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Stock-for-Stock Mergers: An Empirical Study of Fairness Determinations in Fairness Opinions

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  • Sutter Securities Financial Services, San Francisco

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This study asks which valuation approaches and analyses are currently being used as the foundation for fairness opinions in stock-for-stock mergers involving US companies. An examination of the SEC's EDGAR database for the years 2009 through 2014 identified 146 proxy statements for stock-for-stock mergers containing 290 fairness opinions and descriptions of the approaches, methods, and analyses employed. We found that most opinions employed more than one approach, and that opinion providers (primarily investment bankers) determined the fairness of stock-for-stock mergers by considering relative analyses as well as customary valuation approaches. More than 90% of the fairness opinions utilized the two traditional ways to quantify going-concern value: the income and market approaches. In addition, more than 90% used one or more relative analyses. Relative analyses, which assess the relative fairness of the exchange ratios in a stock-for-stock merger, are applicable only when target shareholders continue to own an equity interest in the surviving company. Inputs used in the income approach and multiples used in the market approach were reviewed. Also, fees charged for public fairness opinions were examined.
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Stock-for-Stock Mergers: An Empirical Study of Fairness
Determinations in Fairness Opinions
Gilbert E. Matthews, MBA, CFA
This study asks which valuation approaches and analyses are currently being used
as the foundation for fairness opinions in stock-for-stock mergers involving US
companies. An examination of the SEC’s EDGAR database for the years 2009 through
2014 identified 146 proxy statements for stock-for-stock mergers containing 290
fairness opinions and descriptions of the approaches, methods, and analyses
employed. We found that most opinions employed more than one approach, and that
opinion providers (primarily investment bankers) determined the fairness of stock-for-
stock mergers by considering relative analyses as well as customary valuation
approaches. More than 90% of the fairness opinions utilized the two traditional ways to
quantify going-concern value: the income and market approaches. In addition, more
than 90% used one or more relative analyses. Relative analyses, which assess the
relative fairness of the exchange ratios in a stock-for-stock merger, are applicable only
when target shareholders continue to own an equity interest in the surviving company.
Inputs used in the income approach and multiples used in the market approach were
reviewed. Also, fees charged for public fairness opinions were examined.
Introduction
The Delaware courts, the most important state corporate
law courts in the United States, have held that the
procurement of fairness opinions in merger transactions
provides strong evidence of fairness if litigation later
ensues. Their presence buttresses the board of directors
fiduciary duty to decide the fairness of the proposed
consideration to shareholders and then render their
recommendation of the transaction’s fairness on the basis
of the opinion as well as other factors. The Delaware
Supreme Court’s seminal Van Gorkom decision
1
held that
directors had breached their duty of care by approving a
transaction in which they had not obtained a fairness
opinion. The Court took the absence of an opinion as
evidence that the directors were not fully informed: ‘‘[I]n
the aftermath of Van Gorkom, the fairness opinion became
a de facto if not legal requirement throughout the United
States for targets in a corporate control transaction.’’
2
The
Delaware Court of Chancery recently wrote:
[The directors] . . . chose not to obtain a fairness opinion to
analyze the Merger or evaluate other possibilities from the
perspective of the common stockholders . . . even after
[acquirer’s] counsel expressed ‘‘concerns over [the] common
stockholders . . . not getting any consideration’’ and questioned
whether Trados needed a ‘‘. . . fairness opinion.’’ One can
remain appropriately skeptical of the value of fairness opinions
while at the same time recognizing that an outside analysis of
the alternatives available to Trados would have improved the
record on fair dealing.
3
The importance of fairness opinions to directors in
determining fairness makes it essential to understand how
opinion providers determine and substantiate their conclu-
sions. In the 2012 Cash Transaction Study published in this
journal, the author looked at cash acquisitions of US
companies to assess the valuation methods used to
substantiate conclusions of fairness in fairness opinions.
4
This study looks at the analyses employed by opinion
providers (primarily investment bankers) to substantiate
Gilbert E. Matthews, CFA, is Chairman of Sutter
Securities Inc. in San Francisco, California. He
headed the fairness opinion practice at Bear Stearns
in New York City for 25 years. He is on the editorial
review board of Business Valuation Resources.
