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Transaction Services Roundtable Identifying, realizing, and tracking synergies in the M&A process How synergies drive successful acquisitions
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Transaction Services Roundtable
Identifying, realizing, and tracking synergies in the M&A process
How synergies drive successful acquisitions
Table of contentsHow synergies drive successful acquisitions
As seen through the eyes of roundtable participants in:
Dallas
• AlbertHoover,AT&T• DouglasGlen,MetroPCS• HarishMysore,PerotSystems• BarbaraPapas,TexasInstruments• JohnRexford,AffiliatedComputerServices• ScottThanisch,SabreHoldings• LuisCastellanosTorres,Wal-Mart
Silicon Valley
• MarkCopman,3M• KristinaOmari,Adobe• JacobSayer,Avago• CraigJohnson,Cadence• SandeepJohri,HP• JohnZdrodowski,Intel• RossKatchman,LSI• KevinKettler,McKesson• ChrisKing,Medtronic• MarcBrown,Microsoft• J.R.Ahn,NetApp• BrianMoriarty,Sun• CharlieRice,Symantec
Effectively realizing synergies—Modeling 1Synergy validation
Negative synergies
PwC point of view
Effectively realizing synergies—Executing 7Challenges for synergy realization
Talent retention
PwC point of view
Effectively realizing synergies—Tracking 13PwC point of view
Long story short … 16
Key takeways—Insights into synergies 17
Anoteonthesurveycharts
A short survey was conducted among the roundtable participants to better understand their approaches to synergies in the acquisition process. Some of the responses are shown in this report. Despite the small sample size, we view the survey results as an accurate indicator of the challenges associated with modeling, executing, and tracking synergies throughout the deal process, and they are presented here for that purpose.
Contents
The market rewards or punishes shareholders of a combined company depending on how well its management succeeds at establishing and, ultimately, achieving one primary objective: create value that exceeds the cost of acquisition.
When applied to deals and valuation theory, “synergy” means both companies win. The seller’s shareholders receive an acquisition premium, and the buyer realizes shareholder value by capturing synergies above what is required to justify the deal premium. Because synergies are fundamentally the only tangible justification for making an acquisition, sophisticated and repetitive buyers must orient their acquisition processes—from screening through post-integration monitoring—to focus deal and business unit teams on identifying, quantifying, executing, and tracking synergies by deal, business unit, deal type, and across the portfolio of acquisitions.
To provide business leaders opportunities to share best practices and learn from the obstacles and pitfalls their peers encounter in the acquisition process, PricewaterhouseCoopers (PwC) facilitated roundtable discussions in Dallas and Silicon Valley. Composed primarily of corporate development leaders, participants shared their perspectives and experiences related to synergies.
A well-defined, disciplined, and transparent approach to synergies increases the probability of achieving them. Such an approach involves:
1. Modelingsynergies: Conducting synergy and value driver analyses, including probability weighting of financial impact and success
2. Executingsynergies: Creating a detailed work plan that identifies dedicated and accountable resources
3. Trackingsynergies: Implementing robust approaches to synergy tracking and reporting
We hope you will find this summary of our roundtable participants’ conversations about synergies in the deal process informative and enlightening. We think it provides a practical perspective to some of the challenges and potential solutions facing corporate development professionals.
Our thanks to all who added to the dynamics of each roundtable by generously and candidly sharing their valuable experiences and viewpoints. We are honored to be able to host such discussions and appreciate the opportunity to learn from our clients and friends.
Rob Fisher Dana DruryTransaction Services partner Transaction Services partner Technology industry M&A leader
Exploring synergies
“Diligence feels like speed dating. You have a short timeline to make a critical decision that equates to marriage. The target shows off its colors, and you need to decipher between infatuation and a true match.”
Effectively realizing synergies—Modeling
2
100%
90%
80%
70%
60%Analyst reports
General industry knowledge
Quarterly/annual filings
Analysis of target-providedinformation in due diligence
Discussions with target
Typical inputs for initial synergy calculations
Note: Results represent the percentage of 10 survey participants that use the given input for their initial synergy calculations.Respondents could select more than one input.
Chart1
Synergy calculations require multiple data sources, with the most critical inputs coming from target discussions, analyzed diligence information, and other public data.
