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Operating and Financial Synergy

Operating and Financial Synergy

Synergy is based on the notion that merger of two companies can create greater shareholder value than if they are operated separately. It is the potential additional value from combining two firms.

There are 2 types of Synergy –

1. Operating Synergy

2. Financial Synergy

Operating Synergy –

Operating synergies are those synergies that allow firms to increase their operating income, increase growth or both.

It can be categorized into 4 types –

1. Economies of scale that may arise from the merger, allowing the combined firm to become more cost-effective and profitable.

2. Greater pricing power from reduced competition & higher market share, which would result in higher margins & operating income.

3. Combination of different functional strengths, as would be the case when a firm with strong marketing skills acquires a firm with good product line.

4. Higher growth in new or existing markets, arising from the combination of the 2 firms.

Vertical mergers where a company expands forward towards the consumer or backwards towards the source of raw material by giving the acquiring company control over distribution & purchasing bring in economies of scale.

Economies of scope refer to using a specific set of skills or an asset currently employed in producing a specific product or service to produce related products or services. Hindustan Lever Limited, the consumer giant, uses its highly regarded consumer marketing skills to market a full range of personal care as well as packaged food & tea.

Financial Synergy

Financial synergy refers to the impact of mergers on the cost of capital of acquiring firms or the newly formed firm. Cost of capital can be reduced with financial synergy. If the merged firms have unrelated cash flows, realize financial economies of scale in capital issues from lower interest rate (on debentures) & transaction costs & result in better matching of investment opportunities with internally generated funds, the cost of capital can be lowered.

Merger can help in correcting and evolving a balanced capital structure & make the companies a attractive investment.

Operating and Financial Synergy

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