Control Premium In M&A

Control Premium In M&A

In a mergers and acquisitions transaction, sellers demand a #controlpremium (~15-20%) over the intrinsic value, and the sellers’ rationale for this premium is that buyers historically pay this premium. In my view, buyers should pay a control premium when the incumbent target’s management is not efficient. Then, the buyer can exercise this control premium to replace the target management, which would improve the target’s value. In LBO deals, #privateequityfirms pay a control premium where

Value of control = Present Value (Value of Company with change in management – Value of company without change in control)

In my view, there are only three ways control can add value:

1)First, the overall risk of the target reduces, which would be reflected in the discount rate reduction.

2)The value of the existing assets of the target increases by improving its ROIC by increasing the target’s operating efficiency (reduce costs, terminate projects with lower ROIC)

3)The buyer can grow the target’s earnings by investing in projects that earn a superior ROIC.

If the buyer cannot improve the target’s value, the control value is zero, and any control premium that the buyer pays amounts to overpayment.