The open secret about M&A is that most deals fail to generate the synergies companies expect when they announce a merger. In a Bain & Company survey of 352 global executives, overestimating synergies was the second most common reason for disappointing deal outcomes.
One of the causes of this overestimation is well known: Companies set aggressive targets to justify a deal price to financiers. But Bain analysis comparing deal announcements with the performance of more than 22,000 companies has unveiled another, even more fundamental contributor to the rampant overestimation. Most merging companies entering a deal don’t have a clear understanding of the level of synergies they can expect through increased scale.
Instead, they typically make broad estimates based on prior deal announcements, without considering whether the cost structure of the combined entity is realistic based on benchmarks of like-sized companies. For example, if two $100 million (Dh367.3 million) companies merge, they rarely know what the resulting cost structure will look like based on their industry’s existing $200 million companies. We found that across most industries we analysed, on average 70 per cent of companies announced higher synergy estimates than would be expected just by companies getting bigger.
This is an issue of growing significance in the Middle East. The value of announced M&A deals with any Middle Eastern involvement was $22.7 billion in Q4 2014, more than double the value in the previous quarter and the highest total since the first quarter of 2008, based on a report by Reuters.
A significant amount of M&A activity is taking place in the Mena banking sector. Years ago, western markets saw significant consolidation in their banking industries. With the recent resurgence in the Mena region and an ever-maturing banking environment, we will see this phenomenon also play out in the GCC, where banks having recently pursued acquisitions in Egypt, Turkey and other emerging markets. The question is how fast the regional market will consolidate around a limited number of these regional champions.
Regional acquirers will need to be creative about how they extract synergies from their recent acquisitions, before they return to the negotiation table for more. When they do return however, their experience will mean that they will be best positioned to generate incremental value from their next acquisitions.
How do merging companies become synergies over-achievers? The best companies justify higher targets and provide a roadmap for achieving them. They use the disruption caused by M&A to pursue broader changes like adopting zero-based budgeting initiatives and incorporate new ways of working that help them surpass rivals to become cost leaders.
That approach requires merging companies to be far more disciplined about calculating expected synergies. It also requires them to use industry benchmark data to get a firm grasp on how each company’s costs stack up prior to the transaction and to understand how much can be gained from scale alone, as well as from the additional effects of improving costs.
Few companies illustrate this approach better than AB InBev, the world’s largest brewer created from the 2008 merger of Anheuser-Busch and InBev. AB InBev announced anticipated synergies in its huge merger that were higher than what could be expected from scale alone, but it entered the merger with both a track record for high synergies and a solid plan to back up their claim. They ultimately beat the ambitious announcement by generating synergies of $2.25 billion, much more than what could have been expected from scale. On average, merging consumer products companies increase EBITDA by 3.2 per cent of target net sales. In the case of the AB InBev merger, those synergy gains contributed a 16.8 per cent improvement over a three-year period following the transaction.
A diversified industrials company formed by the merger of two giants serves as another example of synergy excellence. The merged company used the acquisition process to get everybody on board for transformation. Based on industry benchmarks, the merged company would have expected to achieve scale synergies representing just 1 per cent to 2 per cent of combined revenues. It did far better. All told, the acquisition delivered synergies amounting to more than 5 per cent of revenues.
In both situations, the merging companies used a deal thesis and rigorous due diligence to pinpoint where scale synergies and best practice benefits would have the most substantial effect. A deal thesis spells out the reasons for a deal — generally no more than five or six key arguments for why a transaction makes compelling business sense.
In our experience, too few companies enter a deal really knowing how they measure up against competitors. But when the two industrial goods companies merged, they relied on function-by-function benchmarks to know where to expect the greatest synergies. They examined costs down to the sub function level — in areas like tax and treasury, for example — to identify potential synergies.
And they considered benchmarks from multiple angles: Instead of just looking at the cost of a specific function like field human resources, they also considered such benchmarks as HR employees-per-field headcount — anything that could be contributing to the gap against the best performers. That allowed the combined companies to set aggressive goals and see where each had strengths that could be adapted to help the combined entity perform above industry benchmarks.
The disruptive nature of M&A and the integration process opens up the opportunity to implement a broad performance improvement agenda across the organisation. Winning companies distinguish between areas they are primarily integrating and those they are optimizing beyond pure scale benefits.
— The writer is is a partner and director at Bain & Company and leads the firm’s global Financial Services practice.
