Synergy KSB 1.1 KPMG (2001), Synergies Guide

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Synergies: A business guide

What are synergies and
why do they matter?
They are trumpeted by CEOs, paid lip-service to by deal-makers, misunderstood
by the market, played down by operational managers, viewed with fear by
employees…and critical to the successful creation of shareholder value.
Only by understanding the importance that synergies play in a deal can acquirers hope
to pay the right price, convince the market of a deal’s merits and extract full value in
the post-deal phase.
Successful acquirers have recognised this and have embedded a rigorous approach to
synergy analysis in their acquisition process.
In this M&A Integration report, we consider:
What synergies are.
Why synergies matter.
The ‘golden rules’ to exploit synergies to the full.

Who is this guide for ?

We recommend this guide to any CEO or Senior Executive involved in, or
contemplating a major merger or acquisition.
Our recent "World Class Transactions"1 survey once again confirmed that the vast
majority of M&As fail to deliver shareholder value. By illustrating the benefits of a
structured approach to synergies and setting out some best practices in this guide,
we hope to help acquirers improve this success rate.
John Kelly, Partner
M&A Integration
KPMG consulting

Colin Cook, Partner
KPMG Transaction Services

1 "World Class Transactions: Insights into creating shareholder value through mergers and acquisitions", KPMG 2001.



Why the increased focus on synergies?
As we reach the halfway point in 2001, it appears that the global M&A market is
returning to more sustainable levels following the dot-com and telecoms frenzies
that sent deal levels soaring in 1999 and 2000.

M&A Market Activity 1997 - 2001
World Total (cross - border & domestic deals)

1, 400 000
World Half - Year Total

1, 200 000
1, 000 000
800 000
600 000
400 000

Value ($trn)

200 000













Sources: Compusoft Research / Commscan 2001.
Includes all deals completed 1st Jan 1997 - 22th June 2001. Excludes MBOs & Privatisations.

Yet despite this correction, M&A rumours and announcements continue to feature
strongly in the business pages in 2001. The driving forces of M&A remain
strong, as companies continue to seek growth by
extending down the value chain (eg. Vivendi Universal-,
consolidating within their industry (eg. Allianz-Dresdner Bank, ENI-Lasmo)
globalisation (BHP-Billiton, EON-Powergen)
But the market can be quick to punish those who are seen to be doing the wrong
deal, or to be overpaying, as Chase Manhattan discovered when its stock price
fell 10% on the announcement of its acquisition of JP Morgan last year.
As the Wall Street Journal observed in November 1999, citing JP Morgan research "For the first time in several years, the stock price of US acquirers is falling on
average upon announcement of a deal". (WSJ 29/11/99).
Deals can even be scuppered by the market before they are consummated. In


May 2001, Prudential’s bid for US life insurer American General proved so
unpopular with investors that its shares plunged 14% when it was announced,
allowing rivals AIG to step in with a counter-offer.
And as is now widely known, the effects are often lasting. KPMG’s M&A research1
has shown that some 70%-80% of M&As fail to create shareholder value.
So how can CEOs persuade their increasingly sceptical stakeholders that, despite
the evidence, the premium will not be wasted and the deal will create value - and
how will they deliver this promise.
Evidence shows that successfully identifying and realising synergies is a major
determinant of deal success. We explore:
What are synergies - see page 4
Why they are important - see page 6
How they can be identified - see page 9
How they can be realised - see page 11.

1 "World Class Transactions: Insights into creating shareholder value through mergers and acquisitions", KPMG 2001.