When modeling potential synergies, the finance and corporate development teams typically develop initial assumptions based on a collection of target-provided information and other public data (see chart 1).
In general, the more detailed the initial assumptions, the more relevant it will be to the negotiation approval process and,
ultimately, to the diligence teams charged with validating the final investment thesis. One participant described how his company utilizes a proprietary database of synergies developed from dozens of past transactions by the functional and business unit diligence and integration teams. The deal modelers use this database as a source for initial synergy estimates and as a control to limit overly optimistic assumptions.
Typicalinputsforinitialsynergycalculations
As seen through the eyes of participants …
To prepare a deal model, acquirers need information to validate deal-sensitive assumptions. In the context of a competitive auction process, the seller completely controls the abundance or relative scarcity of this information. Accordingly, identifying and validating value drivers need to be high-priority outputs of due diligence. This process can best be accomplished with a good starting point, which requires a focused playbook and the judgment and discipline to walk away in the face of what one participant described as “toxic levels of uncertainty.”
3
A challenge many companies face is the way they approach diligence. Frequently, the diligence process revolves around a dense series of checklists used to unearth everything that could be wrong with the target company. Rather than trying to cover every possible variable or scenario, a more efficient approach breaks down the key value drivers and risk areas before diligence.
It’s easy for the diligence team to get lost when they’re looking at everything instead of concentrating on the things that can potentially make or break the deal.
Synergy validation
Before synergies can be realized from an acquisition, synergy assumptions must be accurately identified then validated by the functional units responsible for hitting the targets. When functional units “own” the numbers and they are vetted by subject matter experts, the accuracy of the synergy estimates increases. Panelists reported having more success with “core” acquisitions, such as consolidating a competitor or closely adjacent entity. Synergies in these types of core acquisitions typically are easier to model, integrate, and realize because the acquirer has a better understanding of the business and already possesses the systems and business process platforms in which to consolidate redundant activities and drive alignment around customer and product strategies.
Panelists also reported more successful business combinations that relied on cost synergies as opposed to revenue synergies. One reason could be that
cost synergies—headcount reduction, elimination of surplus facilities, reduced overhead, increased purchasing power—are more quantifiable and easier to identify and track. In contrast, revenue synergies—marketing and selling complementary product sets, cross-selling into a new customer base or channel, access to new markets, reduced competition—tend to involve a greater number of variables and rely on more subjective assessments to reach synergy goals. Revenue synergies also depend highly on the behavior of third parties including customers, resellers, and even competitors, and thus present variables that are challenging to model. Though large revenue synergy targets sound theoretically achievable, they are rarely fully met and generally require more time and cost more than anticipated, according to panelists. This increases scrutiny on revenue growth acquisitions with fewer cost synergies.
“We apply the same large sledgehammer to all nails, regardless of size or circumstance.”
“We’ve had success in achieving synergies if the acquisition was closer to our core rather than going too far away from the core. If you go too far away, we typically discount all the synergies that the operating people put in the model.”
4
Negative synergies
Our panelists uniformly warned that deal modelers who exclude negative synergies often do so at their own peril. Though most acquirers rely on a range of sources when conducting synergy analysis, negative synergies that are not accurately
captured can prevent a deal from meeting expectations or, ultimately, cause a deal to crumble. Chart 2 shows the types of negative synergies panelists typically address and quantify in diligence.
“Some negative synergies are obvious, such as overlapping customers with a preference for multiple suppliers or misalignment of compensation practices, but others can be more subtle and really require almost a separate thought process or work stream to truly uncover and quantify. A good example is something as simple as misalignment of accounting policies, which, while not affecting cash flows, can materially affect the operating margins of the business inside our organization. We’ve been surprised enough to add a separate component to our evaluation scorecard that reminds business and corporate teams to specifically address the potential for downside.”
“There’s a certain type of acquisition that we’ve had a lot of success with, and it follows that pattern where we are consolidating a competitor. There are lots of cost synergies, and those are the things you can really count on. You feel a lot more comfortable about the synergy projections. However, when it comes to revenue synergies, we’ve missed so many. As a rule, we now automatically discount them by 20 percent or more.”
