isthemostwidelyusedandmisusedrationaleinmergersand
acquisitions.Inthissection,weconsiderthepotentialsources
ofsynergyand categorizethemintotwogroups.Operating
synergies affect the operations of the combined firm and
include economies of scale, increased pricing power, and
highergrowthpotential. Theygenerallyshowup ashigher
expected cash flows. Financial synergies, in contrast, are
more focused and include tax benefits, diversification, a
higher debt capacity, and uses for excess cash. They
sometimesshowupashighercashflowsandsometimestake
the form of lower discount rates.
Operating Synergy
Operatingsynergies arethosesynergies thatallowfirmsto
increasetheiroperatingincomefromexistingassets,increase
growth, or both. We would categorize operating synergies
into four types.
- Economies of scale that may arise from the merger,
allowing thecombined firm to become morecost-efficient
andprofitable.Ingeneral,wewouldexpecttoseeeconomies
ofscaleinmergersoffirmsinthesamebusiness(horizontal
mergers)—twobankscomingtogethertocreatealargerbank
or twosteel companies combining to createa bigger steel
company. - Greater pricing power from reduced competition and
highermarketshare, whichshouldresultinhighermargins
and operating income. This synergyis also morelikely to
showupinmergersoffirmsinthesamebusinessandshould
bemorelikelytoyieldbenefitswhentherearerelativelyfew
firms in the businessto beginwith. Thus, combining two