What are synergies? 1+1 = 3?
Synergies can be defined as incremental improvements in performance following
the combination of two businesses, relative to their expected performance prior to
the combination.
M&As are conducted for many strategic reasons. For example, they may be to
achieve market leadership (eg Glaxo Smithkline), for defensive reasons (eg
Chevron Texaco), or to extend control in the value chain (Vivendi-Seagram).
With increasing attention now being paid to shareholder value, the quantitative
financial benefits of transactions are coming under as much scrutiny as the
strategic rationale. In all cases, investors will be looking for the acquired company
to realise synergies in the transaction, either in the form of incremental revenue
enhancement or in cost reduction.
In many deals in the 1990s, the focus was on cost reduction synergies. Typical
examples included:
rationalisation of premises, manufacturing plants and retail branches by
eliminating duplication
scale economies from mechanisms like combined purchasing power
efficiency gains using best of breed process improvements
financial engineering such as tax benefits.
More recently, many deals have been based on revenue enhancement, particularly
within the technology and telecom sectors. Commonly-cited sources of revenue
synergies include:
leveraging enhanced market power
enhanced new product development and portfolio upgrading
skills and knowledge transfer
faster time-to-market.


The acquisition premium sets a synergy challenge for acquirers. Prior to the
acquisition, the shareholders could have bought shares of the target without paying
a premium.
To repay their shareholders, acquirers must therefore deliver incremental cash
flows from the combined businesses. The cash flows must be at least equivalent to
the amount implied by the premium, or the value of the deal will be destroyed.

Premium table

Price negotiation range

shareholder value

shareholder value

Stand-alone Premium




Stand-alone Required
Operating value



Why are synergies important?
"Don’t talk about synergies, they are never delivered"
- CEO, European Multinational
Synergies are the prime hard key to deal success

KPMG’s 1999 report ‘Unlocking Shareholder Value: The Keys To Success’
established synergy evaluation as the prime "hard" key to deal success. The report
found that acquirers who focused on synergies are 28% more likely to create
shareholder value from their deal.
Therefore, without synergies, an M&A is unlikely to result in any significant
incremental shareholder value.
There are three key ways in which an early evaluation of synergies
contributes to success:
a. To inform the price and / or valuation discussion, avoiding overpayment for the target

It is important for an acquirer to know what synergy figure is achievable when
assessing the price to bid. The greater the uncertainty around the synergy figure,
the greater the risk that an acquirer may be paying an unsubstantiated premium
for the target. This issue becomes more acute as premia reach close to 40%.
An assessment of synergy potential and robust synergy evaluation enables the
deal team to reassure the acquiring and target boards that assumptions built into
the deal price are realistic. Such analysis may enable a higher price to be bid as
the acquirer derives comfort about the scale and achievability of synergies.
This can prove to be the difference between winning or losing a potentially good
strategic acquisition.
b. To formulate effective communications to the market and other stakeholders

Information concerning synergies is now a familiar (though non-mandatory)
element of the public presentation of a proposed deal, and is particulaly
important in the event of hostile bids (see box overleaf).


Hostile bids and synergy statements
In 1997 the Panel on Takeovers and Mergers published its specific
requirements on how statements concerning the expected benefits of a
takeover should be made. The requirements include: publication of the
basis of the belief (including sources of information) supporting the
statement; reports by financial advisers and accountants that the statement
has been made with due care and attention; an analysis and explanation of
the constituent elements sufficient to enable shareholders to understand the
relative importance of these elements; and a base figure for any
comparison drawn.
The requirements do not apply to cash offers, and provided that the
documentation contains a reasonably detailed analysis and explanation of
the constituent elements of the claimed mergers benefits, the Panel will not
normally insist on them in recommended offers unless a competing offer is
announced and the statement is repeated in that context or is otherwise a
material issue.
The Panel has identified two principal reasons for concentrating its
requirements on hostile bids involving share exchange proposals: firstly the
concern that the circumstances of a hostile bid can be expected to limit the
ability of the bidder to obtain sufficient information concerning the target’s
business and prospects and hence meet the Code’s standards of accuracy;
secondly the concern that unless adequate detail of the basis for the
statement is included, it may be difficult for the target or a competing bidder
to respond in a constructive way to the bidder’s claims.
Although public reporting by financial advisers and accountants is thus
relatively infrequent, it is common practice on large plc takeovers or
mergers for accountants to be requested to provide a private comfort letter.
The element of merger benefit statements which is typically most
straightforward for a bidder to substantiate is a cost reduction figure, and
traditionally accountancy firms who provide comfort letters have restricted
their comfort to statements based on such figures, and provided only
qualitative rather than quantitative comment around the potential for
revenue enhancement synergies.
However, the Royal Bank of Scotland hostile bid for Nat West provided a
precedent for revenue enhancement figures to be stated. We can expect to
see such a stance becoming more commonplace in the future.


