Damodaran on Valuation

Chapter 15. The Value of Synergy

When Carly Fiorina argued for Hewlett-Packard's acquisition of Compaq, she offered a number of reasons the deal made sense. She noted that the combined company would be able to meet the demands of customers for "solutions capability on a truly global basis." She also claimed that the firm would be able to lead with its products "from top to bottom, from low end to high end." As her crowning argument, she claimed that the merger made sense because it would create "synergies that are compelling."

Synergy, the increase in value that is generated by combining two entities to create a new and more valuable entity, is the magic ingredient that allows acquirers to pay billions of dollars in premiums in acquisitions. It is true that investors have historically taken a jaundiced view of synergy, in terms of both its existence and its value, and the track record on the delivery of synergy suggests that they have good reason for skepticism. In this chapter, we begin by considering potential sources of synergy and how best to value each of them. We then also examine the problems that analysts often face in valuing synergy and why acquirers often fail to deliver the synergy that they promised at the time of the acquisition.