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3. Introducing the merger case
ShirtShop is a fictional clothing retailer that wants to acquire another retailer TrouserTown. In this lesson, we learn the motivation behind the proposed transaction and the synergies that ShirtShop hopes to achieve.
Buying Growth through Mergers and Acquisitions
- Generally adopted as a strategy when organic growth slows
- Acquisitions can boost both revenue and earnings quickly
- However, transactions cost money and have substantial execution risk
- Consequently, organic growth is almost always seen as preferable
Potential synergies in the deal
- Cost of Goods Sold
- Selling, General & Administrative
- Increased sales per store
In this lesson, I'll introduce our case beginning with the acquirer which is a company called ShirtShop.
ShirtShop sells predominantly men's shirts. It has a presence in the United States, on the East Coast and in the MidWest, and in total it has 538 stores.
With the company founded in 1988. If we look at ShirtShop's revenue and EBITDA growth over the past couple of years, we can see that both have been sluggish. As a result management are under pressure to do something that will substantially impact the share price. Management have struggled to do this by growing organically through opening new stores, and so have turned to mergers and acquisitions. This approach is often called buying growth, it normally happens when organic growth slows. And M&A can potential boost both revenue and earnings, however it costs money to do deals like this, and as a consequence, organic growth is seen as preferable. And obviously more profitable. After meeting with it's investment bankers, ShirtShop has identified a target, TrouserTown. Another men's retailer that just sells trousers to men. TrouserTown also has a presence in the MidWest and in the Southwest, but not on the East Coast where ShirtShop has its headquarters. Both companies have a very poultry online shopping offering, but aim to improve this in the coming years. It's also worth noting that TrouserTown has 317 stores, is privately help by investors, and was founded in 1955. Through the acquisition, ShirtShop has identified a number of potential synergies. Cost of goods sold, on the cost side, along with general and administative, savings due to combining certain stores, savings due to launching an E-commerce platform, and lastly, sales through combining advertising budgets. On the revenue side, we have a single synergy, which is going to be increased sales per store. Where certain stores have been earmarked for selling both trousers and shirts. As a rule, revenue synergies are typically harder to quantify than cost synergies, and the market tends to be more cynical of revenue synergies than cost synergies. When you're building a model, or analyzing companies that are about to merge, always be sure to cast a skeptical eye on certain revenue synergies because they can be very hard to predict.