Expense Synergies in Merger Models

In this expense synergies lesson, you'll learn why expense synergies matter, what they consist of, how they impact M&A deals.
By breakingintowal... "Financial Modeling Training And Career Resources For Aspiring Investment Bankers"
You'll also learn and accretion / dilution, and 3 common mistakes that people make when incorporating synergies into models.
Table of Contents:
3:45 Example of Expense Synergies (Office Consolidation)
7:57 Oversight #1: More Granular Estimates / Checks
11:37 Oversight #2: It Takes Time to Realize Synergies
14:39 Oversight #3: It Takes Money to Realize Synergies
17:39 How Does All of This Impact the Deal, Accretion / (Dilution), and So On?
18:34 Recap and Summary
Why do Synergies matter? And what are they exactly?
Put simply, they're cases where 1 + 1 = 3 in mergers and acquisitions.
You combine 2 companies, and get MORE revenue than just the Buyer's revenue plus the Seller's revenue…or you get LESS in expenses than just the Buyer's expenses plus the Seller's expenses.
Revenue Synergies are tough to estimate and are very error-prone… but sometimes they matter and can be
calculated more precisely.
Expense Synergies are more grounded in reality, because you look at what both companies are spending and decide
what can be cut - at the very least, it's based on actual expenses incurred by both companies.
Synergies matter because some deals require synergies to look good on paper (i.e., be accretive).
And some deals are motivated primarily by synergies, such as this one with 2 very similar men's retailers merging.
BUT… a lot of people get it wrong in 3 main areas when it comes to expense synergies in merger models:
Oversight #1: More Granular Estimates / Checks
Lots of models - even very complex ones - will just say something like, "$100 million in synergies per year!"
This is NOT ideal.
It's better to break out the synergies by specific functional areas, if not by specific employee counts, building rents, anticipated discounts on inventory purchases, and so on.
In real life, as a banker, you don't really know enough to do this - need the input of both companies' CFOs and finance departments to make estimates.
Oversight #2: It Takes Time to Realize Synergies
No matter how evil the combined company is, it can't just take the "Death Star" approach and blow up entire divisions / buildings all at once… it takes time to realize synergies, even if you're simply laying off employees.
And something like consolidating buildings or inventory purchases / processes takes even more time.
Here: The company makes it easy in their investor presentation, since they give us the expected amounts that will be realized each year.
Oversight #3: It Takes Money to Realize Synergies
It's not just "free" to consolidate buildings or factories or shuffle people around… there are costs associated with all of that.
Often labeled "Restructuring Costs" or "Integration Costs" or similar names.
Could show up on the Income Statement or on the Cash Flow Statement or both… depends on the deal and
the type of expenses.
Here: The company makes it easy for us with its estimate of $100 million in Integration Costs "over the next 18 months" - so we allocate that over the first 2 years of the model.
How Does All of This Impact the Deal, Accretion / (Dilution), and So On?
If you factor in the time and money required, it always makes the deal less accretive or more dilutive… because it pushes the Combined Pre-Tax Income lower in earlier years due to:
a) Some percentage less than 100% of synergies will be there; and
b) CFS expenses will push down the company's debt repayment ability, thereby increasing interest expense from debt in the earlier years.
Extra Resources
youtube-breakin...

[@youstupidheadass]

i have a first round with gs in 3 days in the midst of finals and your humor is what's getting me through these long nights. great vid brian, you deserve more credit

[@financialmodeling]

+youstupidheadass Thanks for watching!

[@YHRA16]

I like the way to demonstrate the topics and Your Handicraft Models/Templates

[@financialmodeling]

Thanks for watching!

[@betteru2997]

So if a deal looks dilutive in the early years and accretive in the later years according to the model or vice versa, how does the buyer decide whether it is accretive or dilutive overall quantitively?

[@financialmodeling]

Accretion/dilution is usually only significant in the first few years. Longer term, the IRR vs. Discount Rate or valuation vs. asking price are more important.

[@persande8869]

Can you please upload the excel sheet as well? Love your work!!

[@financialmodeling]

+per sande This one is not available, unfortunately, though you can access the full case study inside our Financial Modeling Fundamentals course.

[@emos8232]

Brian,
Is it possible to make a video on M&A deal when a negative goodwill is created, and how to do the Purchase Price Allocation + the complications that will impact the IS and the BS?
10x

[@financialmodeling]

Thanks for your suggestion. Yes, that will be in an upcoming video. SHORT VERSION: You just record a Gain on the Income Statement in the amount of the negative Goodwill... but you never actually record negative Goodwill because it's not allowed, at least not under IFRS or US GAAP. So it's just a Gain that flows through to increase the company's Pre-Tax Income and Net Income and is then reversed as a non-cash charge on the CFS.

[@emos8232]

Mergers & Inquisitions / Breaking Into Wall Street Great, it will also be interesting how the negative Goodwill is allocated to the PP&E and whether the PP&E Step-down will affect the EPS numbers.

[@financialmodeling]

Emo S Negative Goodwill is never created or allocated to anything... you just record Goodwill of $0. US GAAP and IFRS do not allow negative Goodwill on the Balance Sheet. PP&E step-down is an entirely separate issue and related to the fair market value of PP&E, not the price paid to purchase the company vs. its common shareholders' equity.

[@emos8232]

Mergers & Inquisitions / Breaking Into Wall Street Thanks for the reply Brian. I think Negative Goodwill should be allocated to PP&E. As you said, you actually do not record Negative Goodwill on the BS, you record gain on IS but first you have to allocate the Negative Goodwill to PP&E (meaning Step-down of PP&E to their fair market value) and if any Negative Goodwill is left you record it as an extraordinary gain. www.wallstreetoasis.com/forums/negative-goodwill-question

[@financialmodeling]

Thanks for the link, but the way it's discussed there is not entirely true... you should be skeptical of message board discussions from 7 years ago before the accounting rules changed in a major way in 2008. The full tutorial will explain this in more detail.

[@taimoorali4822]

what's the difference between the EPS and pro forma EPS ?

[@financialmodeling]

ruclips.net/video/utYBy3eB8lk/видео.html

[@taimoorali4822]

@@financialmodeling Thanks Brian !