90%
80%
70%
70%
60%
30%Conflicting suppliers with morefavorable pricing
Revenue from competitors orcompeting channels
Revenue—overlap customers withmultivendor requirements
More generous employee benefits
Additional infrastructure or sales andmarketing investments
Negative effects of conforming accountingpolicies or practices differences
Negative synergies typically addressed and quantified pre-announcement
Note: Results represent the percentage of 10 survey participants who address a certain type of negative synergy. Respondents couldselect more than one type of negative synergy.
Chart2
Negativesynergiestypicallyaddressedandquantifiedpre-announcement
5
PwC’s point of view
Inaccuracies in the identification and validation of synergies often play a critical role when acquisitions fail to meet expectations. Leading practices to mitigate these issues address:
1. Synergy identification
A significant number of companies use a siloed approach when conducting diligence. For example, corporate development works with bankers to determine synergies and valuation while finance and legal conduct a comprehensive diligence review to identify deal breakers. This approach can create inaccurate synergy estimates or cause the diligence team to waste valuable time on risks that are not relevant to the valuation model. PwC’s approach is to identify key value drivers and risk areas at the start of diligence. The diligence teams can then programmatically focus on:
• Analyzing baseline historical results and forecasts to assess standalone value
• Identifying synergies, including the probability of success, the timing of realization, and the cost to realize synergies
• Assessing and mitigating key risk areas or potential deal killers
PwC’s approach focuses on performing diligence on the drivers that have the biggest impact on the valuation model while mitigating risks. Though the availability of information is often limited during the diligence phase, maintaining a focus on key value drivers and risk areas helps prioritize information requests and management discussions. Absent clear expectations to address synergies, diligence teams can become so distracted by deal killers and red flags that they lose sight of the real objectives of the transaction: create shareholder value through synergy realization.
6
2. Synergy validation and accountability
If companies do not validate synergies with the respective functional owners during diligence, they face two major risks. First, inaccurate estimates are more likely to occur without validation from functional owners, who are best positioned to assess: a) the cost savings or revenue growth potential; b) the investments required; and c) the timing and probability of successful synergy realization. Second, the risk of a post-deal synergy shortfall increases without validation because the actual teams required to execute and deliver synergies have no stake in the goals they are being asked to achieve. For instance, a product development team may be excited about acquiring a product, but the sales team might not be aligned to reprioritize its efforts to meet the revenue synergies. It is critical to validate synergies—the single biggest drivers of deal value—and assign owners to drive post-deal accountability before you sign the merger agreement. This validation sets the stage for accountability during execution. Clear ownership and accountability for targets are essential to achieve synergies.
3. Negative synergies
Negative synergies play a pivotal role in many transactions, but despite the high financial cost of the negative aspects of integrating an acquisition, these synergies often are overlooked and underestimated. Vetting the costs associated with any estimated negative synergies and incorporating these numbers into the overall valuation are crucial to creating a realistic model. For example, the costs and potential financial statement ramifications of converging two companies’ revenue recognition policies can be significant because of complex accounting rules and varying business practices. Accurately capturing these types of negative synergies can help companies avoid disaster by taking a deal off the table before they invest significant amounts of time and resources.
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“With respect to targeting synergies, there’s often a different perspective as to what’s achievable between the generals in the ivory tower and the functional team leaders on the front lines in the actual integration. I find that the corporate development team often plays that mediator role, trying to figure out what is actually feasible.”
Effectively realizing synergies—Execution
8
70%
50%
40%
10%Other
Integration leader/function
Functional groups
Business unit leadership
Organizational accountability for synergies
Note: Results represent the percentage of 10 survey participants who assign accountability for synergy targets among businessunit leadership, functional groups, the integration leader, or another party. Participants could select more than one option.
As seen through the eyes of participants …
Chart3
Accountability for synergy targets typically is distributed between business unit leadership, functional owners, and the integration leader.
When strategic initiatives—including acquisitions—fail to fully realize their expected outcomes, the most common reason is weak execution, not flawed strategy. On this basis, companies should focus on ensuring the essential elements of successful execution are in place. Otherwise, they jeopardize their ability to create shareholder value through acquisitions.
Roundtable participants consistently expressed how important accountability and ownership are to realizing synergies. Typically, the corporate development and finance teams serve as a check and balance to each other, while the business unit and functional teams are accountable for synergy execution.
