What is Takeover Premium?
Takeover premium is the difference between the market price (or estimated value) of a company and the actual price paid to acquire it, expressed as a percentage. The premium represents the additional value of owning 100% of a company in a merger or acquisition and is also known as the control premium. The control premium is the additional benefit an acquirer receives (compared to an individual shareholder) from having full control over the business.
Acquirers typically pay premiums for two main reasons:
- The value of control
- The value of synergies
#1 The Value of Control
It is advantageous for shareholders to have complete control over a business. For this reason, they are willing to pay more than an investor who only owns a small fraction of a company, and therefore has very limited influence.
Benefits of full control and reasons for paying a takeover premium include the ability to:
- Choose the board of directors
- Hire and fire the CEO
- Approve budgets and spending
- Influence strategy and long-term planning
- Pay dividends and buy-back shares
- Change capital structure
- Execute M&A
#2 The Value of Synergies
When an acquirer wants to purchase a company, it must find an estimate of the target company’s fair value. In addition to the estimated fair value, the acquirer must determine the potential synergies from the deal.
Based on the two metrics mentioned above, the acquirer can determine the takeover premium. The premium should be paid only if the synergies created as the result of the deal exceed the takeover premium paid to the target company. However, the size of the premium also depends on other factors, such as the presence of other bidders, level of competition within the industry, and incentives of buyer and seller.
The screenshot above shows the value of synergies, as explained in CFI’s M&A Financial Modeling Course.
Accounting for the Takeover Premium
When an acquirer pays a takeover premium during an M&A transaction, goodwill will be recognized on the acquirer’s balance sheet. Goodwill is an intangible asset that includes a target’s company brand name, client base, great customer and employee relations, and patents. In the case of unfavorable economic conditions or adverse events, the market value of goodwill may drop below the acquisition cost. Thus, the acquirer must recognize an impairment of goodwill. If the acquirer pays a discount for the acquisition, negative goodwill will be recognized.
Example of a Takeover Premium
In August 2017, online retail giant Amazon.com received regulatory approval to take over Whole Foods Market, Inc. in an all-cash deal valued at $13.7 billion or $42 per share. The deal’s value represented a 27% takeover premium on the Austin, Texas-based organic grocer’s latest closing price at $33.06 before the announcement of the transaction.
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