Many financial managers, CFOs, analysts, and valuation specialists are familiar with the concept of a “control premium” or “premium paid” that is often observed when a public company is acquired. A control premium is most often measured with reference to the price paid to acquire the company and its trading price immediately prior to acquisition (or rumor of an acquisition). However, the observed premium may not represent a premium for conceptual control inasmuch as it conveys the quantification of actual changes that can be made by exercising that control.
This concept is discussed extensively in the context of fair value measurement in a valuation advisory document entitled The Measurement and Application of Market Participant Acquisition Premiums. This document, issued in discussion draft form in April 2013, was developed by a working group serving on behalf of The Appraisal Foundation’s Appraisal Practices Board. Travis W. Harms, CFA, CPA/ABV, Senior Vice President at Mercer Capital, is a member of the working group.
The term in the title of the document, the Market Participant Acquisition Premium (MPAP), is probably unfamiliar to many. According to the document, the working group’s purpose in introducing this new term was twofold: to emphasize the importance of the market participant perspective when measuring fair value, and to distinguish this premium from the more general (and occasionally controversial) notion of the control premium. The most common instances of fair value measurements that involve such premiums include Step 1 of the goodwill impairment test, portfolio valuation for investment companies, and application of the acquisition method of business combinations for step transactions.
So what are the economic benefits available to market participants that might substantiate an MPAP? The discussion document suggests such benefits are ultimately manifest in two ways: enhanced cash flows or lower required returns.
- Enhanced Cash Flows. Market participants often envision strategies to enhance revenue growth, profitability, and capital efficiency at a target company. Regardless of the source of the enhanced cash flow, these additional benefits would be incremental to the projected financial performance of the target business on a standalone basis.
- Lower Cost of Capital. Market participants may have a lower required return for a controlling interest in a business than for an otherwise comparable non-controlling interest. Factors contributing to a lower cost of capital might include optimization of the target’s capital structure, company size and diversification, reduced operating risks, and investment strategy improvements.
The MPAP discussion document goes on to describe eleven business characteristics that may influence market participant acquisition premiums, including the acquisition activity in the industry, stage in the company’s life cycle, size of the market participant relative to the target company, and the balance of information between the parties. While the window for interested parties to comment on the MPAP discussion draft has passed, the working group is incorporating the comments received and an exposure draft is expected to be released for additional commentary in the next few months. In the meantime, you can learn more about the MPAP in a webinar on Thursday, October 16, 2014 hosted by Business Valuation Resources. Travis W. Harms, CFA, CPA/ABV will be the featured speaker and will discuss the background of the MPAP, its use in fair value measurement, and implementation considerations. Click here to sign up.
- The Measurement and Application of Market Participant Acquisition Premiums (Discussion Draft)
- Comments Received on the Discussion Draft (via The Appraisal Foundation)
- Increasing Scrutiny for Fair Value Measurements