Vetting synergy assumptions requires input from all departments, including operations, finance, strategy, business development, sales and marketing, product development, IT, legal, etc.
Organizationalaccountabilityforsynergies
9
Challenges for synergy realization
The strategic factors that play a role in realizing synergies can vary depending on the type of synergies targeted. For cost synergies, executive management’s tone and monitoring are crucial to securing functional commitments. Transparency and leadership assignment are keys to achieving business combination synergies. Many revenue synergies rely on execution by the sales and product/engineering teams, which align their efforts through a combination of technologies that may then be sold through new distribution channels. This alignment may be more difficult to attain on smaller transactions.
Among our panelists, delayed integration and underestimated integration complexity are the primary drivers of unrealized synergies, followed by overestimated synergies and a lack of accountability (see chart 4). Also, most panelists’ companies will permit changes to synergy estimates without adverse consequences to compensation (see chart 5).
70%
60%
60%
50%
40%
30%
10%
10%Insufficient data was provided in due diligence
System/IT compatibility issues
Integration plan improperly managed/executed post-close
Culture and communication issues
Lack of accountability for particular actions
Potential synergies and cost savingswere overestimated
Integration costs/complexitieswere underestimated
Delays in implementing planned actions
Most common challenges affecting synergy realization
Note: Results represent which obstacles were chosen by the 10 survey respondents as possible challenges to realizing synergies. Respondentscould select more than one obstacle.
Chart4
Mostcommonchallengesaffectingsynergyrealization
10
Talent retention
A significant amount of synergies are enabled through successful employee retention. However, participants expressed issues with retaining talented people. On average, companies
generally use financial incentives to retain key personnel from one to three years post acquisition.
12.5%
12.5%
75%
Changes to synergy estimates
Never
Yes, between announcement and close
Yes, as needed/circumstances change
Chart5
For surveyed panelists, the majority did allow synergy estimates to be revised without adverse consequences in compensation or incentives.
“Essentially, depending on the company we’ve looked at, we may allocate 10 percent of the acquisition price to retain employees. Sometimes it’s pushed to 15 percent with a small company. Obviously, it depends in part on who is getting a payday—if somebody’s getting too much (money) there’s not a whole lot you can do to incent them to stay.”
Changestosynergyestimates
11
PwC’s point of view
Many factors can derail attempts to effectively execute on synergies. Issues often materialize during efforts to drive synergy accountability and ownership. Leading practices to better realize synergies address:
1. Transparency
Realizing synergies requires accurate and transparent reporting. Transparent reporting requires setting granular synergy baseline targets and reporting frequently to senior management on execution progress against the baseline targets. Transparency also requires a very clear connection to the company’s internal and external financial statements, which investors and other stakeholders can use to validate and reward value creation. Additionally, management’s tone and commitment to reaching targets—such as holding delivery teams accountable and rewarding them for synergy realization— are critical to execution success.
2. Integration
Delayed integration and underestimating integration complexity are the primary drivers of unrealized synergies. Taking a disciplined, process-oriented approach and applying leading practices to integration can make a deal more successful. PwC’s approach follows seven fundamental tenets for successful integrations:
• Accelerate the transition
• Define the integration strategy
• Focus on priority initiatives
• Prepare for Day One
• Communicate with all stakeholders
• Establish leadership at all levels
• Manage the integration as a business process
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Synergy analysis Value driver analysis Value driver execution/synergy tracking
Synergy model
Out
put
sTi
mel
ine
Business cases
Announcement Deal close
Workplans
Initial financial model based on limited information and set of assumptions
Due diligence Integration planning Integration execution
Detailed business case for each value driver initiative, including qualitative and quantitative information based on extensive analysis and information
Detailed project plan for each value driver initiative based on qualitative information from business cases; includes tasks, resources, dates, and deliverables
Tool used for tracking and reporting synergy achievement based on quantitative information from business cases
Synergy tracker
PwC synergy life cycle frameworkPwCSynergyLifeCycleFramework
3. Synergy life cycle framework
During diligence, the synergies must be estimated and included in the valuation model. Post-announcement, a more detailed level of synergy planning is required. PwC uses a synergy life cycle framework that helps companies capture synergies through four phases: modeling; business case development; detailed project planning; and tracking. In the business case development phase,
synergy models are substantiated by high-level plans that identify resourcing, risks, and dependencies. The business cases should be prioritized to ensure the organization is not overwhelmed. The company should focus its resources and energy on the 20 percent of business cases that drive 80 percent of the deal’s value. These cases must then be supported by detailed project plans and resourced sufficiently.