Michelle Patterson, JD, PhD, assisted with concep-
tualization, organization, and writing.
1
Smith v.Van Gorkom, 488 A.2d 858 (Del. 1985).
2
Steven M. Davidoff, Anil K. Makhija, and Rajesh P. Narayanan,
‘‘Fairness Opinions in M&As,’’ in The Art of Capital Restructuring,ed.
H. K. Bakeker and H. Kiymaz (Hoboken, N.J.: Wiley, 2011), 496.
3
In re Trados Inc. Sh’holders Litig., 73 A.3d 17, 65 (Del. Ch. 2013).
4
Gilbert E. Matthews, ‘‘Valuation Methods in Fairness Opinions: An
Empirical Study of Cash Transactions,’’ Business Valuation Review 31
(2012):55 (‘‘the 2012 Cash Transaction Study’’ ).
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Business Valuation Reviewe
Volume 35 Number 4
Ó2016, American Society of Appraisers
fairness in stock-for-stock transactions in which the
consideration consisted solely of common stock.
There are distinct differences between cash mergers
and stock-for-stock mergers that affect fairness opinions.
In a cash merger, the target’s shareholders cease having
any interest in the surviving company, but ‘‘ [a] pure
equity exchange results in a continuing equity relation-
ship.’’
5
The underlying difference was explained by Prof.
Lawrence Hamermesh, who wrote:
[T]arget shareholders [in a] cash-out merger . . . have no
further equity claim to [future] gains, and therefore would
not otherwise share in them.
The case of a stock-for-stock merger, however, is starkly
different. In such a transaction, shareholders of both
constituent corporations remain shareholders in the continu-
ing combined enterprise. Thus, both groups—acquirer
shareholders and target shareholders—are able to participate
pro rata in gains arising out of the merger.
6
The substantive difference in consideration and conse-
quencesfor the shareholders in the twotypes of mergersleads
to use of an additional approach to fairness: relative analyses.
This approach, commonly used in stock-for-stock fairness
opinions, is inapplicable in cash mergers. In a cash merger,
equity interests in the target company are terminated in what
the courts have described as a ‘‘final-stage transaction.’’
7
In a
stock-for-stock merger, the target company’s shareholders
will continue as shareholders in the surviving company.
Relative analyses that compare financial, operating, and
market data for each of the combining companies—
contribution analyses, accretion/dilution analyses, and/or
comparative historical market prices—were utilized in the
stock-for-stock mergers surveyed in this article.
This article also reviews the quantitative valuation
approaches examined in the 2012 Cash Transaction
Study: the methods employed, their application, and
differences between the methods applied to financial
institutions and to other companies. Furthermore, this
study looks at fees charged for public fairness opinions, a
topic not discussed in the 2012 Study.
Proxy statements filed with the Securities and Exchange
Commission (‘‘SEC’’), which also serve as prospectuses for
the shares being issued to the target’s shareholders, supplied
the database for this study. The SEC requires that these
proxy statements contain detailed summaries of the
methodologies and analyses utilized by the firms rendering
the fairness opinions. We searched the SEC’s EDGAR
database for documents filed 2009 through 2014 in which
fairness opinions were rendered to a US incorporated
company in a stock-for-stock transaction and where the
smaller companies’ shareholders would end up owning at
least 10% of the combined company’s shares after the
merger.
8
Mergers were excluded if the consideration had a
cash component, if the acquisition value was under $10
million, or if either of the stocks sold at less than $1 per
share. Each fairness opinion description was studied to
determine the methods that were utilized.
We identified 146 stock-for-stock mergers containing
290 fairness opinions to US companies with summaries of
the methodologies used. For some companies, no opinion
was disclosed, either because the acquirer was not required
to have a shareholder vote
9
or the company was private. In
every instance where there was a shareholder vote, a
fairness opinion was received. Some companies received
two or more fairness opinions. Table 1 shows opinions per
company for targets and for acquirers.
