Dis-Synergies

Everything that can go wrong...

"Everything that can go wrong will go wrong" Murphy

Acquisitions are complicated. Mergers even more. There's a lot to go wrong. So far, we have dived into all the reasons for making a transaction like these. The theses that are used to justify a business, as synergies that can add value to it if realized. 

But what about what could go wrong? How to know? And how to prevent it? This is what we are calling dis-synergies or in simpler terms disynergies.

What is a disynergy

Just as synergies can unlock additional value to the union of parties in a mergers and acquisitions deal, disynergies can destroy value. They have the power to make the combination of the two companies end up being worth less than the two alone. That's right, this is a case where 2+2 can be equal to 3, or even 2.

When we try to fit together two puzzle pieces that weren't meant to fit together, we get frustrated. If we force the bar, we can deform the pieces and ruin them. They will end up fitting together, but they won't stay secure and they will both end up ruined from this game.

The metaphor illustrates, but let's discuss real types and examples. 

Types and Examples

When we argue the synergies we look at them in a relatively simplistic way. Value creation could be from the perspective of increasing revenue or reducing costs. The truth is that there are also less tangible forms of synergies and that, although they impact the top or bottom lines of the income statements, it is difficult to establish this correlation when things work well.

But when the integration of operations goes wrong, it is easier to identify the problem, although this does not mean that it is easy to quantify the financial impact of this problem. Let's dive deeper, starting with the most intangible example, to make it clear what we're talking about.

Cultural Misalignment

Culture is possibly one of the greatest success factors of any organization. I say this not out of speculation, but convinced by all of Jim Collins' work, which for me translates a lot into cultural aspects, but which are very well measured in terms of results.

Collins has worked hard to measure the positive impact of intangible aspects of culture. But when we're talking about two companies with significant cultural differences that come into conflict, it's easy to see that things aren't going well.

Some examples of cultural differences that can impact the success of the operation include:

• Agile versus bureaucratic - when a large, rigid organization acquires an agile and uncomplicated one, there is a high probability that cultural differences will cause great damage, such as the mass departure of employees from the acquired company after the acquisition.

• Decentralized versus hierarchical - Similarly, decision-making culture and team autonomy can be a source of problematic cultural differences.

• Radical candor versus politicized culture - Cultures where people have greater freedom and responsibility to say what they think and challenge higher levels of the hierarchy can be sources of conflict in more politicized environments, where everyone is concerned about not being displeased.

I can practically see the conflict situations happening in front of me based on these examples, but to get the real dimension of how much cultural misalignment can hinder a merger or acquisition, let's talk about some cases:

Daimler-Benz e Chrysler (1998): The merger between German Daimler-Benz and American Chrysler was announced as a “merger of equals”. However, cultural differences between the German organization, with its rigid and formal hierarchical structure, and the American one, known for its more casual and innovative approach, resulted in constant conflicts. This cultural misalignment contributed significantly to the failure of the merger, resulting in the separation of the companies in 2007.

AOL e Time Warner (2000): This merger is often cited as one of the biggest M&A failures in history. AOL's fast-paced, innovative culture clashed with Time Warner's traditional, bureaucratic approach. The companies failed to integrate their operations and cultures effectively, resulting in substantial financial losses and, eventually, the separation of the two entities in 2009.

Market cannibalization

Often, the union of two companies can lead to a situation of market cannibalization. In other words, the companies' activities overlap and they compete, even if they are now one. This is very common in transactions between direct competitors and can result in market share erosion and, ultimately, a reduction in the combined company's total revenues.

Some examples of why this might happen include:

• Overlapping Products - When two companies have similar product lines, the merger may result in competition between them. In my experience as M&A director at TOTVS, this was a recurring concern. Software scope, even more so when we are acquiring ERP systems focused on specific segments, are full of overlaps that can destroy value through internal competition and customer confusion.

• Market Segments - Cannibalization can also occur when companies serve the same market segments. Still in the TOTVS example here, the segmentation concern went beyond the economic sector (verticals). The company has a commercial franchise system. In the merger between the large competitors that ended up forming the TOTVS brand (Microsiga, Datasul and Logocenter), a significant effort was required to redefine the scope of the franchises to avoid competition between them. 

Operational Overlays

In the search for synergies, there is a dilemma. When two companies that operate independently with a certain performance come together, overlaps are created that do not make sense. Maintaining these overlaps can create inefficiency and confusion for the customer when there is competition between them (as in the case of cannibalization above). Its elimination can generate a loss of revenue or be costly.

In many cases it is difficult to differentiate overlaps with synergy potential from those that represent simple disynergies. We studied how overlapping back office areas is normally seen as an opportunity for synergy, consolidating financial, accounting, etc. areas. But what about when two retail chains come together, do stores that are too close together represent a competition problem or an opportunity to reduce costs? What about industries with nearby plants and logistics structures?

