side, synergy in M&A is the result of increased revenue and operations or cost reduction through the combined performance of a buyout or merger. Integrating two entities to create something greater than the sum of their parts it what drives investment banks, corporations, and executives to execute M&A deals. Through achieving deal synergies, firms can uncover streamlined cost-saving opportunities while expanding portfolios and generating revenue.

REPORT

Q2 2023 Global M&A Report

Discover what’s in store for M&A with data-driven insights by region and sector in our Q2 2023 Global M&A Report.

Types of synergies

Revenue synergy

Revenue synergy typically results in reduced competition within a particular industry and increased market share. They can increase products within a portfolio, encompassing the liberty to cross-sell to a combined customer base across geographies.
Revenue synergy typically results in reduced competition within a particular industry and increased market share. Revenue synergies can increase products within a portfolio, encompassing the liberty to cross-sell to a combined customer base across geographies.

Microsoft Corporation’s 2021 acquisition of Nuance Communications, a provider of AI and cloud-based speech technologies, created revenue synergies in the healthcare sector by integrating healthtech solutions with cloud infrastructure. Microsoft leveraged Nuance’s expertise in AI voice technologies used for telehealth documentation and other healthcare applications, integrating these technologies into existing offerings, such as Microsoft Cloud for Healthcare. The deal also streamlined healthcare solutions and clinical documentation, increasing customer adoption and generating incremental revenue. Other revenue streams materialized through cross-selling Nuance’s healthcare solutions and tapping existing relationships with healthcare organizations.

Cost synergies

Cost synergies include improved supply chain efficiency, effective scaling and distribution, and addressing workforce redundancies. A cost synergy occurs in the back end of company operations driven by streamlining personnel in line with best practices and leveraging better pricing with vendors.

Cost synergies span full funnel integration, including increased scaling, marketing and distribution. A cost synergy occurs in the back end of company operations driven by streamlining personnel in line with best practices and leveraging better pricing with vendors.

Amazon’s 2017 acquisition of Whole Foods Market, a leading grocery chain, generated numerous cost-saving synergies. This deal allowed Amazon to expand its reach in its grocery and retail space and support Whole Foods by boosting delivery processes. Bolstered by Amazon’s delivery infrastructure, Whole Foods accessed services that optimized sales funnels and cut costs. In addition, better marketing and sales distribution increased visibility through Amazon’s platform, while Amazon Prime members received discounts when shopping at Whole Foods.

Financial synergies

Financial synergies aim to create positive financial results by reducing capital costs and generating better borrowing opportunities. Dealmakers evaluate each entity’s cash flow statements, balance sheets, and capital structure to accurately forecast financial synergies.

Financial synergies aim to create positive financial results by reducing capital costs and generating better borrowing opportunities. Dealmakers evaluate each entity’s cash flow statements, balance sheets, and capital structure to accurately forecast financial synergies.

The 2017 acquisition of Aetna Inc., a leading US insurance provider, by CVS Health Corporation, is a prime example of generating a range of financial services under one entity. The merger differentiated these two businesses through product and services and digital expansion, cutting costs and generating revenue. The combination of CVS’s pharmaceutical network with Aetna’s insurance operations achieved financial efficiencies by eliminating back-end and administrative redundancies, increasing customer acquisition and retention by cross-selling, and generating better negotiating terms with suppliers and pharmaceutical companies.

Top ten US M&A deals in the last ten years

*Source: PitchBook Platform | Geography: Global | As of 9/18/2023

How are synergies forecast?

As it typically takes about 18 months post-deal for quantitative results to become apparent, dealmakers begin with forecasting qualitative assessments followed by a bottom-up approach of company financials. Their first consideration is to define the transaction’s rationale, which means aligning the strategic objectives of the acquiring entity with the target company.
Thorough due diligence aims to deepen the understanding of a target’s operational efficiency, market position, IP, and any regulatory and compliance hurdles. At this stage, dealmakers also conduct case study scenarios that stress test outcomes based on varying market conditions, forecasting the potential for value gain and loss.

How do valuation methods help to accurately predict synergies?

A combination of financial models help investors facilitate and plan for every aspect of the deal, from valuations to calculating earnings per share (EPS) and integration. Here are a few common models M&A practitioners use to forecast a deal’s financial viability:

  • Discounted cash flow analysis (DCF) estimates a deal’s financial impact and future value potential. DCF aims to determine the projected value of an investment by calculating its current value.
  • Precedent transactions are used to compare valuations of historically similar M&A deals, helping dealmakers assess an estimated value for the deal in question.
  • Multiple data, part of financial transaction analysis, including price-to-earnings or (P/E), price-to-sales (P/S), or enterprise value (E/V) to EBITDA, identify companies in the same industry or sector which are then compared with the target company.
  • If a target company’s multiples are lower than their peers, it could indicate that potential synergies can be achieved through operational improvements or cost savings.

Enhance M&A deal outcomes with PitchBook

Successful M&A deals rely upon meticulous due diligence and adaptive strategies. Forecasting synergy and mitigating risk requires careful market analysis, effective communication, and a willingness to be flexible. Explore our platform features to gain more insight into the M&A landscape and optimize your dealmaking workflow:

  • Valuation and multiples data, whether revenue-related or debt-related, are essential for evaluating a target company and helping dealmakers set a fair price to either pay or receive in a transaction.
  • Curated market maps help dealmakers stay up to date, run industry comparisons, and identify the most active investors in a specific space.
  • Leveraged Credit & Debt (LCD) data, such as debt multiples on a deal type by sector, are helpful for investors looking for attractive and discounted opportunities in today’s market.

Explore our global M&A deal data

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