The market for corporate control is staggeringly large. In 2007 alone, the value of M&A transactions in the world was $4.8 trillion. Even in the wake of the economic crisis, it’s still a very active market with many complex features.
One of these features is the type of bidders involved in a corporate takeover auction. They fall into two categories: Strategic bidders such as competitors who are looking for long-term operational synergies, and financial bidders such as private equity firms and divisions of investment banks. Financial bidders are looking for financial synergies as well as for undervalued companies with the potential to improve operations.
In a recent study, Alexander Gorbenko and I looked at whether these bidders have systematically different valuations of target companies and found there are considerable differences across several dimensions.
In turns out that strategic bidders are willing to pay higher premiums relative to market values. On average, they are willing to pay a premium of 16.7% relative to the market value of the target at the time of the auction, while the same number for an average financial bidder is 11.7%.
Our hypotheses are that strategic bidders either generate additional operational synergies or their CEOs simply get some private benefits from making acquisitions.
While strategic bidders’ valuations tend to be higher, they also are more stable over time as economic conditions change. This is in contrast to financial bidders who are significantly affected by fluctuations such as a drop in the stock market. In those instances of low market returns , financial bidders appear to be willing to pay higher premiums relative to market values for targets.
This might be because decline in the market leads to misvaluation of many companies. Financial bidders are able to find good companies that were dragged down by the market and bid for them.
Financial bidders are also susceptible to changes in the debt markets. When the cost of borrowing goes down, their valuations are higher. Financial bidders tend to do a lot of leveraged buyouts, borrowing debt to finance the acquisition price, so it’s crucial that they have predictable and cheap access to a debt market. As those conditions evolve, it affects their ability to participate in corporate takeover auctions.
Another interesting finding was that the valuations of different financial bidders for the same target tend to look pretty much the same. Their valuations are to a large extent explained by observable factors like information about the targets from the market and financial statements. This isn’t that surprising considering that they often share a similar intent for the target company such as absorbing it with low leverage and selling it once exit opportunities become sufficiently good.
In contrast, strategic bidders’ valuations are less tied to publicly observable characteristics. Their synergies with the target company are very specific to their operations and thus are more likely to result in different valuations. This unobserved component is actually twice as important to strategic bidders as it is to financial bidders.Overall, the valuations of strategic and financial bidders substantially differ along multiple dimensions so it’s worthwhile for all parties involved to be aware of these factors and how they affect the takeover auction process.