What is Acquisition Premium?

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An acquisition premium is a figure that's the difference between the estimated real value of a company and the actual price paid to acquire it. An acquisition premium represents the increased cost of buying a target company during a merger and acquisition (M&A) transaction.There is no requirement that a company pay a premium for acquiring another company; in fact, depending on the situation, it may even get a discount.

Definition

An acquisition premium is the difference between a company's valuation and the actual purchase price paid during a merger or acquisition. It represents the additional cost of acquiring a target company. Companies do not always need to pay a premium when acquiring another company; in some cases, they might even receive a discount.

Origin

The concept of acquisition premium developed with the rise of corporate mergers and acquisitions. In the 1980s, as globalization and market competition intensified, M&A activities became frequent, making acquisition premiums a crucial metric for assessing the rationality of such transactions.

Categories and Features

Acquisition premiums can be categorized into strategic premiums and financial premiums. A strategic premium is paid for the strategic resources or market position of the target company. A financial premium is based on the expected future cash flows or profitability of the target company. Strategic premiums are usually higher due to long-term strategic benefits, while financial premiums focus more on short-term financial returns.

Case Studies

A typical example is Microsoft's acquisition of LinkedIn in 2016 for $26.2 billion, with a premium of about 50%. This was mainly due to LinkedIn's user data and social network platform's strategic value to Microsoft. Another example is Heinz's acquisition of Kraft Foods in 2015 for $45 billion, with a premium of about 27%, aimed at achieving cost savings and market expansion through the merger.

Common Issues

Investors often worry that a high acquisition premium may increase the financial burden on the acquiring company, affecting its future profitability. Additionally, a high premium might reflect overly optimistic expectations of the target company's value, posing a risk of overvaluation.

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