The acquisition premium, also known as the bid, purchase or takeover premium, refers to the excess cost that an acquirer pays over the market capitalization value of the target shares being acquired. This difference between the actual price paid to acquire a company and the estimated real value of the acquired company, in terms of mergers and acquisitions, is often recorded as goodwill on the balance sheet.
“Premiums Paid Analysis” is the name of a common investment banking analysis that reviews comparable transactions and averages the premiums paid for those transactions. Looking at historical acquisition premiums when negotiating the takeover of a public company is a key part of framing the purchase price range. Potential rival bids also have a large effect on the premium offered by the acquirer as a bidding war is often to be avoided.
The target firm’s management team will retain an investment bank to analyze historical premiums paid on comparable transactions. In investment banking analysis, this review is often referred to as “Premiums Paid Analysis”. The bank will study historical acquisition premiums paid for similar companies in the same industry to assist in negotiations and act as a guide to the purchase price range. This also demonstrates to the target firm’s shareholders that the board have performed their fiduciary duty of maximizing value to shareholders.
Calculating the Premium
Calculating the premium can be done from share price and deal value. The value of target firm’s stock is $50 per share and the acquirer offers $60 per share. The formula is therefore
($60 – $50) / $50 = 20%
This means the acquirer is offering a 20% acquisition premium.
Acquisition Premium Example
The following text is taken from the Form 8-K filing made by The Meet Group (MEET) on March 5, 2020 in relation to the proposed takeover by Gilead Sciences (GILD)
After careful and thorough review, and following consultation with The Meet Group’s financial and legal advisors, the transaction was unanimously approved by The Meet Group’s board of directors. The purchase price represents a 30% and 43% premium to the unaffected 30 and 60 trading day volume weighted average price, respectively, to The Meet Group’s common stock through December 13, 2019, the last trading day prior to published market speculation regarding a potential transaction involving the company.
In this document, the stock price used in the acquisition premium calculation is clearly identified. Volume weighted average price (VWAP) is a common method deemed superior to a simple average. This is the initial floor price for traders and is of great importance. From this point, traders need to be aware of how the floor price is changing so they can stay aware of the potential downside.
