ACCA AFM Syllabus C. Acquisitions And Mergers - Synergy - Notes ^{5 / 6}

Synergies can be separated into three types:

1. Revenue synergy:

   - which result in higher revenues for the combined entity, 
   - higher return on equity and 
   - a longer period when the company is able to maintain competitive advantage;

2. Cost synergy:

   - which result mainly from reducing duplication of functions and related costs, and from taking advantage of economies of scale;

   Sources of which include:

   o Economies of scale (arising from eg larger production volumes and bulk buying);

   o Economies of scope (which may arise from reduced advertising and distribution costs where combining companies have duplicated activities);

   o Elimination of inefficiency;

   o More effective use of existing managerial talent.

3. Financial synergy:

   - which result from financing aspects such as the transfer of funds between group companies to where it can be utilised best, or from increasing debt capacity.

   Sources of which include:

   o Elimination of inefficient management practices;

   o Use of the accumulated tax losses of one company that may be made available to the other party in the business combination;

   o Use of surplus cash to achieve rapid expansion;

   o Diversification reduces the variance of operating cash flows giving less bankruptcy risk and therefore cheaper borrowing;

   o Diversification reduces risk (however this is a suspect argument, since it only reduces total risk not systematic risk for well diversified shareholders);

   o High PE ratio companies can impose their multiples on low PE ratio companies (however this argument, known as “bootstrapping”, is rather suspect).