In the previous article on An Introduction to Mergers & Acquisitions (M&A), this article will quickly touch on the one key synergy investors should look out for in a M&A activity.
There are basically two types of transactions:
A financial acquisition occurs when a company buys a portfolio of business operations without changing the fundamental performance at either firm. There is usually no synergistic value between the acquiring and acquired firms.
Our focus of the topic. In order for a merger or acquisition to be justified, the acquiring firm or target firm has to contribute some something to the combined enterprise. Such contribution can be an improvement in management, tax advantage, unlocking hidden value, or to increase market share.
Searching for synergy in a strategic acquisition is usually difficult given as price paid for an acquisition usually far outweighs the potential benefits which might be brought to the combined firms. As a result, post-deal operating performance tends to show little or no improvements.
However, not all M&A activities have an adverse impact to shareholders’ value. One criteria investors should look out for is whether there is significant cost advantage in the acquisition. Having a cost advantage is usually due to proprietary technology and/or economies of scale. For example, when there are proprietary production technology, the newly combined entity can reduce costs if the technology can be successfully adopted in the other company. The combined companies may also be able to realize cost savings through economies of scale, mainly through the reduction of fixed costs in distribution, marketing research & development and general overhead.
Value in Action
One important characteristics of an M&A is to see if there are potentially large cost savings to be realized since it is easier to discern from this perspective whether the potential benefits outweigh the costs involved.
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All views and opinions articulated in the article were expressed in Willie’s personal capacity and do not in any way represent those of his employer and other related entities. Willie does not own any shares in the companies mentioned above.