The primary factors considered in these fairness
opinions were quantitative analyses, i.e., the income
approach (discounted cash flow [DCF] and discounted
dividend model [DDM]) and the market approach
(comparable companies and comparable transactions)
10
and relative analyses, i.e., contribution analysis, accretion/
dilution analysis, and/or comparative historical market
prices. More than 90% of the fairness opinions relied on
both of the primary quantitative approaches,
11
and more
than 90% also used one or more relative analyses.
Each description was reviewed to obtain the following
information:
Name of each company
Industry of each company
Date of filed document
Fairness opinion provider
Fairness opinion date
Whether the transaction was arm’s-length or with an
interested party
5
Brett A. Margolin and Samuel J. Kursh, ‘‘The Economics of Delaware
Fair Value,’’ 30 Del. J. Corp. L. 413, 432 (2005).
6
Lawrence A. Hamermesh, ‘‘Doctrines and Markets: Premiums in Stock-
for-Stock Mergers and Some Consequences in the Law of Director
Fiduciary Duties,’’ 152 U. Pa. L. Rev. 881 (2003):883–884.
7
See, e.g., Lonergan v.EPE Holdings LLP, 5 A.3d 1008, 1019 (Del. Ch.
2010); Steinhardt v.Howard-Anderson, No. 5878-VCL (Del. Ch., Jan.
24, 2011), transcript op. at 4.
8
The 10% cutoff was selected to eliminate transactions where the
shareholders of the smaller company had not received a significant
portion of the shares of the combined company.
9
A shareholder vote is usually not required unless ‘‘the number of shares
of common stock to be issued is, or will be upon issuance, equal to or in
excess of 20 percent of the number of shares of common stock
outstanding before the issuance of the common stock.’’ NYSE Listed
Company Manual, §312.03(c)(2).
10
Investment bankers customarily use the word ‘‘comparable’’ or
‘‘selected’’ rather than ‘‘guideline.’’ None of the fairness opinions
summaries used the word ‘‘guideline.’’ The Delaware courts also
generally use ‘‘comparable.’’ We therefore use ‘‘comparable’’ rather
than ‘‘guideline’’ in this article.
11
Because fairness opinions generally address the going-concern value
of companies, the third commonly used valuation approach, asset value,
is usually not considered directly (see ‘‘Alternative Valuation Methods
Used’’ below). However, in applying the market approach, multiples of
asset value are sometimes considered, particularly for financial
institutions (see ‘‘Multiples Used in the Market Approach’’ below).
Business Valuation Reviewe— Winter 2016 Page 121
Stock-for-Stock Mergers: An Empirical Study of Fairness Determinations in Fairness Opinions
Transaction price
Shares outstanding
Premium over latest closing price
Methodologies used
Discount rates used in DCF calculations
Whether WACC was expressly used
Terminal value calculations to determine:
Whether multiples or growth rates were used
What multiple or growth rate was used
Data point to which a multiple or growth rate was
applied
Width of range of multiples or growth rates
Data points used for comparable company and
comparable transaction calculations
Fees paid
Most of the information used was obtained from the
proxy statements/prospectuses for the mergers. Although
the proxy statements/prospectuses provided most of the
data, in some cases information such as a company’s
industry or the number of shares outstanding was not
included and was obtained from the company’s Annual
Report on Form 10-K or its Quarterly Report on Form 10-Q.
Approaches Used to Determine Fairness
Fairness Determinants Frequently Used in Fairness
Opinions
The quantitative valuation approaches most frequently
used are presented in Table 2, which also shows the use of
each of these approaches in the 2012 Cash Transaction
Study. Most opinions used only one form of the income
approach but both forms (comparable companies and
comparable transactions) of the market approach. Table 2
also shows the use of the premiums paid method (a
quantitative approach) and relative analyses, which are
applicable only when target shareholders continue to have
an equity interest in the surviving company.
