Shareholders of publicly traded companies often have to approve a merger or acquisition before it is consummated. That should be a meaningful check on a company’s management and board, but shareholders frequently rubber-stamp what management decides, failing to question which bid is superior and even whether a merger makes sense at all.
Currently the shareholders of NYSE Euronext have an opportunity to cross-examine management about the proposed merger of the stock exchange’s parent with Deutsche Boerse. Deutsche Boerse values NYSE Euronext at $10.2 billion, well under the competing $11.3 billion bid from Nasdaq OMX Group and IntercontinentalExchange. But NYSE Euronext’s management has rejected the Nasdaq/ICE bid twice, and as a result, Nasdaq and ICE are taking their offer directly to shareholders.
What should shareholders demand to know about the proposed deal? Below are five basic questions that should be posed about this merger — and about any potential merger, for that matter. They stem from a 2005 paper called “The Value of Synergy” by Aswath Damodaran, professor of finance at New York University’s Stern School of Business and author of numerous books on corporate finance and valuation.
1. What are the real synergies arising from the firms’ combination?
Managements often justify large transactions by citing operating and financial synergies, but in his 2005 paper, Damodaran describes synergies as “often promised and seldom delivered.” To have an effect on value, according to him, synergy has to affect one of four inputs into valuation: higher cash flows from existing assets, higher expected growth rates, a longer growth period, or a lower cost of capital.
While the NYSE Euronext deal could lead to economies of scale and increased market power, there are more dubious synergies that stakeholders should cast a cold eye on. For example, the NYSE and Deutsche Boerse are touting the merger as diversifying the revenue stream of the New York Stock Exchange, by bringing it into the market for high-margin, fast-growing derivatives. That’s good, but in and of itself that diversification will not have any effect on the combined value of the two firms, at least in situations where the firms are publicly traded and have diversified investors. (Indeed, in times of relatively normal economic growth, markets become pessimistic about the ability of highly diversified companies to deliver robust shareholder returns, applying a so-called diversification discount.)
Likewise, some operating synergies, like claims of better growth prospects, are hard to value and envision preacquisition. A combined firm may be able to earn higher returns on its investments, find more investments than the two firms could independently, or maintain high returns for a longer period, but that can be hard to prove before the merger.
2. What is the actual value of the proposed cost savings?
Cost synergies are the easiest of all operating synergies to model, says Damodaran. That’s probably why Deutsche Boerse and NYSE Euronext were able to quickly find an extra 100 euros in projected cost-savings when the number put forth by Nasdaq/ICE surpassed theirs. Acquirers also have a better chance of delivering cost cuts because they are concrete and may have “explicit mechanisms for follow-up and monitoring,” according to Damodaran.