Financial Synergy

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21 Aug, 2024

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Financial synergy in mergers and acquisitions (M&A) refers to the positive financial benefits that result when two companies combine to operate together. When these companies merge or form a partnership, they are likely to achieve greater financial efficiency and performance together than they did separately.

It seeks to enhance shareholder wealth by improving the financial performance of the merged or acquired companies. It can increase stock prices, dividends, or other shareholder returns. M&A transactions driven by financial synergy aim to position the company strategically within its industry, making it more competitive and resilient in the long term.

Financial synergy Meaning

Financial synergy refers to the positive financial benefits resulting from combining two companies.
It is a key driver behind many M&A transactions as companies aim to enhance their financial performance and create value through strategic combinations.
It involves strategically aligning merged entities to optimize operations, streamline resource allocation, and enhance financial efficiency, facilitating goal achievement beyond individual capabilities.
Financial synergy primarily deals with enhancing the financial aspects of a merged entity. In contrast, operational synergy focuses on improving the day-to-day operations to achieve cost savings, revenue growth, and overall operational efficiency.

Financial Synergy Explained

Financial synergy, in the context of mergers and acquisitions (M&A), refers to the positive financial benefits that arise when two companies combine, creating a new entity whose financial performance is superior to that of the individual companies when they operate separately.

Assessing financial synergy in M&A adheres to the following equation:

Value of merged companies > value of individual companies

This formula signifies that two merged companies' combined value or financial performance should be greater than the sum of their individual values or performances.

Financial synergy primarily arises from improvements in financial activities, particularly in the management of capital and financial resources, including:

Cost of Capital Reduction: Merged entities can achieve financial synergy by reducing their cost of capital. It can result from a larger asset base, improved creditworthiness, or better debt and equity financing access. Lowering the cost of capital can lead to decreased interest expenses on debt and increased shareholder returns.
Tax Benefits: M&A transactions may yield tax benefits, such as utilizing tax loss carryforwards or tax credits from one company to offset the tax liabilities of the combined entity. It can reduce the overall tax burden and increase after-tax profits.
Improved Liquidity: Merged companies may have better access to liquidity, allowing them to manage working capital more efficiently, invest in growth opportunities, and meet financial obligations more efficiently.

This explanation provides a clear and focused overview of financial synergy in M&A, emphasizing its significance and how it is achieved through financial improvements without delving into operational aspects.

Examples

Let us look at the financial synergy examples to understand the concept better.

Example #1

Consider a merger between a technology company (Company X) and a financial services firm (Company Y). After the merger, Company X gains access to Company Y's extensive customer base and financial expertise. It allows Company X to offer its technology products to a broader audience, leading to increased revenue.

Additionally, the combined entity's improved financial stability and diversified business model make it a more attractive prospect for investors, resulting in lower borrowing costs and improved access to capital markets. As a result, the merger generates significant financial synergy by boosting revenue, reducing financing expenses, and strengthening the overall financial position of the merged company.

Example #2

Facebook's acquisition of WhatsApp for $21.8 billion in 2014 was driven by the potential for vertical integration and the strategic value of gaining access to WhatsApp's massive user base. Despite WhatsApp reporting a net loss at the time, Facebook recognized the long-term value of bringing together social networking and mobile messaging, which has since become a pivotal part of Facebook's broader ecosystem. This acquisition is a prime example of companies willing to invest heavily in M&A transactions to secure future growth opportunities and synergies in the evolving digital landscape.

Example #3

TotallyMoney, a FinTech company serving over five million UK consumers, has partnered with Bud Financial to enhance financial services. They utilize Bud's AI-driven platform and open banking data to empower consumers with comprehensive financial insights. The partnership focuses on proactive financial management and credit score improvement.

By integrating real-time open banking data, TotallyMoney provides predictive insights and proactive bill tracking, helping users manage ongoing and future payments. Bud's AI analyzes 12-month banking data to identify recurring payments and offer insights for better financial planning. This service is provided for free to TotallyMoney's customers.

The collaboration streamlines loan application processing, with 75% of applications processed in 15 minutes or less. It addresses the financial inclusion gap and enables lenders to assess eligibility more effectively.

Benefits

The benefits of financial synergy are as follows -

Cost reduction: Financial synergy often results in cost savings through eliminating duplicate functions, streamlining operations, and economies of scale. It can lead to lower overhead, production, and administrative expenses.
Increased profitability: By combining resources and optimizing operations, merged entities can achieve higher profitability. It may result from improved pricing strategies, cost efficiencies, and revenue growth.
Enhanced access to capital: A merged company typically has improved access to financial resources, including debt financing, equity investments, or more favorable lending terms. It can support expansion plans and strategic initiatives.
Tax benefits: Mergers can provide tax advantages, such as utilizing tax loss carryforwards or tax credits to offset taxable income, reducing the overall tax burden.
Improved creditworthiness: Merged companies may enjoy an improved credit profile, making it easier to secure credit lines or issue bonds. It can be crucial for ongoing operations and investment in growth opportunities.
Risk mitigation: Expanding into different business lines or geographic markets can reduce exposure to risks linked to economic downturns or industry-specific obstacles.

Financial Synergy vs Operating Synergy

These two forms of synergy represent distinct approaches to creating value when organizations come together. This comparison table will delve into the key characteristics that set them apart.

Basis	Financial Synergy	Operational Synergy
Nature of synergy	This type of synergy focuses on improving the financial aspects of the merged entity, such as its cost of capital, access to financing, and overall financial performance.	Operational synergy aims to enhance the efficiency and effectiveness of the merged company's day-to-day activities, resulting in cost savings, increased productivity, and revenue growth.
Focus Area	It concentrates on financial activities, including capital management, financing, and tax optimization.	It concentrates on improving the operational functions of the business, such as production, supply chain, distribution, and customer service.

Frequently Asked Questions (FAQs)

1. How do you calculate financial synergy?

Financial synergy in mergers and acquisitions (M&A) is often calculated using the equation Synergy = NPV (Net Present Value) + P (premium). When Company A acquires Company B to create a new entity, Company C, the synergy resulting from the acquisition equals the excess value of Company C over the combined individual values of Company A and Company B.

2. What is the difference between financial synergy and revenue synergy?

Financial synergy primarily aims to enhance the financial aspects of a merger, while revenue synergy focuses on increasing sales and revenue. Both types of synergy can contribute to the success of an M&A deal, but they employ different strategies and approaches to achieve their respective objectives.

3. What are the different types of financial synergies?

Financial synergies in mergers and acquisitions can take various forms. The primary types include cost savings through economies of scale, improved access to capital and financing options, enhanced tax benefits, and increased profitability through optimized operations and pricing strategies. These synergies are sought to maximize the financial benefits of combining two entities in an M&A transaction.