Methods used in valuing financial institutions differ
materially in some respects from other corporate
valuations, and many of the tables in this article include
separate data for financial institutions that illustrate these
differences. Of the 106 fairness opinions for financial
institutions, ninety-five were for banks and eleven were
for other financial institutions. The fifty-two bank
mergers far exceed the number of stock-for-stock
transactions in any other industry in the 2009–2014
period.
12
Banks and other financial institutions accounted
for 36% of the fairness opinions reviewed. Table 2 shows
there were certain differences between financial institu-
tions and other companies in the use of methodologies.
Our review of the all the fairness opinions showed that
the income approach was used in 93% of the opinions and
the market approach in 96%. The income approach and the
comparable company method were employed in approx-
imately the same percentage of opinions as in the 2012
Cash Transaction Study, but comparable acquisitions were
used in a materially lower portion in this study for
companies other than financial institutions. This reflects the
fact that when the target shareholders receive more than
about 30% of the shares of the combined companies,
Table 1
Number of Fairness Opinions per US Company
Arms’-Length Interested Party
TotalTarget Acquirer Target Acquirer
Companies 129 129 17 17 292*
Opinions per Company
1 101 74 15 12 202
21419134
3–44
422
Companies with Opinions 117 97 16 12 242
Total Opinions 137† 124‡ 17§ 12 290
No Opinion Disclosed 3 27 1 36
Foreign Company 9 5 14
* 146 targets and 146 acquirers.
¼101 þ14 32þ234¼137.
‡74þ19 32þ433¼124.
§¼15 þ132¼17.
¶ Includes one opinion discussed in a proxy statement with no disclosure of methodology.
12
The industry with second largest number of mergers in the study is oil
and gas (eleven mergers with twenty-one opinions, 7% of the opinions
reviewed).
Page 122 Ó2016, American Society of Appraisers
Business Valuation Reviewe
investment banks are less likely to consider comparable
transactions as a foundation for their fairness opinions.
Table 3 shows that comparable acquisitions were used
in 85% of the transactions when the shares of the target
company received less than 30% of the shares, but only in
50% of the transactions when the target received more
than 30%.
13
The comparable transaction method was
used more often in fairness opinions rendered to the
acquirer than in opinions to the targets.
Table 4 shows the number of fairness opinions using
all three primary methods, as well as those using only
two, one, or none of them.
At least one of the three primary methods—compa-
rable companies, comparable transactions, and discount-
ed cash flow—was utilized in 98% of the fairness
opinions, and 83% of the opinions applied both DCF
and comparable companies.
14
Use of the Questionable Premiums Paid Method
One-third of the fairness opinions employed the
questionable ‘‘premiums paid’’ method.
15
‘‘Premiums
paid’’ are calculated by comparing transaction prices to
target companies’ market prices prior to the announce-
ment dates of the proposed transactions. Opinion
providers using this methodology have, as the universe
for their data, companies that were acquired. Companies
that were not acquisition targets and thus were not
acquired are, by definition, excluded. Because the data
include companies that were acquired and necessarily
exclude companies that were not targeted, the average
Table 2
Fairness Determinants Frequently Used in Fairness Opinions
Financial Institutions Other Companies Total
Percent in 2012
Cash Transaction Study
Opinions Percent Opinions Percent Opinions Percent Percent
Number of Opinions 106 184 290 352
Income Approach 100 94.3 169 91.8 269 92.8 91.9
Discounted Cash Flow 63 59.4 164 89.1 226 77.9 86.9
Discounted Dividend Model 37 34.9 8 4.3 46 15.9 4.3
Market Approach 108 97.2 169 90.2 269 92.8 96.0
Comparable Companies 98 92.5 166 90.2 264 91.0 93.8
Comparable Acquisitions 83 78.3 106 57.6 189 65.2 88.6
Premiums Paid* 36 40.4 49 30.2 85 33.9 48.3
Relative Analyses 100 94.3 165 91.2 258 91.8 NA
Contribution Analysis 64 60.4 135 73.4 201 69.3 NA
Accretion/Dilution 80 75.5 105 57.1 187 64.5 NA
Historical Market Prices* 25 28.1 115 71.0 140 55.8 NA
* Method not relevant in seventeen opinions for financial institutions and twenty-two opinions for other companies for mergers in
which there was no public market for shares of one party.
