Control premiums refer to the willingness of an investor to pay a premium to acquire control of a company, compared to acquiring a minority interest. The implication is that the control value is higher than simply multiplying the share price by the number of shares.
The market share price of a listed public company represents the portfolio interest price. That is to say, the price an investor is prepared to buy or sell a small parcel of shares, typically less than 5% of the company.
In takeovers of listed companies, an acquirer is sometimes observed (but not always) offering a premium above the market share price. This control premium depends on such factors: as the industry, whether the acquirer already as a share in the target and how heavily traded the companies are.
How much are the control premiums?
According to the 2017 RSM Control Premium Study, the highest control premiums were observed in the Pharmaceutical and Biotech industries with offer prices at an average 38% above market prices two to twenty days before the offer. The real estate sector had the lowest observed premiums, with an average of 21%.
According to the study, acquisitions with the lowest market value, less than $25m, had the highest observed control premiums, an average premium of 49%. Whereas the largest transactions, over $500m, had the lowest premiums, an average of 23%. The explanation for this difference may be due to a large company typically having a more readily traded stock, more buyers and sellers, and so the market price is more likely to approximate control value. Further, there is usually more company information available to investors in a large company, compared to a small traded company, allowing investors to make more informed decisions.
In a Mckinsey study, control premiums were observed averaging 40%. Although in this case, the study appears to attribute the premium primarily to buyer synergy.
Reasons for control premiums
The justifications for an acquirer paying a premium for control may include:
- controlling the composition of the board and management
- controlling decision making such as strategy and financial structure
- controlling cash flow and the nature and timing of dividends
The acquirer is expecting to improve the earnings of the target and may also expect some synergy benefits in merging operations (where it’s a strategic buyer vs an investment buyer).
Arguments against control premiums
The matter is far from clear. A common current argument is that Control in its self is not the basis for a control premium above a public share price. What matters is that, after an acquisition, the acquired company is now under a different management/ stewardship. A price higher than the publicly traded price might be reasonable if the new management expects to improve cash flow or reduce risk.
See the Exposure Draft, The Measurement and Application of Market Participant Acquisition Premiums. Issued in 2015 by the Appraisal Foundation.090115 Exposure Draft Measurement and Application of Market Participant Acquisition Premiums
Simon is a CA Business Valuation specialist, Chartered Accountant and a Certified Fraud Examiner. Simon specialises in providing valuation services. Prior to founding Lotus Amity, he was a Corporate Finance and Forensic Accounting partner with BDO Australia. Simon provides valuation services in disputes, for raising finance, for restructuring, transactions and for tax purposes.