Damodaran on Valuation

15.6. CONCLUSION

Often promised and seldom delivered is perhaps the most apt way of describing synergy in most acquisitions. There is potential for synergy in many mergers, be it operating or financial. In this chapter, we began by looking at the sources of synergy and how best to value each one. In general, operating synergies manifest themselves as higher cash flows, while financial synergies can affect both cash flows and discount rates. To value synergy, both the acquiring and target firms have to be valued independently first, and the sum of these values can be compared to the value of the combined firm (with the synergy benefits built in) to estimate the value gain from synergy.

While there is some evidence of synergy in the aggregate across all acquisitions, most mergers fail in delivering any synergy. Even if we accept the fact that there is value to synergy, acquiring firm stockholders get almost none of the benefits of the increased value; in fact, they overpay for synergy in most acquisitions. We attribute this overpayment to a number of factors including managerial hubris, bias in the estimation process, and a failure to plan for synergy. We closed the chapter by considering how best to improve the odds on delivering synergy and some common errors in the valuation of synergy.