What is Offer Price in M&A?
The Offer Price in mergers and acquisitions (M&A) refers to the monetary value that an acquirer proposes to pay in order to obtain control of a target company.
The implementation of a systematic approach to performing diligence on a potential M&A deal is necessary for practitioners to arrive at a reasonable offer price—or appropriateness of the purchase price—which is set based on an in-depth understanding of the transaction dynamics and optimizing the levers that improve the likelihood of attaining a positive outcome.
How to Calculate Offer Price in M&A
The offer price serves as the foundation for negotiations to occur between the acquirer (or “buyer”) and acquisition target (or “seller”), as part of a potential M&A transaction.
The opportunities for organic growth normally decline as corporations continue to mature and reach the later stages of their business lifecycle.
Therefore, late-stage corporations frequently must engage in M&A to achieve a stable growth rate consistent with trailing periods via inorganic growth strategies, which refers to the growth that stems from mergers, acquisitions, strategic alliances (or partnerships), and joint ventures (JV).
The offer price is the amount that the acquirer is willing to pay to purchase the target company, most often presented as a premium over the current market value of the target.
Embedded within the offer price is the control premium (or acquisition premium), which normally ranges between 25% to 30% in excess of the acquisition target’s normalized share price, but can deviate substantially based on the deal dynamics and prevailing market conditions, such as the interest rate.
In short, the offer price is one of the most significant factors that dictate the outcome of an M&A deal, so the process of arriving at an offer price requires a complex negotiation process between the buyer and seller, in which the deal terms must be deemed amicable to both sides to reach deal-closure.
- Buyer Incentive ➝ From the perspective of the buyer, the incentive is to ensure the offer price is “reasonable” to reduce the risk of overpaying, which is the most commonly cited cause for failed M&A deals.
- Seller Incentive ➝ The seller, on the other hand, strives to maximize the offer price, on behalf of their stakeholders (i.e. “best interests”).
Strategic vs. Financial Buyer: Impact on Offer Price
In M&A, the buyer profile—the classification as either a strategic acquirer or financial buyer—is one of the main determinants of the control premium.
- Strategic Acquirer ➝ Generally, the acquisition premium is much higher for transactions that involve a strategic acquirer—i.e. a corporation acquiring another company—relative to deals where the acquirer is a financial buyer, like a private equity firm. Strategic acquirers can reap substantial long-term monetary rewards via the realization of synergies post-consolidation, which raises the maximum amount that the buyer is willing to pay to purchase the target company.
- Financial Buyer ➝ Financial buyers, such as private equity firms (PE), cannot benefit from synergies in an acquistion, and must prioritize generating sufficient returns on an investment, namely the internal rate of return (IRR) and multiple on invested capital (MOIC). The trend of add-on acquisitions, where a platform purchases a smaller-sized target, has closed the gap is recent times, as firms can afford to pay more considering synergies can be realized post-closing.
Offer Price Formula
The offer price formula multiplies the offer price per share by the fully diluted shares (FSDO) of the acquisition target.
Where:
- Offer Price per Share ➝ The offer price per share refers to the proposed purchase price to acquire a stake in the seller’s equity, expressed on a per-share basis.
- Fully Diluted Shares Outstanding (FDSO) ➝ The fully diluted share count is the total number of shares outstanding, where the dilutive securities issued by the target company—such as options, warrants, and convertible securities—are accounted for.
Given the offer price per share, the formula to compute the control premium divides the offer price per share by the current stock price of the acquisition target, expressed as a percentage.
The “unaffected” share price—which refers to the normalized stock price of the acquisition target prior to the impact of leaked acquisition rumors or speculation among market participants—must be used is to determine the control premium (or acquisition control).
Given the necessity of a control premium to incentivize the seller, the offer price is higher than the unaffected share price in M&A, barring extraordinary circumstances.
In contrast, the offer price can also be calculated using the purchase multiple method, where a relevant multiple is applied to an operating metric of the target, most often EBITDA.
