Control premium
{{Short description|Amount that a buyer is sometimes willing to pay over the current market price}}
A control premium is an amount that a buyer is sometimes willing to pay over the current market price of a publicly traded company in order to acquire a controlling share in that company.{{cite web |last1=Damodaran |first1=Aswath |title=The Value of Control: Some General Propositions |url=http://people.stern.nyu.edu/adamodar/pdfiles/country/controlshort.pdf |website=NYU Stern |access-date=4 March 2019}}
If the market perceives that a public company's profit and cash flow is not being maximized, capital structure is not optimal, or other factors that can be changed are impacting the company's share
Overview of concept
Transactions involving small blocks of shares in public companies occur regularly and serve to establish the market price per share of company stock. Acquiring a controlling number of shares sometimes requires offering a premium over the current market price per share in order to induce existing shareholders to sell. It is made through a tender offer with specific terms, including the price.{{cite journal |last1=Damodaran |first1=Aswath |title=The Value of Control: Implications for Control Premia, Minority Discounts and Voting Share Differentials |year=2005 |s2cid=16798738 |journal=NYU Journal of Law & Business|doi=10.2139/ssrn.837405 }} Higher control premiums are often associated with classified boards.{{Cite journal|last1=Bebchuk|first1=Lucian A.|last2=Hirst|first2=Scott|last3=Rhee|first3=June|date=2014-02-01|title=Towards the Declassification of S&P 500 Boards|url=https://papers.ssrn.com/abstract=2400652|language=en|location=Rochester, NY|doi=10.2139/ssrn.2400652 |ssrn=2400652|s2cid=168499979|journal=Harvard Business Law Review |url-access=subscription}}{{rp|165}}
The amount of control is the acquirer's decision and is based on its belief that the target company's share price is not optimized. An acquirer would not be making a prudent investment decision if a tender offer made is higher than the future benefit of the acquisition.
Example
Company XYZ has an EBITDA of $1,500,000 and its shares are currently trading at an EV/EBITDA multiple of 5x. This results in a valuation of XYZ of $7,500,000 (=$1,500,000 * 5) on an EV basis. A potential buyer may believe that EBITDA can be improved to $2,000,000 by eliminating the CEO, who would become redundant after the transaction. Thus, the buyer could potentially value the target at $10,000,000 since the value expected to be achieved by replacing the CEO is the accretive $500,000 (=$2,000,000–$1,500,000) in EBITDA, which in turn translates to $2,500,000 (=$500,000 * 5 or =$10,000,000–$7,500,000) premium over the pre-transaction value of the target.
See also
References
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External links
- [http://www.philipsaunders.com/TheFirm/Publications/ControlPremiums/tabid/96/Default.aspx Control Premiums, Minority Discounts & Marketability Discounts]
- [http://www.wfu.edu/~palmitar/Law&Valuation/chapter%205/5-4-1caseexample.htm Marketability Discounts and Control Premium Example]
{{corporate finance and investment banking}}
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