The Winner’s Curse

When prospective acquirers evaluate an acquisition, their foremost focus is on the strategic logic of proposed combinations and on the potential social and regulatory consequences. Beyond the strategic logic, acquirers also study deeply into the valuation gains arising from a combination.

• How much can an acquirer pay for an asset while still creating value for its shareholders?
• What price is likely to persuade the acquisition partner to agree to a transaction?

The transaction price that is settled between the two parties depends largely on the synergies created from the combination. In today’s environment, the sources for value creation are mainly through

• Revenue Synergies; where the combined entity is able to generate more revenues than each of them did individually.
• Cost Synergies; savings in the costs and expenses of the combined entity.
• Financial Synergies; Financial synergies arise from the combined entity’s increased size, greater efficiency, diversification, and improved economies of scale. They include

(1) the lower cost of capital achieved due to a better credit profile/rating (2) easier and greater access to bank capital, (3) certainty of access to capital markets, and (4) improved tax efficiency. Having a larger scale and market share is not always advantageous, though. It may be difficult to manage a more diversified business as the focus of the management will be spread out to various priorities instead of a single line of business. Different types of Mergers that lead to the creation of synergies: Horizontal Merger

• Two Businesses operating in the same industry join together.
• An attempt to lower costs and increase efficiency.
• For example, Coca-Cola decides to merge with PepsiCo.

Vertical Merger

• Two companies representing different levels in a buyer-seller relationship join forces.
• For example, Internet provider America Online (AOL) combined with Time Warner which supplies content to consumers through their channels like CNN and Time Magazine, while AOL distributed such information through its internet service.

Conglomerate Merger

• Two companies having nothing in common decide to pool resources together.
• For Example, Procter & Gamble, a consumer goods company, engaged in a merger with Gillette.

Reverse Merger/Takeover

• When a private company acquires a public company, avoiding the hassles of going through an IPO.
• A private company installs its own management and takes all required steps to maintain a public listing.
• For example, digital device-maker Handheld Entertainment purchased Vika Corp in 2006, creating the company known as ZVUE.

While financial synergies are usually seen as a merger benefit, there are many factors that negatively affect merger decisions. Sometimes, acquirers getting a unique chance that may result in beneficial financial synergies are hesitant to undertake large transactions. Financial synergies thus play a significant role in the creation of value through such deals. “Seems that when two companies marry for the right business reasons, other good things often have a way of falling into place.” -Taqdeer Kaur