Valuing synergies in strategic mergers and acquisitions using the real options approach

The purpose of the current paper is to elaborate the model for assessing cumulative synergetic effect in MA (Mergers and Acquisitions) deals on the basis of a real options approach. The majority of papers on the synergetic effects of MA deals typically focus on a particular type of synergy, while the current paper proposes a model that accounts for the cumulative simultaneous effect of different types of operating and financial synergies. The methodology of our research is loosely based on Datar-Mathews real option valuation model, which is flexible and intuitive for practitioners. Formulae for assessing eight types of synergy typically arising from MA deals are developed. They are integrated into a single model to assess their cumulative effect on the MA deal using a simulation modelling approach. The method was used ex post to find synergy values in two recent MA deals in the pharmaceutical industry, and produced sound results. The proposed approach to value target companies could be used by firms before an MA deal in the due diligence process. Using this tool a company can build a bidding strategy and define the maximum premium it can pay for the target.