Buyers Remorse: Does the M&A Process Lead Buyers to Overpay?

Buyer’s remorse, also called winner’s remorse or winner’s curse is the realization that you have won an auction by paying more than anyone else was willing to pay.  Does winner’s remorse mean you have overpaid?  Not necessarily.

When managing a company sale, there comes a point when interested parties are requested to provide non-binding expressions of interest (called an EOI, this is the first indication of value based on reviewing the CIM and answering select questions, see: Steps in Selling a Business).

An expression of interest outlines a value range, structure and other criteria, on which potential buyers are prepared to move forward.  It is requested so as not to waste the seller’s time with potential offers that will not meet the needs of the seller.  When there are multiple expressions of interest for a company, they typically form a normal curve around the company’s intrinsic value.   In the case of a private business, a intrinsic value determination is one in absence of an open market transaction which is, in other words, the notional or stand-alone value.

Winners Remorse

So does the M&A process lead buyers to overpay?  Will there be buyers remorse?

Not necessarily, the process extracts the highest price for the seller by appealing to potential buyers that will benefit most from the purchase.  A buyer has to weigh the risks and benefits of the price they will pay versus not getting the business. Over-payment is in the news from time to time (examples have included HP writing off $8 billion of goodwill from its $13 billion acquisition of EDS and Microsoft writing off $6.2 billion of goodwill in its Online Services Division where it houses the acquisition of aQuantive which it acquired for just over $6.3 billion).  The onus is on the buyer to correctly estimate the realizable cash-flow from a purchase and then to execute on its plan.  Many things can go wrong in execution but the fact remains that if there is more than one buyer at the table it is highly likely that the winner will have paid more than the intrinsic value.

Rationale for paying more than intrinsic value

A strategic buyer may pay more than the intrinsic value for a business for reasons of competitive strategy (i.e. prevent a competitor from strengthening its footprint) or when the seller has certain assets that complement the buyer’s assets thereby allowing for the potential to create value through synergies. The value of a business is different to every potential buyer.  It is not like a consumer good with a price tag on a shelf readily available in many copies.  Every business is unique and and every buyer is unique resulting in a different value for each combination.

For example, to a financial buyer (one that does not have the potential for synergies, but may nevertheless be able to bring special expertise to the table) a business may be worth the intrinsic value which maybe six times EBITDA, generating a 17% non-levered ROI (maybe more than 30% with 50% debt); but a strategic buyer could pay seven times EBITDA and expect to generate even more based on synergies.  Non strategic/financial buyers are typically at or below notional value (E1..E4) and strategic buyers are typically at or above the notional value (E4..E7).

The parties engaged to go forward in the process will be the ones above notional value (E6..E7) suggesting that they may be ready to pay a higher price than intrinsic value, however, fair value is very much in the eye of the beholder.

Recommended Further Reading

For more on strategic buyers, see: Who Will Pay More, a Strategic or Financial Buyer

For more on a private equity buyer, see:  A second bite at the apple