# Synergy

Buying a company is and investment, so basic investment principles could be applied. To evaluate a merger or acquisition it is necessary:

1.Defining the cost and profits of both companies correctly.

2.Considering specific information related to law, taxes or accountability, that in the acquisition of a normal asset is not required.

3.Especially in hostile acquisition, it is necessary defined the strategy to achieve the buy.

4.Understand why mergers happens, and who win or lose from them.

The main objective of any merger or acquisition is synergy.

## Definition of Synergy

Synergy could be defined as the interaction between parts which achieve an effect bigger than the sum between the individual parts.

It could be explained by the expression:

2+2 ≠ 4

It means that the result could be bigger that the sum of individual parts. There are two possible situations:

Positives synergies

Positives synergies imply that the final value is bigger than the sum of the individual parts. It correspond to right mergers.

Negative synergies

Negative synergies imply that the final value is smaller than the sum of the individual parts. It correspond to unfavorable mergers.

Synergy’s sources can be organized in the following categories: Improve in revenues, Reduction in costs, Reduction in taxes, Reduction in cost of capital.

To be able to make the right decision about accomplish or not a merger or acquisition it is necessary calculate the synergy which will be generated. It is important considering that part of the synergy will be payed to the stockholders of the acquired company as bonus. If the bonus is larger than the synergy the merger or acquisition is doomed to failure.

Lets consider that company A is interested in buying company B, being:

$PV_A$ and $PV_B$: Values of companies A and B individually.

\$latexPV_{AB} &s=2\$: Value of the merger company.

In this situation, the profit can be calculated as:

$Profit = PV_{AB} - (PV_A + PV_B)$

But the acquisition cost should be also considered. It can be calculated as:

$Acquisition Cost = Payment - PV_B$

Considering the Acquisition profit and cost it is possible to obtain the Net Present Value:

$NPV = Profit - cost =$

$= [PV_{AB} - (PV_A + PV_B)] - [Payment - PV_B]$

As usually, if NPV is positive the acquisition should be accomplished and otherwise it should not be accomplished.

## Example

Consider that company A has a value of 220 million euros and company B a value of 55 millions euros. It is suppose that the merger between this two companies will let reduce the costs, saving 30 million euros in terms of present value. If B is bought by 70 millions euros, calculate the profit, the cost and the NPV. It is a profitable investment for A?

### Solution.-

$PV_{AB} = PV_A + PV_B + Saved cost = 220 + 55 + 30 = 305$

$Profit = PV_{AB} - (PV_A + PV_B) = 305 - 220 - 55 = 30$

$Cost = Payment - PV_B = 70 - 55 =15$

$NPV = Profit - Cost = 30 - 15 = 15$ million euros

It could be said that company A stockholder obtain 10 million € with the merger, lets proof it:

Company A pays 70 millions to obtaining a company with a value of 305.

The NPV can be also obtained subtracting what they pay and the original company’s value to the new company value:

$NPV = PV_{AB} - payment - PV_A = 305 - 70 -200 =15$ million euros