Control Premium's Financial Justification
My understanding is that the price paid for a target = its intrinsic stand-alone value + PV of Synergies + Control Premium…what is the financial justification for this “control premium”?
In other words, synergy cash flows are quantifiable by discounting the additional cash flows gained through combining companies. I'm looking for a similar way to conceptualize control premium, besides unquantifiable stuff like management greed, etc. I just don’t get why you’d pay anything beyond stand-alone NPV + synergies.
bump
I think the theory is that if an investor has a controlling stake in a company that they can control the direction of the company, and other managerial decisions which basically gives them more influence on the firm's cash flows. For example, the controlling shareholder will control the board and can fire management or place more effective managers in the senior roles. Similarly, the controlling shareholder can cast the deciding vote on capital structure decisions and which business segments to enter, exit or grow. This adds value to their interest in the company, when compared to a minority shareholder who basically has no influence over the company's operations.
It's basically the opposite of the minority discount, so if you're familiar with that, just reverse it.
You're not going to pay the full PV of synergies to the target, but a share of them (otherwise you'd be doing a zero NPV deal). This is a major negotiation point in M&A: who retains the synergy value.
To justify the control premium, I think of it 2 ways: 1) Like the guy above said, you need to pay for the ability to have total authority over the company's direction. 2) If the buyer tried to purchase all the target's stock out in the open market, supply & demand would push the target's price up...so if they want to acquire the whole company, they need to compensate current shareholders for the price run-up that would have occurred.
Thanks, but I don't get why you don't pay full PV of synergies and certainly don't how the deal has a zero PV,
And why and how are the synergies split? I figured you had to pay for them b/c you are buying the additional synergy cash flows just like you're buying the stand-alone target's cash flows: neither of those 2 sets of cash flows (the synergies and stand alone's cash flows) would be possible without the target's willingness to sell itself. Thus, the buyer has the seller to thank for the synergies and thus should pay for all of them...
Similarly, the synergy CF's would not exist without the buyer's operations. If the buyer pulls out from the deal, the target is left with its stand-alone cash flows only.
If a target's stand-alone value is $100, and the PV of potential synergies is $10, the acquiror certainly could pay $110 for the target, but in that case they pay exactly fair value for the future cash flows (no +NPV accrues to the acquiror's shareholders). If on the other hand the target agrees to sell for only $100, then its shareholders don't make an abnormal profit either.
The deciding factor in how the $10 in value is split usually boils down to the availability of other targets/other buyers. If a very unique target company goes through an auction process with multiple strategic buyers, then those buyers will likely have to outbid each other by giving more and more of the synergy value to the target. On the other hand if there are lots of companies just like the target, and only one strategic buyer, then the buyer has more pricing power.
Control premium (Originally Posted: 10/08/2014)
Theoretically, does the control premium account for the entirety of the premium over the target's share price?
BUMP
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