M&A synergy announcements improve total shareholder returns

A new study into M&A practices has found that investors tend to reward companies that are able to make a clear case for a deal, even though these targets also tend to ask for higher up front premiums. Even deals with a lacklustre initial market reaction and no clear synergy announcements benefit from synergy updates throughout the integration process.

M&A activity continues to draw strong investment figures. Last year, strategic buyers and investors invested more than $3.8 trillion in the acquisition of targets, following a bumper year in 2015. Acquisitions and integration remain complex areas of the business process, however, with recent reports finding that not all deals go as planned, and that having a strong strategy in place– as well as past experience – go a long-way toward improving deal outcomes.

For strategic buyers, one of the main rationales for investment is to derive synergy, whereby lower costs or additional sales channels, etc., can be derived or added to the wider business. Shareholders and potential shareholders being well informed about the reasons, and potential benefits, of deals remains a key criterion for them to make additional investment decisions – as well as staving off concerns that management is out to lunch, or transferring value to the shareholders of the target (as premiums tend to run in excess of 40% of the target company value).

In a new report from McKinsey & Company, the strategy consulting firm explores the importance of informing investors about the synergy potentials of a possible deal – which occurs in a surprisingly small number of transactions. In a sample of 1,600 deals, around 20% of the announced deals included concrete synergy strategy statements. The firm's analysis concludes that the potential benefits include improved share value, investor enthusiasm and long-term share stability.

In some instances, companies may have reason to not disclose key data pertaining to expected synergies, such as being compelled to move quickly; not having sufficient data to create an explicit case; or the deal has different rationale – such as the acquisition of R&D capabilities, intellectual property, or emerging technology. However, when companies do disclose the information pertaining to synergies (and they are accepted as rational), the firm’s analysis of the deals shows that investors tend to reward the acquirers with higher share prices when they disclose sources of potential value in their deal announcements.

The acquirers that announced expected synergies tended to earn a higher deal value added in the days following the announcement, although they also tended to pay higher premiums than acquirers that did not. Companies that mentioned synergies also managed to generate an almost 6 percentage point jump on their Total Shareholder Return (TSR) of 2.1% over -3.8%, over the two years following the deal, compared to companies where companies where there was no disclosure.

The research also found that the initial market reaction is stronger when the reported net present value of synergies is greater than the premium paid, which, the firm notes, is not surprising. Remarking on the results of the study, the firm stated, “That return-on-investment perspective isn’t always visible or convincing unless companies explicitly describe expected synergies when they announce a deal – as suggested by the higher longer-term TRS of companies with expected value that doesn’t cover the premium.”

Finally, the research points to a considerable boost to 2-year post-deal excess TSR, when acquirers provide updates on synergies. The acquirers with negative deal value added, who still provided synergy updates, garnered excess TSR of 8.6%, compared to a -7.8% record for acquirers that did not provide synergy updates at all.

The authors concluded, “In our experience, more information is better. Acquirers should disaggregate the cost, capital, and revenue synergies, and provide a clear rationale and vision for each. They should communicate a timeline for when they expect the synergies to be fully recognised and what onetime investments and costs are required to capture the synergies. And their communiqués to investors should clearly identify any risks that could prevent the companies from capturing the synergies, along with mitigation plans.”