Extended-form Case Study

Assessing synergies: A case study of Zillow and Trulia

Published on January 31, 2016   27 min

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Hello, my name is Michael McDonald. Today, we're gonna be talking about assessing synergies, and a case study of Zillow and Trulia.
Let's start by talking for a minute about mergers and acquisitions. 'Mergers and acquisitions' is a term that's used to describe the process by which one company acquires another company. Generally this term is applied to publicly traded companies although it doesn't have to be. Now a merger occurs when two companies of roughly equal size join together and form a new company and this results in canceling the outstanding stock in both existing entities. So a merger essentially expunges the existing two companies and forms one completely new company that's formed from both of the existing companies. In contrast, an acquisition occurs when one company purchases another company, usually for a combination of cash and stock, but sometimes for either all cash or all stock. In an acquisition, if Company A buys Company B, then all of Company A's stock will remain outstanding and all of Company B's stock will disappear, it will be removed and replaced with either more stock from Company A or with cash from Company A. The company that's looking to acquire another company is called the suitor firm, while the company that's being acquired is called the target firm. So in my last example there, Company A was buying Company B. Company A will be the suitor firm, Company B will be the target firm. Now suitor firms look for good target companies that are going to be a good fit with the suitor's business, and they're gonna provide value for the suitor's shareholders. Remember, suitor firms don't care about the shareholders in the target firm, they're only interested in their own shareholders. That's very important, because it leads to the idea of what's called synergies. One of the biggest things the suitor firm is gonna look for in a target is strong synergies between the two companies. A company, of course, cares about the share price but as we're gonna see in a minute, the price that you buy the company for can be materially higher if you expect strong synergies from the deal.
Now synergies refers to the potential financial benefits that a company can achieve when they're combining with another company, either through a merger or an acquisition. These synergies are a result of increased revenue that can occur thanks to combining the technology and resources of the two firms, or as a result of cost savings. Frequently this cost savings is an overhead, but there is other areas where there could be cost savings too. M&A deals are predicated on the goal of improving the financial performance of both the suitor company and the target company. That improvement could come in the form of sales increases for both companies, cost increases for both companies, or a combination of both sales and cost increases. But the basic idea here is that putting the two companies together, they're gonna earn more profit than they did separately. Now a pair of companies will place the highest value on one another if they have the best possible synergies. So if we have company A, B, and C, all looking to buy company D, potentially, out of A, B and C, the company that will end up buying company D is the one that has the highest synergies for company D. It's the one that says, "Look, buying company D will lead to the biggest profit increase for the two combined entities." The reason for that is that if you have higher synergies, that means that you're gonna have a higher potential profit when the merger or acquisition goes through. And so as a result, you'll place more value on that company. Your firm will be willing to buy that target firm for more than anyone else is willing to. Let's see an example of this.
Now a great example of expectant synergies is the acquisition of Gillette by Procter & Gamble in 2005. Procter & Gamble and Gillette of course are both enormous companies in the homecare product space. Gillette was bought by Procter & Gamble about 10 years ago at this point. Procter & Gamble said at the time, "The increases to the company's growth objectives are driven by the identified synergy opportunities from the Procter & Gamble-Gillette combination. The company continues to expect cost synergies at approximately 1 to 1.2 billion in increase in the annual sales run rate of about $750 million by 2008." So the idea here was that Procter & Gamble expected that they were going to get cost synergies of $1 to $1.2 billion and that the acquisition was going to increase their sales by about $750 million by 2008. They felt that they would achieve over a billion dollars in additional savings, that synergies is a one-time number in this case. So they see an opportunity to increase their profits. If they saw better synergies, if Procter & Gamble saw better synergies with Gillette than any other potential suitor out there for Gillette, they would be willing to pay the most for Gillette. As Procter & Gamble Chairman and CEO A.G. Lafley said, "We are both industry leaders on our own, and we will be even stronger and even better together."

Assessing synergies: A case study of Zillow and Trulia

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