It is important that the offer document and the circular, which are distributed to
shareholders when gaining approval to proceed with the deal, both contain a
sound explanation of the deal rationale and robust synergy figures.
There is also a growing expectation amongst analysts for a synergy figure to be
stated whatever the rationale for the deal. The deal advisers and the acquirer
must establish a delicate balance between a synergy figure which will reassure
the market that the valuation implied by the premium is acceptable (and
potentially sufficient to deter other bidders) and one that management believes is
achievable (and ideally, surpassable).
Clearly then, the synergy statement can play a significant role in positively (or
negatively) influencing market perceptions of the deal.
c. To encourage planning and ‘buy-in’

Early assessment of synergies encourages managers to begin the process of
planning for integration and encourages ‘buy-in’ to the deal of the actions
required to achieve success.
Companies that perform synergy assessment and integration planning in the
pre-completion phase have been shown to improve their chances of value
creation by 13% to 28%.2

2 "Unlocking Shareholder Value: The Keys to Success", KPMG 1999.



How to identify
and calculate synergies
There are three golden rules to be considered when assessing synergies:
a. Take a holistic view of the business-look for both revenue and cost opportunities

The CEO has the responsibility to articulate and share a compelling vision for
a merger or acquisition.
Within that framework, management should then be tasked with rigorously
developing a comprehensive picture of the strategic opportunities arising from a
deal. They should examine all areas of the business which may result in cost
reduction, revenue enhancement and other more strategic benefits. This
approach can uncover unexpected benefits compared to the way in which many
acquirers ‘clutch’ only at those synergies which appear easiest to deliver or
most palatable.
A comprehensive view is increasingly important as competitive bidding
becomes more prevalent and acquisition premia rise. Communication around
innovative synergy benefits can play a vital role in market perception, for
example Royal Bank Of Scotland’s incorporation of revenue enhancement in its
battle with Bank of Scotland over NatWest, or BP’s messaging around portfolio
upgrading in its acquisitions of Amoco and Arco.
For mergers where deals are primarily based on long-term benefits (for instance,
in the fast-moving, volatile telecoms or dot-com environments), CEOs can
alleviate perceptions of risk by also communicating short-term efficiencies
and cost savings.
b. Ensure that assumptions are sound by involving key managers

Synergy evaluation is often conducted at a time when acquirers are under
pressure to complete the deal quickly, when confidentiality is paramount and
there is limited access to information.
Commercially sensitive information will often be withheld from the acquirer
pre-deal. Despite this, assumptions must be made to provide the basis for
synergy figures. Ideally, the CEO should ensure that operational managers and
specialists have participated in the derivation of these figures and believe that
they are achievable. Acquirers must remember that in thinking about what
synergy values may be realistic, they must also begin early on to ask themselves
how these will be achieved.
On completion of the deal, the acquirer will at last gain full insight into the
target business and into accurate information on which to base implementation
plans. The new management should then review the synergy assumptions
again to ensure there are no surprises and to confirm the key sources of value
from the deal.


c. Understand timing and phasing

Cost savings will be realised over a period of time. Proposed workforce
rationalisation may require lengthy union or works council negotiations, whilst
procurement savings may not be realised until contracts have expired or
products have been standardised. Buildings may be held under long leases.
All these factors may delay the moment at which actual savings can begin.
Similarly, revenue enhancements may not be realised until rebranding and a
promotion campaign have been implemented.
The value of synergies will also be reduced by one-off implementation costs, such
as redundancy, employee relocation, site rationalisation, clean-up, IT systems
integration and consultancy, which also need to be quantified and scheduled.
It is important to take all these factors into account to develop a phased financial
plan, ideally with targets measured on a timescale corresponding to the
acquirer’s financial reporting calendar. As well as underpinning cash flow
assessments and valuation models, this analysis represents a vital tool to
measure progress and support communications in the integration process.



