Damodaran on Valuation

15.2. VALUING SYNERGY

The key question about synergy is not whether it can be valued but how it should be valued. After all, firms that are willing to pay large amounts for synergy have to be able to estimate a value for that synergy. In this section, we consider how best to value different types of synergy and the sensitivity of this value to various assumptions.

15.2.1. Valuing Operating Synergies

There is a potential for operating synergy, in one form or another, in many takeovers. Some disagreement exists, however, over whether synergy can be valued and, if so, what that value should be. One school of thought argues that synergy is too nebulous to be valued and that any systematic attempt to do so requires so many assumptions that it is pointless. If this is true, a firm should not be willing to pay large premiums for synergy if it cannot attach a value to it. The other school of thought is that we have to make our best estimate of how much value synergy will create in any acquisition before we decide how much to pay for it, even though it requires assumptions about an uncertain future. We come down firmly on the side of the second school.

Although valuing synergy requires us to make assumptions about future cash flows and growth, the lack of precision in the process does not mean we cannot obtain a reasonable estimate of value. Thus we maintain that synergy can be valued by answering two fundamental questions.

1. What form is the synergy expected to take? Will it reduce costs ...