The Control Premium is the excess value paid by an acquirer above the current market price of a publicly traded company to gain full control (or a controlling share) of a target company. It is sometomes referred to as the acquisition premium.
As a rule of thumb, the value that an acquirer firm should be willing to pay for a target firm should equal the sum of
- the target firm’s intrinsic value
- synergies that can be achieved between the two firms
- the opportunity cost of not acquiring the target firm (i.e. the target firm is acquired by a rival who subsequently gains from the above benefits).
The premium paid if specific to the acquirer and their unique situation. This causes premiums to vary widely. Although in practice, premiums often range between 20% to 40%. Academic studies in addition to underlying market wisdom have often correlated the size of the control premium to the improved chances success in closing a deal. Therefore, a higher premium is a significant factor in increasing the deal closing probability (DCP).
Control Premium Example
On February 6, 2020, Advent International offered $33.00 a share for Forescout Technologies (FSCT). The previous day’s closing price was $27.98. This implies a control premium of 17.94%. Many acquirers however may use some kind of average price in the run up to the offer in order to calculate the premium offered. A popular method is the 30 day VWAP (Volume Weighted Average Price) which takes into account trading volumes.
However, in the case of FSCT, the 8-K filing made following the announcement of the deal states,
The purchase price represents a premium of approximately 30% over Forescout’s closing share price of $25.45 on October 18, 2019, the last full trading day prior to the release of the 13-D filings by Corvex Management L.P. and Jericho Capital Asset Management L.P. on October 21, 2019, which disclosed they had formed a partnership to approach Forescout and accumulated a combined 14.5% ownership in the company
This analysis is closely related to the calculation of the floor price. It is of great interest to traders who intend on trading this merger arbitrage spread and need to analyse the risk involved.