13
Since transactions where that the merging companies are of similar size
are often described as ‘‘mergers of equals,’’ it is understandable that
some investment bankers may conclude that change-of-control transac-
tions are not useful reference points.
14
Delaware courts have frequently expressed a preference for using more
than one valuation approach. Generally speaking, ‘‘it is preferable to take
a more robust approach involving multiple techniques—such as a DCF
analysis, a comparable transactions analysis (looking at precedent
transaction comparables), and a comparable companies analysis (looking
at trading comparables/multiples)—to triangulate a value range, as all
three methodologies individually have their own limitations.’’Merion
Capital, L.P. v. 3M Cogent, Inc., 2013 Del. Ch. LEXIS 172 (July 8,
2013) at *17–18, quoting Muoio & Co. v. Hallmark Entm’t Invs. Co.,
2011 Del. Ch. LEXIS 43 (Mar. 9, 2011) at *83–*84.
15
See, e.g., Gilbert E. Matthews and M. Mark Lee, ‘‘Fairness Opinions
and Common Stock Valuations,’’ in The Library of Investment Banking,
vol. IV, ed. R. Kuhn (Homewood, Ill.: Dow Jones Irwin, 1990), 407;
Eric Nath, ‘‘Control Premiums and Minority Interest Discounts in Private
Companies,’’ Business Valuation Review 9 (1990):41–43; Bradford
Cornell, Corporate Valuation (New York: McGraw Hill, 1993), 243;
Shannon P. Pratt, ‘‘Control Premiums? Maybe, Maybe Not—34% of 3rd
Quarter Buyouts at Discounts,’’ Business Valuation Update (January
1999):1–2; Richard A. Booth, ‘‘Minority Discounts and Control
Premiums in Appraisal Proceedings,’’ Business Law 57 (2001):127,
148–51 (2001); Davis Laro and Shannon P. Pratt, Business Valuation
and Taxes (Hoboken, N.J.: Wiley, 2005), 314–315; Z. Christopher
Mercer and Travis W. Harms, Business Valuation: An Integrated Theory,
2nd ed. (Hoboken, N.J.: Wiley, 2007), 81; Lawrence W. Hamermesh and
Michael L. Wachter, ‘‘The Short and Puzzling Life of the ‘Implicit
Minority Discount’ in Delaware Appraisal Law,’’ University of
Pennsylvania Law Review 156 (2007):23–24; Gilbert E. Matthews,
‘‘Misuse of Control Premiums in Delaware Appraisals,’’ Business
Valuation Review 27 (2008):118; Pratt, Business Valuation Discounts
and Premiums, 2nd ed. (Hoboken, Ill.: Wiley, 2009), 29–36; 2012 Cash
Transaction Study, 60–61.
Business Valuation Reviewe— Winter 2016 Page 123
Stock-for-Stock Mergers: An Empirical Study of Fairness Determinations in Fairness Opinions
premiums in announced transactions contain an upward
bias. Nonetheless, as noted earlier, we found that that
one-third of the opinions used this much-criticized
method.
We reviewed the data on a firm-by-firm basis and
found that a majority of large firms rarely used premiums
paid. Table 5 presents a firm-by-firm breakdown for
investment banks that rendered five or more opinions in
the periods reviewed and for all other firms in aggregate.
However, some large firms (Goldman Sachs, Morgan
Stanley, Barclays, and Credit Suisse) relied on premiums
paid in, on average, 38% of their opinions. Two
investment banks that specialize in commercial banks
(Keefe Bruyette & Woods and Sandler O’Neil) prepared
45% of the relevant fairness opinions for financial
institutions; they used the premiums paid method in
68% of their opinions.
As shown in Figure 1 (and as would be expected), the
premium paid tends to decrease as the percentage of the
equity received by target shareholders increases.
Alternative Valuation Methods Used
Alternative quantitative methods that were used in the
fairness opinions reviewed are summarized in Table 8.
