Definition
Acquisition premium, also known as takeover premium, is the difference between the purchase price of a company and its pre-acquisition market value. This is the additional amount that an acquiring company pays to buy another company, above its market value. The premium is typically paid in acquisitions to gain control, obtain synergies, or for other strategic reasons.
Key Takeaways
- Acquisition Premium (Takeover) refers to the excess amount that an acquiring company pays over the market value of the shares of the target company during a takeover. It reflects the perceived potential and inherent value in the target’s future earnings and potential growth.
- The acquisition premium is used as an incentive for the target company’s shareholders to sell their shares. It can also be interpreted as the cost of acquiring the company in addition to its current market value.
- The amount of an acquisition premium is determined through thorough valuation techniques, negotiation processes, and can also be influenced by the competitiveness of the M&A market. Overpayment could lead to financial difficulties for the acquirer, while underpayment could result in a failed takeover attempt.
Importance
The finance term “Acquisition Premium” (also known as the takeover premium) is essential as it signifies the additional price an acquiring company is willing to pay over the current market value to purchase another company.
This premium is vital in mergers and acquisitions as it often serves as a compelling incentive for the target company’s shareholders to approve the sale.
Illustrating the acquirer’s belief in the potential future value of the target, the acquisition premium can also reflect the level of competition involved in acquiring the company.
Therefore, understanding this financial term helps stakeholders to assess the fairness and attractiveness of the acquisition offer.
Explanation
The acquisition premium, also known as a takeover premium, plays a key role in mergers and acquisitions (M&A) process. Specifically, it serves as a tactical tool in takeover transactions.
The purpose of this premium is to incentivize target company shareholders to agree to the proposal put forward by the acquiring firm. This is because the acquisition premium usually represents an offer price that’s greater than the market value of the target company’s shares, thus providing immediate, above-market returns to the target company’s shareholders in the event of a successful takeover.
In M&A transactions, the acquisition premium is used to reflect the value that the acquiring company sees in the target beyond its current operations. This could include intangible assets, strategic benefits, future growth potential, and cost-saving opportunities that might arise from synergies post-acquisition.
It is this additional perceived value that often pushes acquirers to offer more than the target company’s market capitalization. Ultimately, the size of the acquisition premium can signal the acquirer’s confidence in the potential value they can realize from the acquisition, and can often be a deciding factor in whether or not the takeover bid is successful.
Examples of Acquisition Premium (Takeover)
Disney-21st Century Fox Acquisition: In 2019, Disney closed a deal to acquire most of Fox Corporation for $
3 billion. This amount was far more than Fox Corporation’s market value, which created a huge acquisition premium. This premium was acceptable to Disney because they assumed they would receive a strong return on investment by acquiring Fox’s media arsenal.
Microsoft-LinkedIn Acquisition: In 2016, Microsoft Corp. bought LinkedIn for $
2 billion. The price represented a 50% acquisition premium to LinkedIn’s stock price. Microsoft was willing to pay extra to gain access to LinkedIn’s extensive user base in the professional world and new opportunities for their cloud computing segment.
Facebook-WhatsApp Acquisition: In 2014, Facebook acquired WhatsApp for approximately $19 billion, a value significantly above WhatsApp’s intrinsic valuation at that time. The hefty premium was partly justified by the strategic fit, massive user base, and growth potential that WhatsApp offered to Facebook.
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FAQ Section: Acquisition Premium (Takeover)
What is an Acquisition Premium?
An Acquisition Premium, also known as Takeover Premium, is the difference in price paid by an acquirer, which is higher than the market price of the shares of the target company when making a takeover. This premium is often given to persuade the shareholders of the target company to sell their shares.
How is Acquisition Premium calculated?
The Acquisition Premium is calculated by subtracting the target company’s per share market price from the per share price offered by the acquirer, and the result is divided by the target’s market price per share. The outcome is then multiplied by 100 to get the Acquisition Premium in percentage form.
Why do companies pay an Acquisition Premium?
Companies often pay an Acquisition Premium to secure control over the target company. The premium acts as an incentive for the shareholders of the target company to sell their shares. This is typical in situations where the acquirer believes that the target company is undervalued or has potential for significant growth and increased profits.
Does an Acquisition Premium have any risks?
Yes, paying an Acquisition Premium comes with risks. The premium can be a financial burden on the acquiring company. There is also the possibility that the value of the target company may not increase as predicted, causing a loss to the acquirer. Therefore, careful due diligence and risk assessment are essential before deciding on paying an Acquisition Premium.
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Related Entrepreneurship Terms
- Merger and Acquisition (M&A): This is a corporate strategy that involves buying, selling, and combining different companies to aid a rapidly growing company in a business sector.
- Target Company: The company that is to be purchased. It becomes the focus of another company’s takeover plan.
- Takeover Bid: A corporate action where an acquiring company makes an offer to the target company’s shareholders to buy the target company’s shares to gain control.
- Hostile Takeover: A type of corporate acquisition or merger carried out against the wishes of the board of the target company.
- Due Diligence: An investigation or audit of a potential investment or product to confirm all facts, such as reviewing financial records, plus anything else deemed material.
Sources for More Information
- Investopedia: An authoritative website focusing on investing and finance education. Provides information on a wide range of topics, including acquisition premium.
- Corporate Finance Institute (CFI): Offers a variety of finance-related courses and resources. Their website contains extensive information on topics such as mergers and acquisitions, which include acquisition premiums.
- The Balance: An online resource for personal finance advice and information. It covers a wide range of topics, including investment strategies and understanding acquisition premiums.
- Business Standard: A leading business news website providing in-depth news and analysis on finance, market, economy etc. They often have articles discussing M&A deals where you may find real-life examples of acquisition premiums.
