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Inferences from the Academic Articles
The Bradley, Desai, and Kim results are very revealing. On average over
22 years, the acquirers actually gained, with a CAR of 1%. This means
that the acquirers are not paying for control! They are paying for expected
cash ¬‚ows. There is no information in this article to tell us how to break
down the CAR to the target between performance improvements and
synergies. However, the Maquieira, Megginson, and Nail article provides
some information to enable us to do that. The VPEs for the nonconglom-
erate acquirers were about 11% higher than they were for the conglom-
erate acquirers, which suggests that synergies account for the entire pre-
mium. Bidders are approximately four times the size of the targets in
their study.29 Multiplying the VPE differential of 11% 4 44% attrib-
utable to synergies. Since acquisition premiums are rarely even that large,
this is evidence that acquisition premiums are being paid exclusively for
pure synergies and not for performance improvements.
The Roach article suggests the opposite”that the majority of the
increase should be from performance improvements, since there was no
pattern to the acquisition premiums by the difference in SIC codes. The
two articles used different schemes for determining a potential synergistic
merger. Maquieira, Megginson, and Nail only require that the two ¬rms
be in the same two-digit SIC code. A merger of SIC codes 3600 and 3699
would be nonconglomerate, while in Roach™s work they would be a dif-
ference greater than 50 and presumably the equivalent of conglomerate,
although he did not use that terminology. On the other hand, a merger


27. That also would be true about the portion of performance improvements that the bidder keeps.
28. We could add valuation corrections for underpricing errors to the previous list. To the extent
that bidders spot undervalued ¬rms and pay a premium for some or all of that
undervaluation, that portion does not belong in the control premium applicable to private
companies, as we already presume that the valuation before discounts and premiums was
done correctly.
29. The book value of total assets of the bidding ¬rms made up 81.2% of total assets of both ¬rms
combined, and the targets made up 18.8% of total assets.




PART 3 Adjusting for Control and Marketability
224
of SIC codes 3599 and 3600 would be a conglomerate merger according
to Maquieira, Megginson, and Nail, but a difference of one in the SIC
code in Roach™s work. It is logical that one can achieve synergies from
combining two ¬rms in similar but different businesses and that the two-
digit SIC code scheme is better for that purpose. For our analysis, we will
assume that the academic article is the more correct approach.30
Strong evidence supports this conclusion that acquirers are paying
for synergies and not control in Table 7-4, which compiles Mergerstat
acquisition premiums for control and minority interests. The average dif-
ference of control and minority purchase acquisition premiums was
0.16% (K7), and the average minority-to-control ratio was 99.11% (K8).31
If acquisition premiums were really measuring the value of control, then
minority interest acquisitions should have had a signi¬cantly lower pre-
mium. Instead, this is strong evidence that acquisition premiums are mea-
suring synergies, not control.
Back to Bradley, Desai, and Kim, in the 1981“1984 subperiod, the
acquirers did suffer a loss of 2.9%, as measured in CARs. This could mean
that the acquiring ¬rms were willing to suffer a net loss of 2.9% of market
capitalization for the privilege of control over the target. Since targets
were, on average, about one-fourth the size of the bidders, this translates
to 11.6% of target value. However, 4 years out of 22 does not seem enough
to assert strongly that this is a reliable control premium”let alone the
control premium.32
The Maquieira, Megginson, and Nail article provides similar results.
The only negative VPE was for the acquirers in conglomerate mergers,
who had a mean and median VPE of 4.79% and 7.36%. Multiplying
that mean VPE by four for the bidder-to-target size ratio leads to a pos-

T A B L E 7-4

Mergerstat Mean Premiums: Control versus Minority Purchases


A B C D E F G H I J K L

4 1990 1991 1992 1993 1994 1995 1996 1997 1998 Average
5 Control interest [1] 42.3% 35.4% 41.3% 38.7% 40.7% 44.1% 37.1% 35.9% 40.7%
6 Minority interest [1] 39.6% 32.6% 38.3% 38.3% 54.5% 61.7% 29.4% 22.4% 39.5%
7 Difference 2.7% 2.8% 3.0% 0.4% 13.8% 17.6% 7.7% 13.5% 1.2% 0.16%
8 Minority/control interest 93.6% 92.1% 92.7% 99.0% 133.9% 139.9% 79.2% 62.4% 97.1% 99.11%
← Total
9 SYD weights 2.8% 5.6% 8.3% 11.1% 13.9% 16.7% 19.4% 22.2% 25.0% 100.00%
10 SYD difference 0.1% 0.2% 0.3% 0.0% 1.9% 2.9% 1.5% 3.0% 0.3% 0.17%
11 SYD minority/control 2.6% 5.1% 7.7% 11.0% 18.6% 23.3% 15.4% 13.9% 24.3% 97.63%
13 # Transactions
14 Control interest 154 125 127 151 237 313 358 480 506
15 Minority interest 21 12 15 22 23 11 16 7 6

[1] Mergerstat 1999, Table 1-17, Page 25 (Mergerstat 1994, Figure 43, Page 100 for 1990-1993). Mergerstat is a division of Houlihan Lokey Howard & Zukin.