If the valuation multiple used to determine the offer price consists of enterprise value in the numerator, like EV/EBITDA or EV/EBIT, the output is the total enterprise value (TEV), or transaction value, representative of all stakeholders in a company’s capital structure (e.g. common equity, preferred stock, and debt).
But if the numerator of the valuation multiple is equity value, such as the P/E ratio, the resulting figure is the implied equity value, which measures the value attributable to only equity shareholders.
How Do Synergies Impact the Offer Price in M&A
The concept of synergies in M&A—which refers to the potential benefits that can be realized from the combination of two companies—are the primary determinant of an acquirer’s willingness to pay a premium in excess of the standalone value of the target company.
Synergies can be categorized into three buckets, which are each described in the following list:
- Revenue Synergies ➝ Revenue synergies refer to the generation of more sales post-consolidation relative to the sales if the two companies operated as independent entities. The upselling and cross-selling opportunities to reach a broader customer base and expand into new end markets, or developing more innovative product offerings by combining capabilities are common tactics employed to achieve revenue synergies.
- Cost Synergies ➝ Cost synergies stem from the reduction in incurred expenses, achieving economies of scale, and impleneting cost-cutting initiatives. The common strategies to realize cost synergies include removing redundant positions (or functions), consolidating facilities, optimizing supply chains, and leveraging the improved purchasing power to negotiate more favorable terms with suppliers or vendors.
- Financial Synergies ➝ Financial synergies describe the improved financial position and cost of capital (WACC) of the combined company. In short, a larger-sized, more diversified company can access cheaper financing (i.e. lower interest rate on debt) structured with more favorable borrowing terms. Further, certain deal structures can produce tax benefits that enhance the combined entity’s cash flow profile (i.e. NOLs).
The estimation of the synergies attributable to a particular transaction requires an in-depth forecast of the incremental cash flows expected to be generated post-closing.
The realization of synergies—asssuming the benefits do in fact materialize—is a time-consuming process with countless moving pieces, so the future cash flows must be discounted back to the present using an appropriate discount rate to calculate the present value (PV) of the synergies.
By comparing the present value (PV) of the synergies to the acquisition premium—the incremental value paid to purchase the target company, in excess of its pre-deal, standalone value—the likelihood of the deal creating value (or destroying value) can be determined.
If the PV of the synergies exceed the acquisition premium, the deal is implied to be accretive and thereby create more value on behalf of the acquirer’s shareholders.
- PV of Synergies > Acquisition Premium ➝ “Value Creation”
- PV of Synergies < Acquisition Premium ➝ “Value Destruction”
Conversely, if the premium paid is greater than the PV of the synergies, the acquirer is at risk of having overpaid for the purchased asset, and overpaying coincides with destroying shareholder value.
However, the acquirer can identify and capitalize on opportunities to benefit from synergies later on, distinct from the original estimates (i.e. the anticipated sources at closing).
Often, acquirers encounter unexpected obstacles upon deal-close, causing the realization of synergies in M&A to be easier said than done. For instance, management frequently underestimate the time, costs, and operational disruption from the integration of two companies, and cultural differences and missteps can contribute toward employee churn, low morale, and reduced productivity, impairing the realization of the expected synergies.
Offer Price Calculation Example: Acquisition of Wiz by Alphabet
In mid-2024, news circulated on the recent bid by Alphabet Inc. (GOOGL)—the parent company of search engine, Google—to acquire Wiz, a fast-growing cybersecurity startup, at a purchase price of approximately $23 billion.
Alphabet, the tech giant widely recognized as a market leader in the search engine vertical, cloud computing services, and AI technologies, offered to acquire Wiz to improve its cybersecurity capabilities.
Cybersecurity startup Wiz offers cloud-based security solutions provider for enterprise customers, and thereby was an attractive acquisition target that could have placed Alphabet in a strong position to better compete with industry leaders, Microsoft (MSFT) and Amazon (AMZN).
Google Cloud is trailing behind Microsoft Azure and Amazon Web Services (AWS) in the enterprise cloud security solutions market, at present.
