While most mergers and acquisitions frameworks are concerned with the pre-deal valuation and the maximization of the transaction’s enterprise value, post-merger integration focuses on the realization of the predicted values once the transaction has been completed. The post-merger integration process is designed to harmonize two company’s departments and functions while benefitting from identified synergies without losing traction in the day-to-day business. Post-merger integration is synonymous for combining two different entities and fabricating a new and better combined enterprise.
The relevance of post-merger integration
History taught us, that a global crisis negatively impacts the mergers and acquisitions landscape globally both regarding total number of deals as well as median EBITDA multiples achieved by the sellers. The bankruptcy of Lehman Brothers, the largest bankruptcy filing in United States history, is also widely regarded as the culmination of the subprime mortgage crisis which ultimately resulted in the 2008 global financial crisis. Lehman’s bankruptcy filing led to a heavy decline in median EBITDA multiples achieved by sellers in the mergers and acquisition environment (Falkensteg research, Aug. 2020).
Despite experiencing a slight decline (4%) in the number of deals carried out in Q1 2021 (compared to Q4 2020) we are experiencing increasingly high multiples, 11.5x EBITDA in Q1 2021 (Clearwater International research, 2021). Market development behaving contrary to 2008 mainly stems from the high investment pressures and exceptionally low interest rates we are experiencing since the burst of the real estate bubble of 2007.
At this point it is necessary to mention, that the identification of synergies and their valuation happens prior to the signing and closing of an M&A deal (Figure 1), and that synergies play a key role in determining the transaction value. Combining the natural importance of synergies within the mergers and acquisitions environment with the increasing deal volumes after the global pandemic stresses the importance of synergy capitalization during the post-merger integration process.
Figure 1: Post-merger integration process, actions, and goals
Types of synergies
The success of mergers and acquisitions is mostly based on the value created during the post-merger integration process, which is driven by the four dimensions depicted in Figure 2. Synergies are widely regarded as the core of the post-merger integration process and as stated above, are one of the main value drivers in determining the enterprise value of the transaction. Hence, exploiting synergies post-closure becomes of utmost importance to the acquirer. However, the ability to capitalize on synergies presupposes the correct identification and assessment of existing of the latter. Consequentially, this chapter will focus on a variety of commonly identified synergiesand their implications.
Figure 2: Four dimensions of post-merger integration
Cost synergies can be realized whenever the combined companies can be supported by an overall lower cost base than on an individual basis. These synergies can generally be divided into one time cost reductions and long-term cost benefits.
One time cost reductions are also known as quick-wins and can be realized shortly after the company has been handed over to the new owner. Such quick wins include the reduction of temporary employees or the reduction of the warehouse stock.
Ongoing cost savings may be more demanding to realize but will certainly have a lasting positive impact on the companies’ profitability. The combination of two companies often leads to the duplication of certain functions. Consequentially, the company can achieve cost savings through well thought layoffs of redundant functions. Companies may integrate horizontally or vertically to acquire superior technology; this is especially true in the context of E-Commerce companies. Such a transaction benefits the company saving on costs that would have been required for purchasing or developing the software itself, while also increasing market share and competitive positioning. Finally, the merged company can also benefit from supply chain effects through economies of scale, as they can leverage their newly combined purchasing power against their suppliers.
Even under the assumption, that top line revenues stay linear and do not realize any growth, the capitalization of previously mentioned cost synergies increases overall profitability. These synergies are relatively easily quantifiable and can be materialized with comparably low complexity.
In contrast to cost synergies, revenue synergies increase the top line of the company but do not necessarily increase the overall profitability. Consequentially, they are generally valued lower than cost synergies in pre-deal financial modelling, as they are more difficult to plan and to assign a value to. Hence, in comparison to cost synergies, revenue synergies play a subordinated role in determining the Enterprise Value compared to merger effects on the cost basis.
When merging companies, their respective product and service portfolio offerings as well as their distribution channels and networks become synergistic, allowing for increased sales. Furthermore, the newly merged company will benefit from an increase in traffic and their newly diversified portfolio will allow for cross- and/or up-selling.
Despite their subordination to cost synergies in terms of valuation, revenue synergies are more complex in their realization (i.e., it is more difficult to achieve cross-selling than to eliminate redundant corporate functions).
Not all synergies create effects, that can immediately be quantified on the profit and loss statements. In fact, certain synergies create cash flow statement effects which ultimately have little impact on the profit and loss statement. However, synergies of this sort can have strategic benefits and need to be taken into consideration when identifying the list of potential synergies.
Commonly, larger enterprises, as they emerge from mergers and acquisitions, have better prerequisites, and hence can gain easier access to credit facilities and debt capital for that matter. This largely stems from the fact, that the combined companies likely have a larger asset base that can be utilized as collateral and that they create larger free cash flows for debt repayment than on a standalone basis. The profit and loss impacts are limited to the effective interest rates from the additional loans, while the additional cash enables capital expenditure and investments which can be a catalytic converter for additional top line growth. Furthermore, the merged company may be able to leverage additional tax breaks (i.e., tax shields: allowable deduction from taxable income, which leads to a reduction of the total tax burden), which does not have an immediate effect on EBITDA and transaction valuation for that matter but liberates additional post-tax cash flows for investments or dividends.