The most widely used alternative approach, applied in
30% of the opinions, was a comparison of the transaction
price with target prices in security analyst reports. Since
good research coverage is a prerequisite for applying a
comparison of the value of the merger consideration with
analysts’ published target prices, this method is employed
primarily for companies whose shares are actively traded.
Among the major investment banks, the firms that
employed analysts’ targets in a majority of their opinions
were Barclays Capital, BofA Merrill Lynch, Morgan
Stanley, J.P. Morgan, and Lazard Fr`
eres. Collectively,
they considered targets in fifty-four of their seventy-nine
opinions.
The present value of the future stock price is computed
by multiplying historical (or anticipated) EBITDA
multiples or P/E ratios of the company and comparable
companies to the company’s projected EBITDA or EPS.
Goldman Sachs is a major proponent of this market-based
method, using it in nine of its eighteen fairness opinions
in this study. In the other 269 opinions, this approach was
applied only nine times.
Asset or liquidation value was used in twenty-eight
opinions. Asset value is commonly not employed in
fairness opinions, but it is relevant to certain companies
Table 3
Use of Comparable Transaction Method
Percent of Equity
Received by Target
Target Acquirer Total
Used Not Used Percent Used Used Not Used Percent Used Used Not Used Percent Used
.40.0% 19 26 42.2 28 29 49.1 47 55 46.1
30.0–40.0% 18 16 52.9 21 12 63.6 39 28 58.2
20.0–30.0% 35 9 79.5 30 4 88.2 65 13 83.3
10.0–20.0% 26 5 83.9 12 0 100.0 38 5 88.4
Table 4
Combinations of Primary Valuation Methods Used in Fairness Opinions
Primary Valuation Methods Used
Financial Institutions Other Companies Total
Opinions Percent Opinions Percent Opinions Percent
DCF, Comparable Companies and Comparable Transactions 76 71.7 100 54.3 176 60.7
DCF and Comparable Companies Only 18 17.0 53 28.8 71 24.5
DCF and Comparable Transactions Only 4 3.8 0 0.0 4 1.4
Comparable Companies and Comparable Transactions Only 2 1.9 6 3.3 8 2.8
DCF Only 2 1.9 14 7.6 16 5.5
Comparable Companies Only 2 1.9 7 3.8 9 3.1
Comparable Acquisitions Only 1 0.9 0 0.0 1 0.3
None of the Three Primary Methods 1 0.9 4 2.2 5 1.7
Total 106 184 290
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Business Valuation Reviewe
whose market value is closely related to the value of their
assets. Of these twenty-eight opinions, eleven were for
REITs (based on the value of their real estate) and nine
for oil and gas companies (based on the present value of
their reserves).
17
The sum-of the-parts approach, which was used in
seventeen opinions, is applicable to companies operating
Table 5
Firms Not Using or Using Premiums Paid as a Fairness Standard
Opinions* Premiums Paid Used Premiums Paid Not Used Percent
JP Morgan 26 1 23 4.2
Goldman Sachs 18 7 11 38.9
Morgan Stanley 18 6 11 35.3
Barclays Capital 15 4 7 36.4
BofA Merrill Lynch 14 0 11 0.0
RBC Capital Markets 7 0 5 0.0
Credit Suisse 7 3 4 42.9
Raymond James 7 1 6 14.3
Houlihan Lokey 6 1 5 16.7
Lazard Fr`
eres 6 0 6 0.0
UBS 6 0 5 0.0
Citigroup Global Markets 5 0 5 0.0
Deutsche Bank 5 1 4 20.0
Wells Fargo 5 0 4 0.0
Subtotal 145 24 107 18.3
Keefe Bruyette & Woods 26 14 8 63.6
Sandler O’Neill 20 13 5 72.2
Firms with Five or More Opinions 191 51 120 29.8
Firms with Four or Less Opinions 99 36 46 43.9
Total 290 85 166 33.9
* Including thirty-nine opinions in which premiums paid were not relevant because there was no public market for shares of one party.
