Takeover Premium
Represents the markup value most companies are willing to offer in M&A deals
What is Takeover Premium?
Takeover premium, also known as the “acquisition premium,” represents the gap between the figure paid to acquire a company subtracted by the market or the “real” price of the company.
This figure represents the markup value most companies are willing to offer in merger and acquisition (M&A) transactions or deals.
It can also be deemed the control premium, the amount a buyer is occasionally ready to pay above the present market price.
The most frequent question is: Why do companies pay a premium when acquiring another company?
Companies often pay a premium to eliminate rival bidders and seal a deal with the target company.
However, the main reasons are to acquire a value of control over the company and to obtain synergies that may arise from the given transaction.
Many advantageous benefits may arise from gaining control over a business, including the following:
- selecting the board of directors
- supporting spending plans and budgets
- strategizing and influencing long-term plan
- modifying the capital structure, etc.
Usually, before a company undergoes any mergers and acquisition (M&A) deals, the acquirer must determine an estimate of the target company's fair worth before making an acquisition. In addition, the acquirer must figure out any potential synergies from the deal and estimate the projected fair value.
The acquirer can then decide on how much the premium should be. However, the premium should be paid only if the deal's synergies outweigh the takeover premium given to the target business.
Key Takeaways
- Takeover premium is the extra amount paid in acquisitions, representing the gap between the purchase price and the true value, often known as the control premium.
- Companies pay premiums to secure control, outbid rivals, and gain benefits like influencing strategic plans and modifying the capital structure.
- Premiums can be calculated using formulas based on enterprise value or share prices.
- Takeover premiums contribute to accounting "goodwill," representing the intangible asset formed when the acquisition price surpasses net fair value.
Understanding Takeover Premium
The first step for acquirers is to choose a target company and estimate how much the company's value is worth. In other words, this includes assessing the "real value" of the company, which can be achieved by utilizing the target company's public information.
For example, if you want to estimate the price of a specific company listed publicly, we can use the 10-k or 8-k report published by the company.
After the acquiring company has estimated and decided on its value, it may have to decide on how much more it is ready to pay to offer the target company an attractive deal, especially if other companies are also exploring an acquisition.
To understand more about it, let us see an example.
Suppose Company X found that it could increase its growth and improve its market share by undertaking a deal with Company Y. In this context, Company X is the acquiring firm, and Company Y is the target firm.
Suppose Company X utilizes Company Y's 10-K report and estimates the true value to be approximately $10 million. Company X is willing to offer a takeover premium worth 33% to fend off interest from any other potential acquirers.
The cost that company X would have to pay would be $10 million x 1.33 (33% premium), which equals $13.3 million. If Company Y is willing to accept the proposal, then the takeover premium will be calculated as follows:
$13.3 million - $10 million = 3.3 million
The $3.3 million would therefore be equivalent to the premium that Company X is willing to offer or, in percentage form, a 33% premium.
Alternatively, Company X can offer a takeover premium on the shares of Company Y. Say, for example, that Company Y is trading at $15 per share and that a 33% premium is willing to be offered by Company X.
Therefore, it is willing to offer an amount of $15 x 1.33 (33% premium), which equals $19.95 per share. Therefore, the premium is equivalent to $19.95 - $15, a markup of $4.95 per share.
Takeover Premium Formula
The formula to calculate the takeover premium using enterprise value is:
[(Takeover Price - Market Price)/ Market Price] X 100
The takeover price represents the acquirer's price to purchase the company, and the market price is the pre-acquisition price.
For instance, if the takeover price is 16.6 million and the market price is 12.6 million, then the takeover premium is:
[(16.6 - 12.6)/ 12.6] X 100
Which is approximately 31.476%.
We can also use share price value to calculate. The formula is:
[(Share price offered - Original Share Price)/ Original Share Price] X 100
For example, Company X wants to acquire Company Y and offers each share of Company Y at $12. Company Y’s original share price is valued at $10. The takeover premium is calculated as follows:
[(12 - 10)/ 10] X 100 = 20%
Therefore Company X offers a 20% premium.
Accounting Takeover Premiums
People who have studied accounting should already be familiar with the term "goodwill'.' Goodwill represents an intangible asset formed when a business acquires another business. In this case, it refers to the takeover premium.
It is referred to as the takeover premium since it is formed when the purchase price exceeds the total of the net fair value acquired assets plus the liabilities assumed during the acquisition. The acquiring company will then account for goodwill separately on its financial sheet.
Takeover Premium FAQs
According to RSM Global, the average premium at 20-days pre-bid for the Australian market lies at 34.5%. The data was based on the following transactions completed from the financial year (FY) 2005 to the financial year (FY) 2016.
Usually, in the case of an acquisition, there are multiple consequences for both the acquirer and the target company's share price. In most cases, the target firm's share price will usually rise due to receiving a premium for the stock.
On the other hand, the acquiring company's share price is likely to fall when an acquisition takes place because it pays a premium to the target firm which will reduce its cash reserves or, in other situations, may result in more debt.
In most cases, when investors undervalue the market, the premium seems to be higher and vice versa. When investors overvalue the market, the premium tends to be lower. Other factors may impact the premium, such as:
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The bidders' intentions
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The number of bids
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Industry rivalry
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The nature of the industry
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