Fool’s Gold

Acquirers seeking synergies would do well to shrink their expectations.

Kmart and Sears were being conservative last November, they said, when they predicted a half-billion dollars of revenue and cost synergies within three years of their merger’s completion. Last month Oracle was preparing a detailed synergy estimate for its combination with PeopleSoft — which itself predicted synergies of between $167 million and $207 million from buying J.D. Edwards a couple of years earlier. And in 2004, General Electric projected $400 million to $500 million in synergies from combining its NBC unit with Vivendi Universal’s entertainment assets.

These deals might indeed make their synergy numbers. Then again, they might not. A recent McKinsey & Co. study finds that 70 percent of mergers fall short when it comes to achieving their targets for revenue synergies, while 40 percent lead to cost-synergy disappointments. And occasionally, of course, deals enter the realm of dis-synergy disasters — the classic being AOL/Time Warner’s $106 billion merger in 2001. That $1 billion synergy play, considered the 20th century’s biggest, had resulted in $99 billion of write-downs by January 2003.

Why do companies miscalculate so often? In the case of revenue synergies — top-line enhancements beyond the simple addition of two companies’ sales — McKinsey says typical reasons include unexpectedly high customer-defection levels, poor assumptions about market growth and competitive realities, and overly optimistic prospects for cross selling opportunities in a deal’s wake.

“Mergers are tough,” says Diane Sias, leader of McKinsey’s Americas postmerger management practice and co-author of the study. Synergy projections are often rushed. “It’s not until the merger is closed that you get access to all the data,” she notes, and by the time “you can have a good ‘think’ about it, you’ve changed everything for all the employees in both companies, and you have to make sure those people don’t walk out the door.”

The McKinsey study recommends that acquirers reduce their revenue synergy projections to reflect their lack of predictability, and suggests that companies avoid making “simplistic and optimistic assumptions about how long it will take to capture synergies and sustain them.” Bad assumptions make cash-flow accretion and other deal metrics look unrealistically positive, it says, “leading to substantial overestimates of synergy net present value.”

If acquirers do better at estimating cost synergies — from combining systems or operations, including through layoffs — their mistakes still can have a severe impact. The estimation of one-time costs often gets short shrift during due diligence, Sias says, and the merger’s impact on pricing and postmerger market share may not be adequately examined. And afterwards, acquirers are usually unwilling to face the reality of how much a merger disrupted business, how cost-reduction efforts eroded the customer base, or how wishful thinking might have governed the projections. Banking mergers represent an obvious case, where any talk about customer defections is avoided. But in other industries, too, says Sias, acquirers seeking historic synergy examples may find “only two or three good precedents.”

Trust the Business Sectors

What about just not projecting revenue synergies at all? That would be difficult in a world where acquirers often have to justify their offering price to investors.

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