The art of effective mergers
One of the driving forces behind business mergers is the importance of the synergies that exist between the two organisations. Synergies are the component parts of the businesses which, when merged into a larger organisation, will provide for a more effective and cost efficient operation. Understanding and analysing these synergies is essential for mergers to be successfully completed.
There are a number of factors brought into play immediately thoughts of a merger are given credence. When a merger takes place, the acquirer, almost without exception, is required to pay a premium over and above the value of the business. This premium and the method of payment have a marked effect upon shareholder values, thus the importance of synergy. A simplified example can be used to explain this event. For instance, where company A pays six million for company B, which is only worth five million they will be paying a one million premium. The focus of management in company A will therefore be to find efficiencies (synergies) within the merged corporation that will be enable them to achieve cost reductions that will not only aid the recovery of the premium but also improve cost reductions in the combined operations of the two companies’. Another objective of this process is to improve future returns to the business stakeholders, such as shareholders. They will also be expected to achieve them within the timescale set out before the merger, a feat that has historically proven to be extremely difficult, even in the most efficient of business mergers.
The strategic relatedness and relative size is also important in terms of the level of synergy it is possible to achieve. In like-to-like mergers, the relatedness is not a problem as, generally, all the products and services offered are similar if not almost identical. Size is important too because mergers are more effective and efficient if the acquired business is of a smaller size than that of the acquirer. With business mergers where the two businesses are not operating within the same industry sector, the relatedness is likely to be applicable to limited areas of operation, such as the management and administration structures.
Therefore, the management has to study the equation in depth to ensure that the required synergies can be achieved from the various internal factors, on either a cost cutting or revenue enhancing basis. Operational areas are usually targeted for direct cost cutting purposes, which will includes the capital assets of the business. An example would be freehold or leasehold commercial property, system integration such as information technology and Internet, strategy, control and culture. If all of these parts are in place then the management of the acquiring business is then set with the task of measuring the expected synergies.
MEASURING SYNERGIES "SOFT SYNERGY"
One of the most important parts of the measuring of "soft" synergies, those dealing with revenue enhancement, is the value generated for shareholders (Earnings per share). Paying a premium for an acquired business will have an effect on the EPS and it needs to be calculated how many years the effects of the merger on EPS will take to recover from the original impact, and again be returning value to shareholders comparable with pre merger levels. The higher the level of premium paid for the acquired business, the bigger the initial dilution in shareholder value and the longer term it takes in respect of years, to recover the equity position.
Similarly, it is extremely important to evaluate any areas of concern that the work force may have at a very early stage in the process. Disruption because of lack of focus, or a drop in the standard of customer care in the early stages of the merged businesses life, could seriously affect the timescale in which the synergies should be producing results. This in turn would have a negative effect in both shareholders and the financial markets confidence. At the same time, the merged businesses need to look realistically at the quality of their staff and the training levels. Customer liaison and care in all areas of the business will be vital for the success of the venture.
MEASURING SYNERGIES "HARD SYNERGY"
To give examples of the measurement of "hard" synergies, I will take the example of the merger between two banks. Here, the methods for calculating the effects of a larger branch network and increase in the numbers of trained personnel available to increase sales of products are relatively straightforward to calculate. It is a matter of analysing historical statistics. For example, in a situation where the acquirer has 3,000 branches and the acquired 500, it is a relatively straightforward exercise to calculate the additional sales opportunities available. The same would be the case in terms of property assets and disposals of these post mergers. All of these are measured by simple mathematical calculations.
However, with regard to branch disposals it would not just simply be a question of the release of capital back to the business. There is also the synergy of Revenue Enhancement to consider. As most of the branches closed are likely to result from duplication, there is a value added element. The majority of the customers from the branch that is closed will transfer to the other branch of the merged entity. Thus the company will end up with the same income as was available to the two pre-merged entities, but with substantially reduced costs applicable to that income. This is known as the economies of scale.
When evaluating synergy in relation to mergers, one method of measuring that is always employed is economies of scale. The following simple example shows the basics of this method. If a cost of a service to a bank was $1,000 and that bank had 100 customers, the Average cost per customer would be $10. If the number of customers doubled, but the costs remained the same, then the cost per customer would halve to $5. Of course, in reality the law of diminishing returns is not that simple because there is a time when the benefits begin to fall away. However, the principle of economies of scale method is very popular in mergers. The general opinion is that, because of the economies of scale and scope deriving from the combination of similar skills, a firm competing on low cost and operating efficiency will benefit from merging with an organisation that has similar strategies.
From all of the above discussions it can be seen that, to make mergers work, it is essential that the separate organisations ensure that there are sufficient "soft" and "hard" synergies between the two corporation's involved to guarantee success.