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

Winners remorse: does paying more for a business than anyone else mean you have overpaid?  Not necessarily.

When managing a company divestiture, 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 Small 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 notional value.   In the case of a private busines, a notional value determination is one in absence of an open market transaction which is, in other words, the intrinsic or stand-alone value.

EOI interest curve

So does the M&A process lead buyers to overpay?  Will there be winner’s remorse?  Not necessarily; the process extracts the highest price for the seller by appealing to potential buyers that will benefit most from the purchase.  The 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 include 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 notional value.

A strategic buyer may pay more than the notional value for a business for reasons of competitive strategy (i.e. prevent your 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.  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 notional 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.