Synergy Identification and Valuation Presented by Andy Sheats
How it fits together
Valuation
Income
Asset Market Valuation:
What’s it worth?
Synergy
Valuation
What’s it worth
TO ME?
• A clear strategy of what you want to accomplish
through the merger
• Detailed understanding of the target’s business
• Detailed knowledge of your own business
• A clear plan to knit the two together to create
value
• Quantification of the risk of total or partial failure
Bid Price +
Deal Structure
Key PMI
initiatives
Agenda
• What are Synergies?
• Corporate Strategy Example: homesite.com.au
• Business Strategy Example: Airline merger
• Tools of the Trade: Strategic DD = Value of Information
Three Motivations to Acquire
Business Strategy Corporate Strategy Investment Strategy
Improve the competitive
position of an existing
business
• Scale
• Assets
• Capabilities
• …
TPG/iiNet
“Link” multiple
businesses to create
synergies between them
• Scope
ATT/DirectTV
Buy Low, Sell High
Buying cheap
(ie. “undervalued”)
PE/Qantas?
Seeking Synergy
“Worth more to us than to the Seller”
Synergy -- Management links two or more
businesses together such that:
Revenue
Increases
Cost
Decreases
Every other synergy is a figment of your imagination
(“organizational synergy”, “knowledge synergy”, etc.)
Simplistic Example
Cost Synergy through Scale
Bob’s
Bakery
Pat’s
Patisserie
Merger
Synergy “NewCo”
# Customers 10 10 20
Rev/Customer $10 $10 $10
Revenue $100 $100 $200
Trucks 1 1
Scale benefit:
1 truck 1
Cost/Truck $110 $125
Lowest cost
in group $110
Opex $110 $125 $110
“Profit” ($10) ($25) $90
Assumption
• Excess capacity allows consolidation
• Bob’s is “good enough”
Simplistic Example
Revenue through Pricing Power
Bob’s
Bakery
Pat’s
Patisserie
Merger
Synergy “NewCo”
# Customers 10 10 20
Rev/Customer $10 $10 +10% $11
Revenue $100 $100 $220
Trucks 1 1 1
Cost/Truck $110 $125 $110
Opex $110 $125 $110
“Profit” ($10) ($25) $110
Assumption
• No other bakeries in the area
• Cost advantage of 20% over more distant players (petrol cost)
• Customer has 200% profit margin (WTP)
• Note: Be careful of ACCC issues
10
A structured “value driver model” is helpful in identifying
detailed synergy opportunities (every consulting firm has one)
Get a copy from D&T at : http://tinyurl.com/4q69ym
Deloitte Consulting Enterprise Value Map (EVM)
Agenda
• What are Synergies?
• Corporate Strategy Example: homesite.com.au
• Business Strategy Example
• Strategic DD = Value of Information
Corporate Strategy in one slide
AU
Core
Business
Technology Link
“We will only have to use
one data center to serve both
markets”
New
Country
Product Link
“We can sell our existing products into a new market with low incremental cost”
New
Product
Business
Market Link:
“We get 4 million people to our
website each month, and can
sell this to them with no
incremental cost”
Your Corporate Strategy Answers These Two Questions:
1) What businesses are you in?
2) How you build links between them to create synergies?
Porter 1985
13
Corporate Strategy Example:
Acquisition of Homesite.com.au
58% owned by News Corp Australia’s #1 Real Estate website
(4M UVs)
Advertisers
include RE
Agents,
Developers,
Mortgage
lenders, etc.
Refresher on realestate.com.au
Corporate Strategy Example:
Acquisition of Homesite.com.au
A JV between News Corp and
Home Industry Association
Australia’s #1 Home Renovation
Webite (400K UVs) Advertisers
that REA
does not
currently
serve
What We Knew
Corporate Strategy Example:
Acquisition of Homesite.com.au
What We Found Out
A JV between News Corp and
Home Industry Association
• News Corp driving the business
with little input from HIA
• News Corp funding losses, and
unhappy to continue without JV
partner stepping up
Advertisers that REA does not
currently serve
• Advertisers unhappy due to low
advertising conversion
• Many on free trials
Australia’s #1 Home
Renovation Webite (400K UVs)
• Losing money hand-over-fist
• No clear way to improve financials
• News Corp funding losses, and
unhappy to continue without JV
partner stepping up
$M
Advertisers 1.9$
Display Ads 0.1$
Revenue 2.0$
SEM 1.5$
Staffing 1.0$
Rent 0.4$
IT 0.4$
EBITDA 1.3 )($
Note: P&L is not actual company data, but is illustrative of case issues
So how do we find the synergies???