30. This is not to denigrate Roach™s work, which was very creative and is still signi¬cant evidence.
I made the same mistake in my own research.
31. In the data provided to me by Mergerstat, the average size of minority purchase was 38%.
32. Even though the regression coef¬cient was signi¬cant at the 0.01 level.




CHAPTER 7 Adjusting for Levels of Control and Marketability 225
sible control premium of 19.2% of the target™s pre-announcement value.
Perhaps this is a subset of the market that is paying something for pure
control, but it is not representative of the market as a whole.
Thus, it appears that our tentative conclusion, that the 7.4% differ-
ence between acquisition premiums in ordinary acquisitions and going
private premiums represents synergies, appears to be incorrect. However,
it is still possible that going private premiums might be the true control
premium. We will come back to this question.

The Disappearing Control Premium
Let™s consider the acquisition process. Conventional wisdom is that Com-
pany A buys control of Company B and pays, say, a 40% premium for B.
Therefore, B is worth 40% more on a control basis than on a marketable
minority basis. However, what happens after the acquisition? B no longer
exists as an entity. It is absorbed into A, which itself is a public ¬rm
owned by a large number of minority shareholders.
How can one justify the 40% premium to the shareholders of A?
Won™t the minority shareholders of A lose? If it is true that A is paying
purely for the control of B, then yes, they will lose, because the minority
shareholders of A pay for control that they ultimately do not receive.
Paying for control means that the buyer is willing to accept a lower rate
of return in order to be in control of the seller, and the Bradley, Desai,
and Kim results do not support that contention.33 After the acquisition,
who is in control of B? The management of A is in control, not the share-
holders of A. For there to be a pure value of control, it must go to man-
agement, who may enhance their salaries and perquisites for running a
larger organization. It makes sense that if ¬rms are paying for control
anywhere, it is in conglomerates. That only goes so far, though, before
the shareholders revolt or another ¬rm comes along and makes a hostile
takeover, booting out the inef¬cient management team (or a team who
looks after its own interests at the expense of the shareholders).
This seems to suggest that Mercer (1998) and McCarter and Glass
(1995) are correct. There is no value to control in itself. The appraiser
should simply try to quantify the performance improvements that one
can implement in the subject company, if they are relevant to the purpose
of the valuation, and proceed with the discounted cash ¬‚ow or guideline
company valuation. The difference in the marketable minority value and
the ˜˜control value™™ comes from the changes in cash ¬‚ows, not from a
control premium.

The Control Premium Reappears
Does this mean there is no such thing as a value to control? No. It™s just
that we cannot ¬nd it directly in the U.S. M&A market or in the public
markets, with the possible exception of the conglomerate mergers in the
Maquieira, Megginson, and Nail article. The reason is that there has to
be one individual or a small group of individuals34 actually in control


33. Again, with the possible exception of the 1981“1984 period.
34. Henceforth, for ease of exposition, reference to one individual in this context will also include
the possibility of meaning a small group of individuals.


PART 3 Adjusting for Control and Marketability
226
who derive psychic bene¬ts from it for there to be a pure control pre-
mium”and there is no such thing in the United States”almost.

