The Value of Synergies through the Real Options Lenses: The Case of DaimlerChrysler: could failure have been predicted?

Giulia Patregnani

Student thesis: Master thesis


This thesis uses concepts from the field of strategic management to motivate the potential behind the use of real option (RO) for the valuation of synergies, in the context of a merger or acquisition. The discount cash flow (DCF) model, vastly utilized by practitioners, has been argued to not fully grasp all the variables and factors underlying the uncertain, irreversible investments a company can embark on. If synergies are seen as investments, and as real options given the uncertainty, irreversibility and managerial discretion surrounding them, then real options valuation (ROV) seems to be a more suitable tool to come to a final more likely value of their realization. Initially, a general introduction about M&As is made, and a particular attention is given to the elements leading to failures in such a context. Here, the wrong valuation of synergies and a too optimistic view of their materialization represents one of the most significant pitfalls in the decision process, and can therefore lead to a failure. Since synergies are proven to be uncertain, not only in their actual materialization, but also in the value they are going to transfer to shareholders, the DCF approach is definitely too simplistic for this goal. On the contrary, RO seem to have the same characteristics as synergies, i.e. uncertainty, irreversibility, and managerial discretion surrounding their exploitation. Consequently it is argued that the ROV method can be applied to those synergies that have the right characteristics. Through these lenses the value of a target company can be divided into three elements, namely the value of the assets in place, the target’s RO, and finally the value added given by the out-of-the-money RO the target holds, that can be turned into in-the-money RO through the acquirer’s resources. Lastly, a valuation of the synergies from an M&A failure is made. The deal chosen is that of DaimlerChrysler, signed in 1998. First, it is assumed that the stand alone value of the target has been estimated correctly at the time. Secondly, as the Datar-Mathews method for ROV requires, the incremental value of synergies in three different scenarios is calculated. Third, a Monte Carlo simulation is performed, and the value of the free cash flows from synergies calculated for every trial. This measure includes the integration costs needed to increase the likelihood of synergies realization. The RO value, i.e. the value of synergies, is then calculated for each of Chrysler’s shares, namely $2.83 per share. In conclusion, this thesis shows how ROV can be a valid addition to the DCF when calculating the value of synergies.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
Publication date2014
Number of pages91