Table 6
Use of Premiums Paid Method in Relation to Percent of Equity Received by Target Shareholders
Percent of
Equity
Received
by Target
Target Acquirer Total
Premiums
Paid
Not Used
Premiums
Paid
Used
Percent
Using
Premiums Paid
Premiums
Paid
Not Used
Premiums
Paid
Used
Percent
Using
Premiums Paid
Premiums
Paid
Not Used
Premiums
Paid
Used
Percent
Using
Premiums Paid
.40 29 11 27.5 39 10 20.4 68 21 23.6
30–40 18 8 30.8 19 9 32.1 37 17 31.5
20–30 22 16 42.1 16 15 48.4 38 31 44.9
10–20 18 12 40.0 5 4 44.4 23 16 41.0
87 47 35.1 80 38 32.2 167 85 33.7
Table 7
Average Premiums Paid in Relation to Percent of
Equity Received by Target Shareholders
Percent of Equity
Received by Target Mean Premium Median Premium
.40 12 10
30–40 14 13
20–30 26 18
10–20 45 36
All 23 16
17
Although financial institutions and regulated utilities are commonly
valued in part on their net assets, these asset-based values are
customarily determined by using the market approach, i.e., multiples
of tangible book value derived from comparable companies and
comparable transactions. See ‘‘Multiples Used for Financial Institutions’’
below.
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Stock-for-Stock Mergers: An Empirical Study of Fairness Determinations in Fairness Opinions
in diverse market sectors. A dozen of these opinions
were for electric utilities, where the regulated sectors of
the business were valued differently than the unregulat-
ed sectors. An LBO model, a valuation method used in
many fairness opinions for cash transactions, was used
in less than 1% of the opinions in stock-for-stock
mergers.
Relative Analyses
In stock-for-stock mergers, opinion providers have a
larger array of tools they can use to make a considered
judgment regarding the fairness of a transaction. As in
other transactions, they quantify value using the income
approach and the market approach, and they sometimes
use other quantitative measures. However, additional
Figure 1
Premiums Paid in Relation to Percentage to Be Owned by Target’s Shareholders
Table 8
Other Valuation Methods Used
Methods Used
Financial Institutions Other Companies Total
Number Percent Number Percent Number Percent
Target Prices of Security Analysts 10 10.1 75 41.2 85 30.2
Asset or Liquidation Value 1 1.0 27 14.8 28 10.0
Present Value of Projected Future Stock Price 0 0.0 18 9.9 18 6.4
Sum of the Parts 0 0.0 17 9.3 17 6.0
Leveraged Buyout (LBO) Model 0 0.0 2 1.1 2 0.7
Page 126 Ó2016, American Society of Appraisers
Business Valuation Reviewe
metrics of fairness—relative analyses—are available and
applicable to stock-for-stock mergers. Since the target
shareholders continue to own equity interest in the
surviving company, the question of fairness can be
conceptualized as ‘‘Will the future value of my equity
interest be greater than or less than it would be without
the merger? Will I be better off after this merger than
before?’’ ‘‘Better off,’’ ‘‘ greater than,’’ ‘‘ less than’’ are
relative comparisons that require not a fixed value, but an
assessment of the relative fairness of the exchange ratios.
Fairness in a stock-for-stock merger is therefore a
function of the relative value of the two parties. This
type of assessment is done through the use of relative
analyses, which take into account the fact that sharehold-
ers of both companies continue to be shareholders in the
surviving business.
There are three ways in which relative analyses are
used in fairness opinions: contribution analyses, accre-
tion/dilution analyses, and historical market prices. The
usage of these methods in the opinions reviewed is
summarized in Table 9.
A contribution analysis (sometimes called financial
impact analysis, pro forma merger analysis, or has/gets
analysis) measures the relative value of the two
companies, and it is independent of their respective
market prices. It is of particular relevance when the two
companies are in similar businesses. A contribution
analysis examines each company’s contribution to the
combined entity. It was used in 75% of the fairness
opinions issued to target companies. It is customary to
consider the implied exchange ratio based on data points
that are commonly considered in determining multiples,
such as revenues, EBITDA, and net income (see
‘‘Multiples in the Market Approach’’ below). Other data
points that are sometimes used, depending on the
company’s industry, include inter alia, free cash flow,
dividends, and net asset value. Production and reserves
are commonly used for oil and gas producers, and loans,
total deposits, and core deposits
18
are used for banks.