13
“We track actual operating income, actual revenue, and what they said they were going to spend, and we see if that makes sense. If the operating profit is good, then the numbers will work well. Typically, the first two years’ performance is really strong because that’s something that we have an integration team for, but we really have a hard time tracking it beyond that. The operating profit typically exceeds what we said we were going to do, and the revenue typically lags a little bit behind. Usually, we never get the sales synergies.”
Effectively realizing synergies—Tracking
14
100%
100%
88%
75%
38%
38%
13%Revenue growth—reduced competition
Cost reduction—increased purchasing power
Cost reduction—reducedproduction overhead
Cost reduction—eliminate surplus offices
Revenue growth—access to newregional markets
Cost reduction—head count reduction
Revenue growth—complementaryproduct sets/cross selling
Synergy realization
Note: Results represent the percentage of eight survey respondents who reported realizing certain types of revenue or cost synergies.
As seen through the eyes of participants …
Chart6
Synergies tracked generally include revenue, operating costs, and earnings before interest, taxes, depreciation, and amortization (EBITDA). Comparing these results with the deal model is a common method used to evaluate the success of the transaction. Most companies also track nonfinancial metrics such as employee and customer retention, product release dates, and integration milestones.
Synergies most frequently realized by panelists include cross-selling, headcount reduction, entry into new markets, and the elimination of redundant offices (see chart 6). A number of panelists described a high degree of conservatism in modeling revenue synergy targets because of perceived risks and a lack of available data prior to announcement.
“Our point of view is that revenue synergies are a very low probability. You ought to spend the time to measure cost synergies discretely to estimate them and track them. However, you’re going to track them separately. The negative synergies, you’ve just got to have your eyes wide open because culture can cause a negative synergy.”
Synergyrealization
15
PwC’s point of view
A mature deal process incorporates a thoughtful, proactive approach to tracking synergies. Leading practices to measure deal success often include an emphasis on:
1. Synergy tracking
Most companies track high-level metrics, such as total cost synergies and head count retention, but few have a robust process that ties integration milestones to synergy realization targets. To prevent post-closing surprises, companies should aggressively monitor the progress of more granular synergy targets. While responsibility for delivering synergies may rest with specific business units and functions, a centralized process and set of tools for monitoring, tracking, and reporting synergies is essential to delivering results. Tracking and measuring synergies is also essential to communicating progress on stated deal objectives to the market.
2. Deal process
Deal success is driven by defining and deploying a repeatable, scalable, and evolving M&A process. A mature process instills the right tollgates and discipline to drive successful acquisitions, from deal sourcing through diligence and integration. We view the critical steps in managing the deal process as:
• Deal evaluation
• Negotiation and close
• Integration
• Capturing value
In-depth due diligence is crucial to deal evaluation, including cost and revenue synergy analysis, and synergy tracking is a key component in the integration phase that acts as a report card on pre-deal synergy valuation and post-deal execution. Measuring shareholder value:
3. Measuring shareholder value
Although most companies find it difficult to measure useful metrics outside profit-and-loss targets and operational milestones, it is vital to factor the intended shareholder value creation targets into a transaction’s success. Companies that measure the economic value added by acquisitions will ensure a cause-and-effect scenario is built for each transaction. This will improve a company’s understanding of deal successes and failures and enhance decision making.
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Long story short …
As the economy rebounds and the credit crunch eases, acquisitions will reemerge as a strategic tool for generating shareholder value. When buyers’ prospects of hitting initial value expectations rise, deal timelines will shrink, placing a greater emphasis on due diligence and putting a higher premium on the teams conducting the acquisition process.
