This content is from: Portfolio

I Will Pay More

3 reasons why buyers are shelling out rich premiums.

In the gloomy world of mergers and acquisitions, there is an encouraging note : Buyers are paying the highest premiums in years. Average premium – defined as bid price compared with the trading price one week before bid – reached 27 percent this year, up from 21 percent in 2005, according to data provider Dealogic. The premiums are richer for deals engaged in hot bidding wars : They reached 37 percent, much higher than in the past three years when they stood around 29 percent.

One obvious reason: Prices – the premium baselines – have been lowered. Even with a 31 percent bull run from its March low, the S&P 500 index is still 43 percent off the 2007 peak . “Many companies are under priced in the stock market today,” says Robert Profusek, a partner in the merger and acquisitions group at law firm Jones Day.

Second, good companies are unwilling to sell in this depressed market, and therefore buyers have to offer rich premiums to win over shareholders. “Potential sellers are repelled from this market place,” says Paul T. Weisbrich, senior managing director at California-based middle market investment bank McGladrey Capital Markets. “They just don’t want to sell into the negativity at market’s bottom.” This attitude creates what Weisbrich calls a “scarcity factor” that is, a small number of high quality sellers chased by many aggressive buyers.

Last, an enormous amount of capital competes for prime assets. Take the bidding war between the third largest British natural gas firm BG Group and Calgary-based Canadian oil company Arrow Energy to win the heart of Australian coal seam gas explorer Pure Energy Resources. Arrow made a stock-and-cash offer of $5.40 per share last December, only to be topped by BG Group’s all cash offer of $8.25 in February, a 57 percent premium. BG Group could well afford it: it sat on £1 billion of cash at the end of last year.

Private equity firms also have mountains of cash in their hands. Dow Jones reported that 173 private equity funds raised $54.9 billion in the first six months this year, on top of $287.5 billion raised in 2008 and $343.3 billion raised in 2007. “Fund raising continued but investing has slowed,” says McGladrey Capital Markets’ Paul T. Weisbrich. “People are saying it’s not funny any more. They really need to start putting money to work.”

That may be good news for sellers. The rich premiums are likely to stay.

Xiang Ji (Nina) is the capital markets reporter at Institutional Investor, covering mergers and acquisitions, debt and capital markets from an institutional investor’s perspective. Xiang Ji was formerly with BusinessWeek in China covering the wider business world. Send email to capitalbeat@iimagazine.com.

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