Synergies
M&A / Merger ModelThe value created by combining two businesses that neither could produce alone, split into cost and revenue.
Also written: synergy
Synergies are the entire justification for paying a premium. If the combined business is worth no more than the two parts separately, the acquirer has simply transferred value to the target's shareholders.
Cost synergies come from removing duplication and are the credible half: one head office, one finance function, consolidated procurement. Revenue synergies come from selling more together, usually cross selling, and are treated far more sceptically because they depend on customers behaving as hoped.
Valuing them properly means taxing them, capitalising the recurring ones at the cost of capital, and subtracting the one off integration costs needed to achieve them. Skipping any of those three overstates the case.
The test that decides whether a deal creates value is whether the net synergy value exceeds the premium paid. The premium is certain and immediate; the synergies are uncertain and in the future.