As leaders on their respective companies’ corporate development teams, our panelists consistently expressed the importance of:
1. Recognizing potential synergies and incorporating them into the valuation process
2. Transparency and accountability throughout the execution phase of an integration
3. Tracking synergies post-deal to enable proper evaluation of the acquisition
17
Key takeaways—Insights into synergies
Stronger balance sheets and an improved credit market often help pave the way to strategic deal making. By effectively harvesting synergies, companies increase the chances of achieving aggressive targets and creating additional shareholder value.
Establishing a scalable, robust playbook that rigorously assesses risks and identifies value drivers is intrinsic to realizing synergies. Companies that apply the same rigid, all-inclusive process to all deals, regardless of size or complexity, may not be nimble enough to capitalize on their potential acquisitions.
Though acquisitions outside a company’s core can be successful, experience shows it is more difficult to realize synergies and increase shareholder value—in non-core deals.
Even when the M&A process correctly identifies and realizes cost and revenue synergies, an acquisition can still be disrupted by failing to accurately capture the negative synergies inherent in every deal.
Assigning accountability for synergy planning, prioritizing value drivers, and establishing clear roles throughout the deal process are critical to success.
The bottom line: Leveraging processes, people, templates, and tools that quickly and accurately capture and track synergies is essential to an effective M&A process. By themselves, these factors may not guarantee value creation, but without them a deal maker’s prospects for success diminish considerably.
Again, we thank our roundtable participants for sharing their experiences with us and, through this summary, with you.
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AboutPricewaterhouseCoopers’TransactionServicesgroup
The PricewaterhouseCoopers Transaction Services practice provides due diligence for M&A transactions, along with advice on M&A strategy, deal evaluation and integration, restructuring, divestitures and separation, valuations, accounting, financial reporting, and capital raising. With approximately 1,000 deal professionals in 16 cities in the United States, and a global network of over 6,000 deal professionals in 90 countries, experienced teams are deployed with deep industry and local market knowledge and technical experience tailored to each client’s
situation. The Transaction Services team can be involved from strategy to integration and employ an integrated business approach to uncover the realities of a deal. The field-proven, globally consistent, controlled deal process helps clients minimize their risks, progress with the right deals, and capture value both at the deal table and after the deal closes.
For more information about M&A and related PricewaterhouseCoopers services, please visit www.pwc.com/ustransactionservices.
OtherTransactionServicespublications
• US technology M&A insights: Analysis and trends in US technology M&A activity 2010
• Entertainment & media M&A insights: Analysis and trends in US M&A activity 2010
• TS insights: Key considerations in preparing and executing an IPO—A summary of a recent IPO Conference in Silicon Valley
• Capturing synergies during integration: How to complete the M&A integration process, minimize disruptions, and achieve desired synergies
• Speed of integration improves M&A success: PwC M&A Integration Survey Report 2008
• Post-Merger Integration Survey 2009: European results
For information about these or other PwC publications, please contact a Transaction Services professional listed on the back page.
AboutPricewaterhouseCoopers
PricewaterhouseCoopers (www.pwc.com) provides industry-focused assurance, tax and advisory services to build public trust and enhance value for its clients and their stakeholders. More than 163,000 people in 151 countries across our network share their thinking, experience and solutions to develop fresh perspectives and practical advice.
“PricewaterhouseCoopers” refers to PricewaterhouseCoopers LLP or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.
pwc.com © 2009 PricewaterhouseCoopers LLP. All rights reserved. “PricewaterhouseCoopers” refers to PricewaterhouseCoopers LLP (a Delaware limited liability partnership) or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity. *connectedthinking is a trademark of PricewaterhouseCoopers LLP.
AT-09-0249
For a deeper conversation about capturing synergies in the acquisition process, please contact:
Rob Fisher
(408) 817-4493
Todson Page
(408) 817-1223
Amity Millhiser
(408) 817-7850
Bryan McLaughlin
(408) 817-3760
Dana Drury
(214) 758-8245
Gregg Nahass
(213) 356-6245
Mike Giguere
(617) 803-6377
Marc Suidan
(408) 817-7908
Todd Weissmueller
(214) 754-7382
Debra Skorupka
(312) 371-0137
© 2010 PricewaterhouseCoopers LLP. All rights reserved. “PricewaterhouseCoopers” refers to PricewaterhouseCoopers LLP, a Delaware limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity. This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. LA-10-0327