REA
Technology Link
“We will only have to use
one data center to serve both
markets”
HomeSite
Market Link
“4M people come to the site every month. We can use this traffic
to “feed” homesite, saving $2M pa in SEM”
Thomas 1986
18
Corporate Strategy Example:
Acquisition of Homesite.com.au
Integration with REA’s navigation
would drive more traffic, for “free”
Relevant “Content” presented well and “in
context” would improve user experience
for all REA visitors
Greater traffic
would
increase
value to
advertisers
(and
advertising
rates)
Integration Hypothesis
Broader
appeal would
support new
advertiser
types
I recommend using a structured review of a business’s key value
drivers to identify potential synergies
REVENUE SYNERGIES
Free
Cash
Flow
20% Listings Revenue Uplift as we
reach scale to “define the
marketplace for commercial
property in Australia”
• Pricing power with lift to traffic
• More advertisers
Cost of Inputs
• Cost of Traffic / Google SEM
Remove duplication
• G&A
• R&D
• Facilities
Rationalization of PP&E
• IT infrastructure (over time)
Homesite Illustrative P&L Synergies
$M Before Synergy After
Synergy
"DCF" Comment
Advertisers 1.9$ 20% 2.3$ 1.0$ Uplift with traffic increase
Display Ads 0.1$ 0.5$ 0.6$ 1.3$ New advertisers, more inventory
Revenue 2.0$ 2.9$
SEM 1.5$ 1.5 )($ -$ 3.9$ Cut SEM to nil
Staffing 1.0$ 0.1 )($ 0.9$ 0.3$ One Managent Role
Rent 0.4$ -$ 0.4$ Move to our office with no net savings
IT 0.4$ 0.1 )($ 0.3$ 0.3$ We can supply for less
EBITDA 1.3 )($ 1.3$
6.7$
BASE CASE SYNERGY P&L and VALUATION ($) Illustrative Example
Note: P&L is not actual company data, but is illustrative of case issues
P&L Impact
Basic Synergy Model
Optimistic Synergy Valuation
Stand Alone
Valuation
(“Value to Them”)
Potential Value
“Value to Us”
Potential
Value
Creation
BASE CASE DCF VALUATION ($)
Increase
Advertising
Rates
$1M
Display
Ads
$1.3M
SEM
Reduction
$3.9M
IT+Staffing
$0.6M
Note: P&L is not actual company data, but is illustrative of case issues
But how sure are we?
Isn’t this the “optimistic” case?
How do we deal with uncertainty in
whether we get them, and what they are
worth?
Dealing with uncertainty
Illustrative Example
Note: P&L is not actual company data, but is illustrative of case issues
$M Pessimistic Optimistic EV
Advertisers 20% 0.2$ 80% 1.0$ 0.83
Display Ads 10% 0.2$ 90% 1.3$ 1.19
SEM 25% 1.5$ 75% 3.9$ 3.29
Staffing 20% 0.3 )($ 80% 0.3$ 0.15
IT 10% 0.3 )($ 90% 0.3$ 0.20
Synergy Value 1.3$ 6.7$ 5.7$
Leakage Optimistic to Pessinistic 5.4 )($
Leakage Optimistic to Exected Value 1.0 )($
- 2.00 4.00 6.00 8.00
Advertisers
Display Ads
SEM
Staffing
IT
Total
SYNERGY DCF VALUATION SENSITIVITIES ($)
Basic Synergy Model
DCF VALUATION ($)
Potential Value Destruction
(“Leakage”)
(1.0M)
$5.7m
Negotiation
Range
“Value to Them” “Value to Us”
Optimistic Synergy Valuation
Agenda
• What are Synergies?
• Why Acquire Anyway
• Corporate Strategy Example: homesite.com.au
• Business Strategy Example
– Business Strategy on one slide
– Example: Commercial Property Sector
• Strategic DD = Value of Information
• Synergy Capture
A practical example of linking businesses
AU
Residential
Website in Australia
with real estate
classifieds
c. $100M in revenue
Mortgage Broking
Company in London with
c. GBP10M in revenue
A good move?
UK
Mortgage
Broking
A long time ago (1991) Geoffrey A. Moore made a bowling pin analogy for expanding into related
businesses
Moore 1991
This drives a path-dependent expansion into related businesses and markets that minimizes
risk at each step
AU
Residential
IR
Resi
UAE
Resi
NZ
Display
AU
Comm
UK
Display
UK
Mortgage
Broking
UK
Resi
NZ
Resi AU
Commercial
AU
Display
AU
Mortgage
Broking
AU
Renovate
Agenda
• What are Synergies?
• Why Acquire Anyway
• Corporate Strategy Example
• Business Strategy Example: Airline merger
• Strategic DD = Value of Information
Business Strategy Example:
Merger of Two Large Airlines
• Clients:
– Jointly engaged by the Boards of two large competing airlines
– Airline industry under extreme pressure (macro, competitive, … )
– Secretly considering a full merger
– Very contentious political and labour environment
• The Project:
– How would merger improve competitive position of the merged
business?
– Identify potential merger synergies
– Develop post-merger operating model
– Develop PMI plan to implement
• The Team:
– 10 consultants for 10 months
Business Strategy on One Slide
Market Selection Competitive Position
• What you can do?
(resource view of the firm)
• What you should do?
(value maximization)
• How you do it to beat competitors
How will this acquisition improve our competitive
position?