Estimating the Control Premium
We begin the process of estimating the control premium by starting with
the voting rights premium (VRP) data, which show that there is a value
of the vote to individual shareholders. If the vote has value, then logically
control must have more value”but again only to an individual who is
really in control.
Our VRP analysis shows two levels of voting rights premium. The
gross premiums were 5.4% and 3.2% in the United States from the Lease,
McConnell, and Mikkelson study and the HLHZ study, and 13.3% in
England, per Megginson (1990). The net premiums”meaning those
above and beyond expected higher cash ¬‚ows to the voting stock”were
1“1.4%. For the valuation of most small and medium-size businesses, the
gross VRP is the more relevant measure, for reasons we will discuss
shortly.
The U.S. gross VRPs average 4.3%, i.e., the average of the 5.44% and
3.2% gross VRPs from Lease, McConnell, and Mikkelson and HLHZ ar-
ticles. According to Professor Megginson, we then need to add another
2% to 3%, say 2.5%, for the depressing effect on the VRP of the illiquidity
of the voting shares, which brings us to 6.8%, which we round to 7%.
Control must be worth at least three to four times the value of the
vote. That would place the value of control to an individual at at least
21“28%. It could easily be more. Currently, the only possible direct evi-
dence in the United States is the conglomerate control premium of 19.2%
in the Maquieira, Megginson, and Nail article, which is very close to the
above estimate. The VRP in Switzerland, Israel, and Milan of 20%, 45.5%,
and 82%, respectively, is another indication of the value of control when
minority shareholders are not well protected, again keeping in mind that
those were the value of the vote, not control.
Another piece of data indicating the value of control is the one outlier
in the Lease, McConnell, and Mikkelson study, which had a 42% VRP.
Such a high VRP in the United States is probably indicative of control
battles taking place and could rapidly reduce to a more normal VRP.
Thus, the voting shareholders probably could not rely on being able to
resell their shares at a similar premium at which they buy. That 42%
premium is evidence of the value of the vote in an extreme situation when
small blocks of shares would have a large impact on who has control.
The reason why the gross VRP is relevant for most businesses in the
process of inferring the value of control is that as long as the buyer of a
business can turn around and sell the business for the same control pre-
mium as he or she bought it, there is no loss in net present value of cash
¬‚ows, other than the pure control portion, which derives from the net
VRP.35 The buyer will eventually recoup the control premium later on as
a seller. That works as long as the business is small enough that its buyers


35. There is actually a second-order effect where this is not literally true. To the extent that the
owner is taking implicit dividends in the form of excess salary, there is some loss in present
value from this.


CHAPTER 7 Adjusting for Levels of Control and Marketability 227
will be either private individuals or private ¬rms. If the business grows
large enough to be bought by a public ¬rm or undergoes its own IPO,
then instead of recouping a private control premium, the owner may
receive an acquisition premium with synergies in the case of a buyout.
In the case of an IPO, the company will experience an increase in value
from increased marketability.36 Also, while the control premium will be
smaller, DLOM may also be smaller.
The best source of data for control premiums and DLOC for private
¬rms in the United States will probably come from a thorough analysis
of the international literature. The publicly traded ¬rms overseas are
probably better guidelines to use to understand the value of control than
United States ¬rms for two reasons. The ¬rst reason is that in most foreign
countries”especially those outside the United Kingdom”ownership of
public ¬rms is far more concentrated than it is in the United States. The
second reason is that the minority shareholders there are far more vul-
nerable to abuse by the control interests, which is closer to the case in
privately held ¬rms in the United States.
Unfortunately, that will have to remain as future research. In the
meantime, I would suggest that the 21“28% control premium based on
the gross VRP is probably reasonable to add to a marketable minority
FMV”at least for small and medium ¬rms. For large private ¬rms, that
range may still be right if a synergistic buy is likely in the future. Oth-
erwise, it is probably more appropriate to use a smaller control premium
based on the net VRP, which would be in the 3“6% range.
At this point, we need to compare our control premium inferred by
VRPs with going private premiums, as the latter is also a candidate for
our measure of the value of control. The median going private premium
of 24.1% (Table 7-1, E21) is right in the middle of our 21“28% range for
control calculated by VRPs. However, the mean going private premium
of 32.1% (Table 7-1, D21) is above our VRP-calculated range. Which is
more likely to be right?
The going private premiums have the advantage of being directly
calculated rather than indirectly inferred, so that is one point in their
favor. There is no consensus in the valuation profession in general
whether medians or means are better measures. All other things being
equal, then, it would make sense to use the median, as it is consistent
with the VRP-calculated control premium. I more often use means than
medians, which leaves me a little dissatis¬ed relying solely on the con-
sistency of the two measures.
There is other logic that convinces me that the lower measure of
control is more correct. What are the motivations for going private? The
management team may believe:
(1) The company is underpriced in the market.
(2) Removing the burdens of SEC reporting will increase
pro¬tability.


36. The appraiser must consider the issue of restricted stock discounts in this case.




PART 3 Adjusting for Control and Marketability
228
(3) If the going private transaction is a division of a public
company, it can operate more ef¬ciently without interference
and the burden of overhead from the corporate people.
(4) The management group and the buyout group want to be in
control of the company.

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