The proposed $23 billion offer price represented a substantial premium over Wiz’s most recent valuation in the private markets of $12 billion from a funding round that closed around May 2023.
Given the $23 billion price tag, the acquisition premium to gain control of Wiz is implied to be 92%, reflecting the strategic value (and potential synergies) that Alphabet perceived from the deal.
- Offer Price = $23 billion
- Target Valuation = $12 billion
- Control Premium (%) = ($23 billion ÷ $12 billion) – 1 = 91.7%
Wiz ultimately decided to decline the $23 billion takeover bid from Alphabet, however, impeding an acquisition that, if closed, would’ve been Alphabet’s largest acquisition to date by a substantial margin, nearly double the $12.5 billion paid to acquire Motorola Mobility in 2012.
Assaf Rappaport, the co-founder of Wiz, stated the cybersecurity startup decided to instead pursue an initial public offering (IPO) in an internal memo shared with employees.
Wiz Internal Memo — Assaf Rappaport
“Wizards,
I know the last week has been intense, with the buzz about a potential acquisition. While we are flattered by offers we have received, we have chosen to continue on our path to building Wiz.
Let me cut to the chase: our next milestones are $1 billion in ARR and an IPO.
Saying no to such humbling offers is tough, but with our exceptional team, I feel confident in making that choice.
The market validation we have experienced following this news only reinforces our goal — creating a platform that both security and development teams love. We are grateful for the faith our employees, investors, and customers have in us as we build the best cybersecurity company in the world.
Thank you for your hard work and focus during these days, which helped us stay on track and finish the quarter stronger than ever. As we always say: LFG.
Assaf”
From the perspective of Alphabet, the strategic acquisition of Wiz would have enhanced its cybersecurity offerings, particularly in cloud security, where Wiz’s platform enables visibility, threat detection, and risk assessment across multi-cloud environments.
With the ongoing shift toward more enterprises migrating their data (and applications) to the cloud, the market opportunity could’ve been a compelling acquisition for Alphabet via the integration of Wiz’s offering into the Google Cloud platform, including the potential to attract more enterprise customers to its core platform.
Therefore, the integration of Wiz’s cutting-edge technology and expertise in-house presented an opportunity for Alphabet to differentiate its current cloud offerings from competing offerings in the market and expanded Google Cloud’s total addressable market (TAM), contributing toward considerable revenue growth.
The acquisition aligned with the strategic initiatives of Alphabet to secure its own cloud environment—i.e. the build-out of a more comprehensive, end-to-end solution spanning infrastructure and platform services, with far more advanced security capabilities—while capitalizing on customer dissatisfaction and concerns around recent security breaches.
The $23 billion acquisition offer represented a 92% premium to Wiz’s latest private valuation, with a clear pathway for the startup to access significant resources to improve its scale and accelerate revenue growth.
The offer price must have been deemed insufficient relative to the upside potential of the startup (and loss of control) — not to mention, the inevitable regulatory scrutiny that would have emerged if acquired, which can detract on the startup’s current growth trajectory and momentum.
With that said, Wiz is betting that more value can be created on behalf of its stakeholders by remaining independent and pursuing an initial public offering (IPO), in lieu of being acquired by Alphabet, including the potential to have a more significant impact on the enterprise cybersecurity market as a whole.
Considering Wiz managed to exhibit substantial revenue growth, reaching $100 million in annual recurring revenue (ARR) in merely 18 months and surpassing $350 million in ARR in early 2023, the reported figures support management’s notion that the startup is on course to soon become a market leading publicly-traded cybersecurity company.
Still, the high-profile acquisition offer from Alphabet—despite the fact that the offer was rejected—brought significant market validation and press coverage to Wiz, contributing toward widespread recognition as one of the most promising startups to monitor in the cybersecurity space in coming years.
In closing, Wiz seems to be well-positioned to become a market leader in the increasingly competitive (and critical) cloud security for enterprises, as the startup continues its current trajectory to attain $1 billion in ARR and plan to go public via an IPO.
