For years, the valuation profession has debated the definition of a control premium, including its distinction from an acquisition premium. What began years ago as a relatively simple question—if there is a control premium, what should it be?—now includes analyzing such concepts as invested capital premiums and equity-based premiums, transaction synergies and strategic values, marketability, and levels of control. All are “key points” to keep in mind throughout the quantification of a control premium, say Tim Meinhart and Nate Novak (both of Willamette Management Associates), who led a webinar on this topic titled Evaluating and Applying Control Premiums earlier this year. “The way we think about these premiums is a little different now than the way we did 10, 15, maybe 20 years ago.” In a chapter in the new BVR Briefing—Control Premiums: A Deep Dive Into the New Data on Invested Capital Premiums, the application of an invested capital premium is shown in a step-by-step process, traditionally starting with these three first steps:
1. Determine whether the valuation method develops a control value indication or noncontrolling value indication. Depending on subject ownership interest and objective of valuation, further adjustments may not be needed.
2. Determine whether a change in control transaction could result in incremental economic benefits. If yes, there may be a material difference between control value and noncontrolling value. If no, there may not be a material difference between control value and noncontrolling value.
3. Determine the magnitude of any incremental economic benefits to estimate a control premium (or discount) by use of theoretical models and empirical data, including Mergerstat Review, Factset MergerStat/BVR Control Premium Study, etc., with an eye toward using data that are as targeted as possible to the subject transaction and performing a company-specific analysis to identify positive (and negative) attributes that control (or lack of control) may impact.
Based on the discussion data in the chapter, consider the following discrete, discounted cash flow (DCF) analysis to quantify a control premium, along the following four steps:
4. Perform traditional DCF analysis using company-provided projections (status quo, noncontrolling).
5. Analyze and identify potential changes that a hypothetical controlling owner could make to enhance business on a stand-alone basis. Potential areas include identifying new, organic areas of growth, diversification, customer base, geographic reach; reducing operating and nonoperating expenses without harming the business; reducing rates of employee and management compensation; and exploring options to decrease working capital requirements and/or the cost of capital.
6. Perform a secondary DCF analysis using the controlling-owner projections, as adjusted by potential changes identified in Step 5.
7. Compare results of two DCF analyses to quantify implied control premium.
In the final analysis, “it really is as simple as comparing the two DCFs,” says Nate Novak. What you’re left with, after the completion of the entire exercise, is a noncontrolling value and a controlling value; you don’t even need to apply any discounts or premiums. “You have your two dollar-amount value conclusions” and can use them as a reasonableness check against what the empirical data show. If, for example, the empirical data indicate a 15% control premium, but your comparative analysis shows no real room for any changes by a hypothetical controlling owner to improve cash flows, then you may want to rethink whether the 15% (or any) control premium is warranted, based on your company-specific analysis, or whether you need to reconcile the two.
Although the empirical data on invested capital premiums are new, the careful, case-specific analysis of any business valuation still applies to the ultimate selection and application of a control premium. Summary factors to keep in mind:
- Control premiums are not necessarily equal to acquisition premiums—analysts should understand differences and distinguish between the two;
- Prerogatives of control do not have value in isolation but instead have value based on changes to cash flow or risk that may result from a change in control.
- We have much better data available to help us select acquisition premiums and control premiums, but we still need to consider how variables such as size of the ownership block, type of transaction (strategic or financial), and leverage affect the premiums.
- In recent years, the difference in average premiums for strategic transactions versus financial transactions has narrowed.
- Consider invested capital premiums and acquisition multiples when the capital structure of the comparable transactions differs from that of the subject company.
- An analysis that includes both controlling and noncontrolling DCFs may provide the most accurate estimate of a control premium.
To learn more about control premiums as they relate to business valuation, be sure to check out the new BVR Briefing—Control Premiums: A Deep Dive Into the New Data on Invested Capital Premiums. Preview the table of contents and look inside to learn more about how this invaluable resource can help any business valuation professional stay ahead of the game.
Editor’s note: This information is based on a portion of a webinar, Evaluating and Applying Control Premiums, conducted on March 31, 2021, by Timothy J. Meinhart and Nate Novak, both with Willamette Management Associates. A recording and transcript of the entire webinar is available.