Synergy

Synergy

Akshitha B Raj1MS10MBA07

What is synergy?Synergy is a stated motive in many mergers and acquisitions.

If synergy is perceived to exist, the market value of the combined firm, after a merger announcement, should be greater than the sum of the market values of the bidding and target firms(standalone), prior to that same announcement.

Where :V(AB) = Value of a firm created by combining A and BV(A) = Value of firm A, operating independentlyV(B) = Value of firm B, operating independently

V(AB) > V(A) + V(B)

What is synergy?Popular definition: 1 + 1 > 2

Roundabout definition: If am I willing to pay 6 for a business market-valued at 5 there has to be the synergy

justifying the same.

More technical definition: Synergy is ability of merged company to generate

higher shareholders wealth than the standalone entities.

Potential sources of synergy from mergers and acquisitions:

Increased revenues may result from: Increased market (monopoly) power Better or more efficient marketing efforts Strategic benefits such as entry into new markets

Decreased operating costs may arise from: Economies of scale Economies of scope Complementary resources Elimination of operating or management inefficiencies

Increased growth rate

Types of synergy

Manufacturing synergy Operations

synergy

Marketingsynergy

Financial synergy Tax synergy

The value of synergy in three steps:

1. • First, we value the firms involved in the merger independently, by discounting expected cash flows to each firm at the weighted average cost of capital for that firm.

2. • Second, we estimate the value of the combined firm, with no synergy, by adding the values obtained for each firm in the first step.

3. • Third, we build in the effects of synergy into expected growth rates and cash flows and we revalue the combined firm with synergy.

The difference between the value of the combined firm with synergy and the value of the combined firm without synergy

provides a value for synergy.

CASE STUDYP & G + The Gillette Company

P & G MNC catering to the consumer goods industry.

Established in 1837 by William Procter & James Gamble.

Fortune 500 companies

5th most admirable company

Headquartered in Downtown Cincinnati, OHIO ,USA

Serve more than 180 countries. Operations in 80 countries.

Four billion times a day, P&G brands touch the lives of people around the world

Some of their familiar & well known brands are : Covergirl, Dawn,Ariel,Herbal essences, Head & shoulders , Olay, Wella ,Pringles, Pampers, D & G fragrances…and the list goes on…!

The Gillette Company The original Gillette Company was founded by King camp

Gillette in 1895 as a safety razor manufacturer.

Based in Boston , Massachusetts ,USA

A leading global supplier of products under various brands, which was merged into P&G in 2005.

 In addition to Gillette, the company marketed under Braun, Duracell and Oral-B, among others, have also been

maintained by P&G today.

Today, Gillette is a brand of Procter & Gamble currently used for safety razors , among other personal care products.

P & G + The Gillette Company

In January 2005 P&G announced an acquisition of Gillette, forming the largest consumer goods company and placing Unilever into second place.

This added brands such as Gillette razors, Duracell, Braun, and Oral-B to their stable.

The acquisition was approved by the European Union and the Federal Trade Commission, with conditions to a spinoff of certain overlapping brands.

On January 28, 2005, Cincinnati-based P&G announced its investment deal to acquire Boston-based Gillette for

$57 billion.

According to the deal, P&G agreed to pay 0.975 for each share of Gillette.

P & G + The Gillette Company

The annual sales of the combined entity would

be $60.7 billion. (82.6)

After its purchase of Gillette, P&G would have 21 billion-dollar brands-sales with a market capitalization of $200billion.(24)

P&G agreed to pay Gillette 40% in cash and the rest 60% in stock.

P & G + The Gillette Company

On October 1, 2005, Procter & Gamble finalized its merger with The Gillette Company.

The merger created the world's largest personal care and household products company. 

The Gillette Company's assets were initially incorporated into a P&G unit known internally as "Global Gillette". In July 2007, Global Gillette was dissolved and incorporated into Procter & Gamble's other two main divisions, Procter & Gamble Beauty & Grooming and Procter & Gamble Household Care. Gillette's brands and products were divided between the two accordingly.