How to realise the synergies
a. Start identifying them as early as possible

Our research has shown that early investment in implementation planning and
synergy assessment increases an acquirer’s chance of delivering value from the
deal. Outline implementation plans, particularly those which address key soft
issues such as management and culture, are essential to provide credibility when
presenting and communicating the transaction to the market.
There are several different stages during the deal cycle where synergies should
be considered. Synergy evaluation should begin pre-deal and continue to be
refined post-deal during the integration process, with actual synergy benefits
being tracked during the implementation.
The diagram below illustrates a typical process:

As all those who have been through the process know, there are considerable
demands on management time and pragmatic limits on the number of managers
who can be involved in the pre-deal phase. It is easy for teams to work full-time
on simply ‘doing the deal’.
However the research findings are clear; time and resource allocated to synergy
planning will pay back in the implementation phase.


b. Set challenging targets internally, but communicate prudently externally

Successful acquirers cultivate a reputation for over-delivering on challenging
targets, ideally ahead of schedule.
Although revenue benefits are key to many deals, they cannot be treated in the
same way as cost reduction since they are not usually solely within the power of
management to deliver, and are more vulnerable to external market dynamics.
It may be particulary prudent to ‘aim off’ any revenue enhancement figure, which
is being publicly quoted, by building in contingency, in both scale and timing.
A similar approach should be taken with cost reductions although the market
may apply more scrutiny to these assumptions.
c. Track benefits throughout the implementation phase

As identified in KPMG’s report “Unlocking Shareholder Value: The Keys to
Success”, acquirers that focus on linking pre- and post- deal processes
significantly improve their chances of success. The pre-deal evaluation
of synergies should feed directly into the post-deal integration plan for
further challenge.
Immediately following deal completion, management will be able to gain access
to more detailed operational information. Expert teams should be formed and
tasked to review the key areas of projected synergy, and develop practical
implementation plans to realise them. Ideally, this effort should take place within
a structured, accelerated ‘100 day’ or similar integration plan.
Finally, during implementation, benefits should be rigorously tracked as they are
realised, providing the market with effective communication on progress.


KPMG viewpoint
To justify and deliver the maximum value from a deal, CEOs must ensure that
sufficient management time is dedicated to evaluating the potential synergies.

develop an objective, quantitative view of the merger benefits and
synergies as early as possible, considering both cost savings and potential
revenue enhacements
involve key managers wherever possible to verify synergy assumptions
and forecasts
understand the phasing of benefits and the implementation costs that will be
incurred in integrating the acquistion
ensure that the premium paid does not exceed the incremental value implied
by the synergies
constantly update the analysis for new information (understandings gained
during the investigation process).

communicate the expected synergy benefits clearly but prudently
review all initial synergy assumptions once access to full data is available
focus and challenge the integration plan on synergy delivery
build synergy targets into financial budgets and targets
ensure benefits are tracked in the implementation phase.
M&A activity is notoriously risky and no process is guaranteed to ensure
success. However, our research and our experience of pre- and post-deal
corporate M&A activity consistently shows the same message; that by linking
robust synergy analysis with early integration planning, successful acquirers set
a firm foundation for value creation.


For further details, contact:
John Kelly
M&A Integration
KPMG Consulting
1-2 Dorset Rise
United Kingdom
Telephone: +44 (0) 207 694 8542
Facsimile: +44 (0) 207 311 1690
Colin Cook
KPMG Transaction Services
8 Salisbury Square
United Kingdom
Telephone: +44 (0) 207 311 1000
Facsimile: +44 (0) 207 311 1640

KPMG is registered to carry out audit work and authorised to carry on investment business by the Institute of Chartered Accountants in England and Wales.
© 2001 KPMG, the UK member firm of KPMG International, a Swiss association. All rights reserved. Printed in the UK.



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