No Country for Old Discounts: Rethinking Illiquidity and Minority Discounts in European Take-private Transactions

Abstract

This thesis challenges the existing understanding of control premia in take-private transactions, focusing on European developed markets between January 1st, 2000, and December 31st, 2022. Existing literature predominantly treats the observable premium in take-private transactions as interchangeable with the control premium. This thesis proposes that such an equivalence is a fallacy, as it overlooks that observable premia do not solely represent the value of control. However, previous studies often significantly encompass the synergistic benefits an acquirer anticipates from the transaction. This oversight conflates control premia with synergistic benefits, obscuring the actual value of control, a misinterpretation this research addresses by differentiating between control-related and synergistic benefits. Although this study primarily focuses on the nuances of the control premium, it inherently addresses the minority discount, given their inverse relationship (Pratt, 2009). By challenging conventional views on control premia, the thesis aims to provide a more accurate estimation of minority discounts in take-private transactions.
A critical distinction of this thesis is the adjustment for illiquidity in the observable transaction premium, which previous literature has overlooked. This adjustment is imperative, as delisting significantly increases share illiquidity, increasing the target company’s risk. Furthermore, controlling interests inherently face illiquidity due to lacking a formal market for controlling stakes. Hence, the concept of a liquid controlling interest does not exist. Although research suggests that the effects of control and illiquidity counterbalance each other (Pratt, 2009; Bernström, 2014), resulting in a net zero effect on the valuation of controlling interests, this oversimplification neglects the intricate relationship between control premia and liquidity discounts when estimating the actual value of control.
An options-based approach is applied when assessing the illiquidity discount for controlling interests in transactions where control is acquired. The methodology centers around Longstaff's (1995) lookback put option model due to its relevance in capturing the cost related to illiquidity. A probability-weighted exit assumption is introduced to refine the model's applicability and robustness. This adjustment aims to provide a more nuanced estimation of the time required to divest a controlling interest, considering actual data on the duration it takes to sell a controlling interest. Following this methodology, an average illiquidity discount of 26.8% is estimated.
When adjusting illiquidity, the observable premium becomes a gross transaction premium, increasing the average premium. A multiple regression model is employed to delineate the control premium, incorporating a range of determinants related to the transaction, target, and acquirer, including the determinants related to control. This approach yields an estimated control premium of 24.3%. Given the inverse relationship between the control premium and the minority discount, the minority discount is calculated at 19.5%.