Airline Industry Challenges circa 2003
1. World events
2. Cost structure
3. Industry profitability
4. Asia-Pac industry changes
3. Industry Profitability: Sage Advice
“The worst sort of business is
one that grows rapidly, requires
significant capital…, and then
earns little or no money. Think
airlines.
…
If a farsighted capitalist had
been present at Kitty Hawk, he
would have done his successors
a huge favor by shooting Orville
down.”
— Warren Buffett, annual letter to
Berkshire Hathaway shareholders,
February 2008.
Investment in Airlines
“People who invest in aviation
are the biggest suckers in the
world.”
David G. Neeleman, after raising a
record $128 million to JetBlue Airways,
quoted in Business Week, 3 May 1999.
QF + SQ Merger
Generic Strategy for Airlines:
• Differentiation strategies: quality of service (seats, food, lounges);
routes, alliance programs, FF programs
• Cost: utilization (SWA), Scale, hedging strategies, low-cost labour pools,
outsourcing (variabilizing fixed costs)
• Focus: Geography (QF=AU), Leisure/Business, full service/LCC
How will this acquisition improve
competitive position?
(Hint: $Rev Up or $Cost Down Relatives to Competitors)
Sources of Value: Routes
Improved Aircraft Utilization
through on-flying
destinations
(cost down)
Combine latent capacity in
both Companies to enter
new markets ($ up)
Rationalize overlapping
routes to increase utilization
(cost down)
Sell onward flights to
“Newco” rather than
alliance partners – interline
leakage ($ up)
Sources of Value: OpEx Reduction
Flying
Baggage
Cargo
Holidays
Catering
Engineering/
Maintenance
Airline A
Flying
Baggage
Cargo
Holidays
Catering
Engineering/
Maintenance
Airline B
Corporate Corporate
SMASH!
1) Remove Duplication
2) Realize Scale
3) Lvg Best in Group
cost structure)
Flying
Baggage
Cargo
Holidays
Catering
Engineering/
Maintenance
Airline C
Corporate
Brand A Brand B
Corporate
Sources of Value: CapEx Reduction
Airline A Airline B
747 Jumbos 737 A320 747
A380’s
A380’s
SMASH! 1) Remove Duplication
2) Realize Scale
3) Lvg Best in Group
cost structure)
Sources of Value: CapEx Reduction
• Common Engineering
– Low-cost engineering units (location)
– Common spare parts (massive – engines
cost heaps)
– Scale in parts/service suppliers
• Common Facilities
– $500M to $1B per model
– Many of these currently under construction
(A380)
• Leverage with Boeing/Airbus
– Current orders/options
– Ongoing
– future
Airline C
A320 A380’s
Billions of dollars in CAPEX reduction
In the case of Airline mergers, synergies typically result from a
richer network that unlocks new revenue sources, and cost
reduction of overlapping and duplicate functions
Synergy
value
(NPV)
Cash
synergy
(run rate)
Sources of
merger
synergy
Airline value
drivers
Revenue
growth
Capture interline “leakage”
Combining passenger volume to increase frequencies in key markets
Open new destinations and increase routing possibilities
Operating
margin
improvement
Reduce duplication
Leverage scale benefits where appropriate
Migrate to best-in-group productivity where appropriate
Leverage best-in-group pricing for engineering, ground services, IT and
in other sourcing
Increase fleet commonality to decrease engineering
Reduced
tax rate (Potential corp tax rate changes)
Reduced
working capital Create scale benefits in spares/inventory pool
Reduced
CapEx
requirement
Increase fleet commonality to the extent possible:
Coordinate future CapEx for engineering
Create purchasing scale in aircraft purchase
Move to best-in-group aircraft purchase cost
Centralise and share engineering, simulation and training
Rationalise lounge CapEx
Reduced
cost of capital (Potential dual listing / migrated listing
NPAT
Improveme
nt
(run rate)
~50%
increase
Reduced
use of cash
to fund
operations
~2%
reduction
Outcomes Value
Billions of $
in value creation
Agenda
• What are Synergies?
• Why Acquire Anyway
• Corporate Strategy Example: homesite.com.au
• Business Strategy Example
• Tools of the Trade: Strategic DD = Value of Information
Value of Strategic DD = Value of information
• What’s it worth to know more about the target than anyone else?:
– Hidden value
– Turnaround action plan
– Company Risks & Turnaround Risks
• How it is typically done…
– Personal contacts at targets (developed over a long time)
– Conference hallways/starbucks
– Specialist firms (LEK is one, there are others)
Outcome of Strategic Due Diligence
• Highly informed “Go/No-go” decision
• Informed valuation : Public + non-public + industry knowledge
• Valuation checklist : Key deal attributed
• 100-day plan
The keys to capturing synergy value in an acquisition
1. Sound strategy
2. Sound rationale for acquisition
3. Sound synergy assumptions
– Tested against “the facts”
– Risk adjusted valuation
– Execution ownership (us/them)
4. Key elements of valuation maintained in deal execution
– The right price
– The right terms
5. Key synergy assumptions “baked into” post-merger integration
(PMI) plan
6. Governance in place through value capture