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Credit Ratings and Acquisition Currency > Credit Ratings and Acquisition Curren... - Pg. 66

66 INVESTMENT BANKING process for forecasting synergies by bringing representatives from both companies together to define what needs to be done to capture synergies and the value derived from this capturing process. Cost synergies can be identified in the following general areas: Administration (exploiting economies of scale in central and back office functions); Manufacturing (eliminating overcapacity); Procurement (purchasing power benefits through pooled purchasing); Marketing and Distribu- tion (cross-selling and using common sales channels and consolidated warehousing); and R&D (eliminating R&D overlap in personnel and projects). Investment bankers are responsible for making sure that forecasted synergies are realistic and a credible total cost savings amount is included in post-transaction valuation calculations. Revenue synergies should be, in many cases, discounted from management's projections since they are very difficult to capture. According to research by McKinsey, 88% of acquirers were able to capture at least 70% of estimated cost savings, while only half of acquirers were able to capture at least 70% of estimated revenue synergies. A control premium relates to the price that an acquiring company is willing to pay to pur- chase control over a target company's decision-making and cash flow. This premium equals the difference between a control-based purchase and a minority (non-control) purchase of shares. In many acquisitions, the acquirer is willing to pay a higher price than the current market price for a public company based on consideration of both expected synergies and a control premium. Credit Ratings and Acquisition Currency Companies must consider the credit rating impact of an M&A transaction: a transaction can result in a ratings upgrade, downgrade, or no rating change. A downgrade may lead to a risk- adjusted higher cost of capital, which impacts the benefits of the transaction as well as the com- pany's operating model going forward. As a result, companies and their investment bankers some- times have confidential discussions with rating agencies before transactions are consummated to determine the probable rating impact of a transaction. This, in turn, can affect the decision regarding whether to use shares or cash as an acquisition currency. Share-based acquisitions have a more salutary effect on the acquirer's balance sheet, so ratings may not be negatively impacted. When considering the acquisition currency, acquiring companies should also focus on the transaction's impact on their EPS, balance sheet, cash flow, financial flexibility, and taxes. Although using shares as the acquisition currency can mitigate credit rating concerns, it can also have a negative impact on EPS relative to a cash-based acquisition. In addition, if more than 20% of the outstanding shares of a U.S. public company are to be issued in an acquisition, a share- holder vote is required to support the issuance. Higher P/E (price to earnings) companies use stock as consideration more frequently than lower P/E companies do. However, the cost of issuing equity should always be compared to the cost of debt when determining whether to use cash or shares as the acquisition currency. If a target firm prefers receiving the acquiring company's shares because it is more tax-effective for selling shareholders (capital gains taxes are deferred until the shares received from the acquisition are sold), the acquirer may need to consider shares as the acquisition currency. In addition, target shareholders might prefer receiving shares to enable their participation in the future share appreciation potential of the post-acquisition company. See Case Study 4, "The Best Deal Gillette Could Get? Procter & Gamble's Acquisition of Gillette," to review acquisition currency considerations.