While financial synergies pose low levels of complexity as they are mainly realized on an accounting level, they are easily attributed with a value before signing and closing for the same reason.
Mergers and acquisitions transactions have many root causes, one of the most common reasons for an acquisition is based on the qualities of the management team of the acquired company. The combination of two management teams into one company may have positive and/or negative synergistic effects, which depends on the quality of cooperation between the teams. Despite the risk of negative synergies, the combination of management teams can reduce complexity in leadership while creating a high-performance management team at the same time.
Positive management synergies can essentially materialize in two radically different ways. In the first type of positive management synergy, both teams cooperate and therefore create a higher service level and better resource utilization through higher employee motivation as well as additional growth opportunities for the business. The second typus of positive management synergies includes the reduction of redundant functions and competences, which results in the creation of a leaner more efficient management team consisting of the top performers of both companies. This creates cost synergies as stated above while also increasing efficiency for the corporate decision making.
Except for the cost synergies achieved when reducing redundant management positions, management synergies are not only hard to be quantified but also complex to materialize during the post-merger integration process. They are often included in the additional premium (goodwill) a buyer is willing to pay above the actual valuation.
The identification of synergies is the first step and generally takes place long before the post-merger integration process is initiated. However, the core challenge of post-merger integration is being able to materialize these identified synergies and benefitting from them. The following chapter will provide “capitalization strategies” for a selection of synergies while also taking consequences and challenges into account.
Figure 3: Level of complexity and valuation implication of different identified synergies in PMI
Capitalizing on synergies – Living up to pre-deal valuations
After having identified the potential synergies of the forthcoming mergers and acquisitions transaction, the signing and closing of the latter, the synergies must be capitalized into hard cash, so that the acquired company or the merged group lives up to its pre-deal valuation expectations (which heavily affects the overall enterprise value of the transaction).
Ideally, the capitalization process of identified synergies already begins during the final phase of the due diligence, when the acquirer prepares a realization plan. This plan should define short-term and long-term synergies as well as relevant key performance indicators to measure the actual impact of the synergies.
Realizing relevant cost synergies from the elimination of redundant functions requires a detailed analysis of existing employees in existing functions to be made. Redundant functions must be identified and the employees working in these functions need to be reviewed critically in the context of the future strategy of the corporation to choose the best fitting person based on overall set of skills and personal fit. However, it is necessary to mention, that bias of the acquirer may impact the evaluation process and lead to demotivating the employees after all. The final selection of team members should be a (if possible) well-balanced mix of highly trained professionals. The advice of a team of consultants can aid in preserving emotionless and unbiased evaluation of the potential team members.
Capitalizing from the most important revenue synergy, cross- and upselling requires a thorough analysis of the served customer spectrum as well as the industry and market dynamics. A deep understanding of the company’s product portfolio and their end customers as well as macro trends and trends within their sales channels which may impact their requirements. Furthermore, a detailed analysis of the newly combined product portfolio needs to be prepared, paying special attention to products which complement each other and suit the current customer needs and industry trends.
Summarizing, the acquirer is required to perform a detailed market intelligence to understand industry trends, as well as a product and product category analysis on SKU basis. This process may take up larger periods of time, which should be used to focus on the integration of core functionalities and the capitalization from cost synergies. Consequentially, it would be logical to consult experts and focus on the more operative part of the post-merger integration.
Both financial synergies and management synergies represent special cases regarding their “capitalization strategies.” As far as financial synergies are concerned, they do not require a specific capitalization strategy as they are generally realized on the accounting side of the company. Consequentially, the financial synergies should easily be capitalized based on a proper financial and tax due diligence. Management synergies on the other hand can only be planned to a certain extend. The elimination of redundancies can be anticipated, and a new organizational chart can be prepared ahead of the integration process specifying the new management. However, management performance is dependent on individuals rather than on strategic planning and well-designed processes, which makes management synergies the most complex to capitalize, as stated before.
Overall, the post-merger integration process is largely concerned with the monitoring and the harmonization of organizational processes and departments. Furthermore, it aims at capitalizing the previously identified synergies in the realms of costs, revenues management and financials. To capitalize from previously identified synergies, the integrator requires in depth knowledge about processes, products and industry trends and needs to monitor the situation closely. Seeking help from a professional advisory firm, which will accompany the post-merger integration process and will focus on materializing synergies is recommended.
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Markus Fost, MBA, is an expert in e-commerce, online business models and digital transformation, with broad experience in the fields of strategy, organisation, corporate finance and operational restructuring.Learn more
Antonio Adriano Lucà, MLB, has collected valuable experience with M&A transactions from both an advisory perspective, through his consulting and investment banking experience, as well as from an investor’s perspective.Learn more