Synergy
1
The Value of Synergy
Aswath Damodaran
Stern School of Business
October 2005
2
The Value of Synergy
Many acquisitions and some large strategic investments are often justified with the argument that they will create synergy. In this paper, we consider the various sources of synergy and categorize them into operating and financial synergies. We then examine how best to value synergy in any investment and how sensitive this value is to different assumptions. We also look at how this synergy value should be divided between the parties (or companies) involved in the investment. We conclude with an empirical examination of how much synergy is actually created in corporate mergers, and how much is paid. Synergy, we conclude, is so seldom delivered in acquisitions because it is incorrectly valued, inadequately planned for and much more difficult to create in practice than it is to compute on paper.
3
When Carly Fiorina argued for Hewlett-Packard’s acquisition of Compaq, she offered a number of of reasons the deal made sense. She noted that the combined company would be able to meet the demands of customers for “solutions capability on a truly global basis.” She also claimed that the firm would be able to lead with its products “from top to bottom, from low end to high end.” As her crowning argument, she claimed that the merger made sense because it would create “synergies that are compelling.”
Synergy, the increase in value that is generated by combining two entities to create a new and more valuable entity, is the magic ingredient that allows acquirers to pay billions of dollars in premiums in acquisitions. It is true that investors have historically taken a jaundiced view of synergy, both in terms of its existence and its value and the track record on the delivery of synergy suggests that they have good reason for skepticism. In this paper, we will begin by considering potential sources of synergy and how best to value each of them. We will then also examine the
The Value of Synergy
Aswath Damodaran
Stern School of Business
October 2005
2
The Value of Synergy
Many acquisitions and some large strategic investments are often justified with the argument that they will create synergy. In this paper, we consider the various sources of synergy and categorize them into operating and financial synergies. We then examine how best to value synergy in any investment and how sensitive this value is to different assumptions. We also look at how this synergy value should be divided between the parties (or companies) involved in the investment. We conclude with an empirical examination of how much synergy is actually created in corporate mergers, and how much is paid. Synergy, we conclude, is so seldom delivered in acquisitions because it is incorrectly valued, inadequately planned for and much more difficult to create in practice than it is to compute on paper.
3
When Carly Fiorina argued for Hewlett-Packard’s acquisition of Compaq, she offered a number of of reasons the deal made sense. She noted that the combined company would be able to meet the demands of customers for “solutions capability on a truly global basis.” She also claimed that the firm would be able to lead with its products “from top to bottom, from low end to high end.” As her crowning argument, she claimed that the merger made sense because it would create “synergies that are compelling.”
Synergy, the increase in value that is generated by combining two entities to create a new and more valuable entity, is the magic ingredient that allows acquirers to pay billions of dollars in premiums in acquisitions. It is true that investors have historically taken a jaundiced view of synergy, both in terms of its existence and its value and the track record on the delivery of synergy suggests that they have good reason for skepticism. In this paper, we will begin by considering potential sources of synergy and how best to value each of them. We will then also examine the