Synergy arising from

Boy meets girl hook up! (Wharton analysts).

The wedding of these two successful firms also has a marketing rationale.

P & G5.5 billion $ Gillette1 billion $

Will give the combined firm more power to negotiate advantageous deals with media companies.

The deal would give the company even more control over shelf space at the nation's retailers and grocers .

The combined firm will be able to grow faster than separately, with

P&G opening doors for Gillette in markets such as China and Japan while Gillette bringing P&G some product segments that are growing faster than the company's overall current portfolio of products.

Synergy arising from

A marriage made in heaven—and in the bathroom! (The economist).

Whereas cultural differences have wrecked many past mergers, especially cross-border ones, such problems are less likely in this case, given the relative proximity of the two firms’ headquarters.

"Both companies are focused on the consumer and continually trying to make improvements.“

(overcoming managerial inefficiencies)

Gillette may be able to teach P&G about marketing products with a recurring revenue stream.

Valuation of P & G (Standalone)

Year EBIT(1-t)

Reinvestment

FCFF TV PV [email protected]%

1 7632 (3053) 4579 42782 8201 (3280) 4920 42943 8812 (3525) 5287 43124 9469 (3787) 5681 43295 10174 (4070) 6105 4346Terminal 10607 (6412) 4194 4194/

(0.0703-0.0425)= 1,50,864

1,07,413

Value of P & G 1,28,972

Valuation of Gillette (Standalone)

Year EBIT(1-t) Reinvestment

FCFF TV PV [email protected]%

1 1859 (929) 929 8652 2010 (1005) 1005 8713 2173 (1087) 1087 8774 2350 (1175) 1175 8835 2541 (1270) 1270 889Terminal 2649 (1523) 1125 1125/

(0.0739-0.0425)= 35,828

25085

Value of Gillette

29,470

Value of combined firm with NO synergy

The value of the combined firm (P&G + Gillette), with no synergy, should be the sum of the values of the firms valued independently. Therefore , add the value of P&G to the value of Gillette to arrive at the value of the combined firm:

Value of P&G = $ 1,28,972 millionValue of Gillette = $ 29,470 millionValue of combined firm = $ 158,442 million

This would be the value of the combined firm in the absence of synergy.

Value of combined firm WITH synergy

Year EBIT(1-t) Reinvestment

FCFF TV PV [email protected]%

1 9670 (4056) 5613 52402 10445 (4386) 6069 52913 11305 (4742) 6563 53424 12223 (5128) 7096 53935 13216 (5544) 7672 5444Terminal 13216 (7704) 5510 5510/

(0.0710-0.0425)= 1,93,333

1,37,202

Value of P & G(with synergy)

1,63,912

Value of SYNERGY createdValue of combined firm (WITH synergy) = $ 1,63,912

million

Value of combined firm (with NO synergy) = $1,58,442 million

Value of Synergy = $ 5,490 million

Synergy arising from

The combined firm will achieve economies of scale, allowing it to increase its current after-tax operating margin.

A new and beneficial cost of capital for the firm

= 7.10% (7.03 P & G AND 7.39 Gillette).

As a result, the growth rate over the first 5 years will be

=8.02% (7.45 P & G AND 8.13 Gillette)

Quick fact…  The stadium was originally known as CMGI Field

before the naming rights were bought by Gillette after the "dot-com" bust. Although Gillette has since been acquired by Procter & Gamble, the stadium retains the Gillette name because P&G has continued to use the Gillette brand name and because the Gillette company was founded in the Boston area. 

2031

Why do bidders overpay for synergy? Biased Evaluation Process Managerial Hubris Failure to plan for synergy

Bibliography http://money.cnn.com/2005/01/28/news/fortune500/pg_gillette/

people.stern.nyu.edu/adamodar/pdfiles/papers/synergy.pdf

http://knowledge.wharton.upenn.edu/article.cfm?articleid=1135

nb.vse.cz/~pichanic/cesp363/synergy