COMMON ERRORS IN VALUING SYNERGY
While firmsareoftenwillingto paybillionsof dollarsfor
synergyinmergers,thereareseveralcommonerrorsthatare
made byanalysts whoarecalled uponto valuesynergies.
Acquiringfirmsoftensubsidizetargetfirmstockholdersby
misidentifying sources of synergy or using the wrong
discountrateonsavingsfromsynergy.Itisalsocommonto
seeamixingupanddoublecountingofsynergyandcontrol
values.Finally,overoptimismaboutwhensynergygainswill
show upoftenleadsto too high avalue beingattachedto
synergy.
Subsidizing Target Firm Stockholders
Acquiringfirmsshouldfollowasimplerulewhenitcomesto
value.Theyshouldnotrenderuntotargetfirmstockholders
premiumsforitemsorstrengthsthatthesestockholdershad
noroleincreating.Considertwoverysimpleexampleswhere
wecanseethissubsidizationoftargetfirmstockholdersby
acquiring firms:
1.Anacquiringfirmwithahighdebtratingacquiresatarget
firmwithamuchlowerdebtrating.Assume,forpurposesof
this illustration, that the after-tax cost of debt for the
acquiring firmis 3 percentand thatofthetargetfirmis 5
percentandthatthedebtratioofthelatteris 30 percent.In
computingthecostofcapitalforthetargetfirm,theanalyst
decidestousetheacquiringfirm’scostofdebt,arguingthat
theacquisitionwillbefundedwithnewdebtatthelowercost.
Thelowercost ofcapital(arisingfrom replacingthetarget
firm’scostofdebtwiththeacquirer’slowercostofdebt)will
resultinahighervalueforthetargetfirm.Whyshouldtarget