Preparing management for synergy announcements
October 12, 2018
A robust, detailed synergy case is fundamental to identifying acquisition value pre deal, and delivering synergies quickly post deal. For some deals it’s mandatory that this be publically reported upon, but there are practical difficulties. We believe these are best overcome by a staged approach. Typically we would approach the pre deal synergy case in three phases - an early phase data gather and estimate by the deal team; a second phase 6-8 weeks before announcement built as bottom up as possible by functional and business heads; and then a final phase to build a robust bottom up with more access to target management. Post signing, the real work of detailed integration planning and execution should start straight away.
In 2013, the Takeover Panel updated the City Code on Takeovers and Mergers. One change was rule 28, which widened the requirement for publically reported Quantified Financial Benefits Statements (QFBS) beyond hostile bids. Rule 28 requires that projected synergy savings announced, and associated phasing and costs, have an extremely high level of certainty. We often liken it to the “beyond reasonable doubt” test used in criminal law, as compared to the “balance of probabilities” test used in civil law.
That high degree of certainty can only be achieved through a robust synergy case with all the core aspects (see below) thought through in detail, or the application of significant contingencies (see the website and brochure for our methodology). But significant contingencies lower the number that can be announced and dilute the desirability of the deal as well as potentially impacting the negotiation strategy.
An implication of leaving synergy assessments (and consequently the independent review) until late in a process could be that this leads to a higher required contingency than planned and thus a lower announced number, with the risk that a competitor joins the bid process because they think they can “announce better” to the market.
Figure 1: Core aspects of a synergy case – a summary of rule 28 which requires various elements for a QFBS, outlined in Fig.1
Nevertheless we have found that only a few weeks before announcement, companies can sometimes have a synergy case that requires a lot of work to get to high robustness – or a lot of contingency.
1. The deal rationale is not cost savings
One reason is materiality of the synergies in the deal. The main driver of some deals is not cost synergies, but more strategic or transformative in order to access new customers, markets, products, services or talent. Other drivers include increasing market share or to accommodate diversification strategies. As an illustration, around a third of recent deals (five of 13 since start 2017) announced synergies in single digits of combined EBITDA. So, not unreasonably, the main focus of work is on diligencing and planning for other aspects, and the cost synergy plan is left until late in the process.
However, the flip side of this is that around two thirds of recent deals had synergies in double digits vs the aggregated businesses EBITDA, with the highest announced since start 2017 being 40% and the average 18%. Those synergies, even for the single digit minority, are robust independently reviewed cost synergies, the majority of which fall within the next two years, so they are the bankable benefit that underpins the takeover premium paid with shareholders and debt providers.
2. A good understanding of the takeover code is needed
Another reason for lack of robust planning is not understanding the UK Takeover Code. The rules apply to UK registered targets – but many buyers (over a third since start 2017) are not UK corporations, and even the UK corporations have often not done a deal that falls under the code. The UK rules are much more stringent than many other stock markets in the USA, Europe and Asia.
3. Practicalities need to be addressed
Limited access to information – Rule 21.3 of the Takeover Code says that “Any information given to one offeror or potential offeror, whether publicly identified or not, must, on request, be given equally and promptly to another offeror or bona fide potential offeror even if that other offeror is less welcome.” For this reason, targets often choose to restrict the data that they can share with a buyer, even for a friendly merger. So baselining and building the synergy case bottom up is a challenge, at least until near the end of the process when a buyer sometimes shares more detailed data.
Availability of operational expertise – in an ideal world, the people involved in the detailed integration planning would be the department and functional senior management who will run the acquired business post deal, who understand the nuts and bolts of their part of the business, and will be accountable for delivering the plan. But the future management structure is often not known or communicated pre deal, and it is difficult to inside too many of management until very late on lest the deal leak.
Underestimation of work required – significant effort and dedicated resources are needed to build a robustly baselined, detailed, bottom up synergy estimate. The effort involved is often underestimated, meaning that the work starts too late and builds a plan of insufficient detail. Even when the effort needed is well understood, modern lean organisations often simply don’t have enough staff with the analytical capabilities and strategic knowledge available.
So what do we suggest?
Clearly the lack of understanding of the code requirements is something that can be easily overcome by early preparation and discussions with advisors such as ourselves who understand and have practical experience of the code.
On the synergy case preparation itself, we advocate a staged approach. This approach and timelines can vary depending on the circumstances. A typical approach we have used successfully is:
Early phase: At this stage, target baseline data is unlikely to be available beyond statutory financials, and only a very small team is insided. That team estimates the baseline, interpolating from the stats and using their own baseline as a proxy. High level integration principles, assumptions and synergy areas are identified, and the benefit, costs and phasing in each area estimated top down using benchmarks. Other information will be required by the reporting accountants, such as evidence of track record.
Phase 2: Once a deal looks likely, with 6-8 weeks to go before signing, some data is forthcoming from the target, and some business/functional heads are insided. They build a synergy case bottom up, making assumptions as necessary (such as target operating model, details around the cost base or technology platforms). This exercise helps crystalise what data and assumptions are vital to finalise in the next stage.
Final phase: At this stage, with 4-6 weeks to go, some contact is made with department/functional management at the target, more management on the buyer side are insided, key assumptions are tested and key data clarified. This allows a bottom up case to be built by management who understand the details, will be accountable for delivery and that will pass the robustness tests of the QFBS.
And after signing the real work starts to realise deal value…
Of course, the reason for producing a detailed and robust synergy case is not mainly compliance. Pricing in the current market is high and on top of that it is often necessary to pay a significant takeover premium. So to ensure shareholder value is enhanced and not diluted, significant synergies have to be delivered without damaging the underlying performance of the business. That requires a robust integration plan and a methodology for creating and protecting value. However, the work doesn’t stop at signing. Once the deal is announced, we advocate a rapid discovery period to validate assumptions and address gaps in due diligence. Further detailing and more iterations of the integration plan is required so that the combined management team can validate the synergy case, create buy-in from key personnel from both parties and thus move quickly to execution.
Once a deal is signed, the work doesn't stop - our early insights from a M&A research report we are writing with Mergermarket has indicated that globally 52% of acquirers are underperforming their industry benchmark 24 months after completion, highlighting the importance of the synergy case. The report will be released soon - sign up here to receive it on its release.