Explain the concept of synergies and provide some examples.

In simple terms, synergy occurs when 2 + 2 = 5.  That is, when the sum of the value of the Buyer and the Target as a combined company is greater than the two companies valued apart.  Most mergers and large acquisitions are justified by the amount of projected synergies.  There are two categories of synergies:  cost synergies and revenue synergies.  Cost synergies refer to the ability to cut costs of the combined companies due to the consolidation of operations.  For example, closing one corporate headquarters, laying off one set of management, shutting redundant stores, etc.  Revenue synergies refer to the ability to sell more products/services or raise prices due to the merger.  For example, increasing sales due to cross-marketing, co-branding, etc.  The concept of economies of scale can apply to both cost and revenue synergies.

In practice, synergies are “easier said than done.”  While cost synergies are difficult to achieve, revenue synergies are even harder.  The implication is that many mergers fail to live up to expectations and wind up destroying shareholder value rather than create it.  Of course, this last fact never finds its way into a banker’s M&A pitch.