Some types of overlap that can generate disynergy include:

• Physical structures - such as plants, warehouses, agencies, stores. Eliminating the overlap can be expensive, precisely because we are talking about buildings. However, its maintenance creates a de-optimization of processes, commercial capacity, and asset use.

• Processes and systems - Companies often have systems and processes supporting their core business that are ingrained and difficult to replace. Here too, the maintenance of both is at least sub-optimal, but their integration or replacement is expensive and risky. 

Some good cases include:

Itaú Unibanco (2008) -  The merger between Banco Itaú and Unibanco created the largest bank in the Southern Hemisphere at the time. However, the overlapping of agencies and services in many locations has led to an unoptimized situation. Often the agencies were located side by side. Additionally, two huge banks with ingrained systems and processes needed to be integrated to operate efficiently. A long and very expensive integration project was necessary to eliminate these overlaps.

Raia Drogasil (2011) - The merger between the pharmacy chains Droga Raia and Drogasil resulted in the creation of the largest pharmacy chain in Brazil. Both had stores in close locations and similar product offerings, leading to overlapping coverage areas. The company needed to optimize store distribution and reposition some units to avoid internal competition.

Brand power dilution

When two strong brands come together, it is difficult to maintain the value of both. It often makes no sense to maintain both brands and only one of them should remain. In this case the value of the other brand is lost.

The most notorious Brazilian example is again the merger between Itaú and Unibanco. In 2008, the year of the merger, it was estimated that the Itaú brand was worth around US$10.5 billion, making it the most valuable in Latin America. Unibanco was in ninth place in this same ranking, with US$4.7 billion.

In other words, the union threw away the almost US$5 billion value of the Unibanco brand, left aside. All investments made over decades to build this brand were discarded. Yes, but the union created a stronger and more valuable institution that was reflected in the appreciation of the chosen brand, Itaú, the following year. In 2010, the brand was valued at the equivalent of US$11.47 billion at the time. Can you say that part of the value of the Unibanco brand was transferred to Itaú? In my opinion, it's not that simple. A huge effort to reinforce the chosen brand was important to minimize this disenergy and even so, a large part of the value was lost.

Interestingly, just looking at the picture after fifteen years, we could even be sure that this value was lost. In 2024, the Itaú brand is still the most valuable in Brazil, but its estimated value has reduced to US$8.4 billion. The exchange rate made an important contribution, but competitive pressure removed a lot of value from the brand in dollars.

Margin dilution

The damage that can be caused by the dilution of EBITDA margin in the acquisition of a less profitable company can be great. Say what? If a publicly traded company, valued by a certain EBITDA margin multiple, acquires a company of a relevant size that makes a loss, it is possible that stock market investors will penalize the share price, lowering the value of the acquirer.

When (then named) Facebook acquired Whatsapp in 2014, the market's initial reaction was negative, as it considered the offered value of US$19 billion in total to be high for a company that had no revenue and was burning a lot of cash. Facebook shares fell 3.5% throughout the day, equivalent to a loss in value of more than US$6 billion.

But investors ended up considering it positive and the company recovered the loss quickly. Over the years, the acquisition has proven to be a great strategic success, despite the initial negative reaction. 

Regulation

Adherence to regulatory aspects and the scrutiny of regulatory bodies can be a difficulty faced by mergers and acquisitions. iFood, for example, acquired some smaller competitors, including the Brazilian operation of PedidosJá, and became a major player in the delivery sector in the country.

As a result, it became on the radar of the Administrative Council for Economic Defense (CADE), which hinders new acquisitions that could result in a greater concentration of market share, but also resulted in restrictions on its exclusive contract practices.

Growth disparity

When an established company buys a high-growth startup, this disparity can cause some problems that I would classify as disynergies. For example, a hypergrowth startup typically needs recurring injections of capital to maintain its trajectory. Although the acquisition is possibly motivated by the growth of the target company that gives it value, a strategic acquirer is unlikely to have the same investment appetite as the venture capital industry. At this point, demands for profitability can generate friction that ends up deoptimizing the value that was being created by the pre-acquisition strategy.

Furthermore, the disparity in speed may mean that the new parent company does not have the agility to maintain the growth of the acquired company, resulting in a different result than expected.

Distraction from integration

Post-acquisition integration is the way to build synergies. Synergies are difficult to create without a significant effort to unite operations. But the complexity of this project could disrupt the existing operation of both parties. This "distraction", in relation to what would be the normal life of independent companies, can be considered a disynergy.

How to prepare 

Reading about all this may seem disheartening, especially if you are on the buying side. With all these reasons for a deal to go wrong, how can a transaction be justified? Is there anything that can be done to reduce the risks and impacts of each of these types of disynergies?

Yes, let's discuss how to prepare to face this challenge head-on.