An accretion/dilution analysis examines whether the
merger is accretive or dilutive to shareholders, usually
with respect to earnings per share. Most of the analyses
that considered this approach looked only at short-term
effects; however, this approach is more meaningful when
it also looks at projected earnings in future years.
A review of historical market prices looks at the
exchange ratios implied by the two companies’ market
prices at various dates prior to announcement of the
proposed merger. Although this analysis is based on
historical data, the market’s view of future prospects at
any given time are reflected in the market prices.
Table 10 demonstrates that it is common for opinion-
givers to consider more than one of the three relative
analyses. About 87% of the opinions reviewed considered
either a contribution analysis and an accretion/dilution
analysis or both.
Inputs Used in DCF Analyses
WACC Was Widely Used for Determining Discount
Rates
Table 11 shows the number of opinions that specified
using WACC (weighted average cost of capital) for the
determination of discount rates. A substantial portion of
the proxy statement disclosures explicitly state that the
discount rates were calculated using WACC.
Half of the opinions did not explicitly state how the
discount rate was determined, but it is likely that many of
them utilized WACC without specific disclosure.
Terminal Value: Multiples Used More Often than
Growth Rates
The valuation community generally determines termi-
nal value using a growth model, the academically
preferred method. However, this study and the 2012
Cash Transaction Study show that the investment banking
community favors the use of multiples, primarily
multiples of EBITDA based on comparable companies
and/or comparable transactions. Table 12 shows the
number of opinions that used a multiple to determine
Table 9
Relative Analyses
Target Acquirer Total
Used Not Used Used Not Used Used Not Used Percent
Contribution Analysis 115 39 86 50 201 89 69.3
Accretion/Dilution Analysis 99 55 88 48 187 103 64.5
Historical Market Prices* 75 57 65 54 140 111 55.8
* Excluding 39 opinions in which there was no public market for shares of one party.
18
Core deposits are deposits made by businesses or individuals located in
the bank’s market area.
Business Valuation Reviewe— Winter 2016 Page 127
Stock-for-Stock Mergers: An Empirical Study of Fairness Determinations in Fairness Opinions
terminal value and the number using growth rates. Of the
232 opinions that calculated a terminal value, seventy-
four used multiples, and only twenty-nine used growth
rates (three used both).
We reviewed the data points to which multiples were
applied by the opinion providers for computing terminal
value, as well as the data points to which growth models
were applied. The information is presented in Tables 13
Table 10
Use of Relative Analyses
Number of Opinions
Target Acquirer Total Percent
Contribution Analysis, Accretion/Dilution and Historical Market Prices 38 35 73 25.2
Contribution Analysis and Accretion/Dilution (Historical Market Prices Not Applicable)* 11 8 19 6.6
Contribution Analysis and Accretion/Dilution Only 27 17 44 15.2
Contribution Analysis and Historical Market Prices Only 22 17 39 13.4
Accretion/Dilution and Historical Market Prices Only 7 8 15 5.2
Contribution Analysis Only 13 8 21 7.2
Contribution Analysis Only (Historical Market Prices Not Applicable)* 4 1 5 1.7
Accretion/Dilution Only 13 16 31 10.0
Accretion/Dilution Only (Historical Market Prices Not Applicable)* 3 2 5 1.7
Historical Market Prices Only 8 5 13 4.5
No Relative Analyses (Historical Market Prices Applicable) 6 11 17 5.9
No Relative Analyses (Historical Market Prices Not Applicable)* 2 6 8 2.8
Total 154 136 290
* Excluding 39 opinions in which there was no public market for shares of one party.
Table 11
Use of WACC
WACC Used Not Disclosed WACC Not Used
Percent Disclosing
Use of WACC
Percent Not
Using WACC
Firms with Five or More Opinions
Other than Bank Specialists 74 54 10 53.6 7.2
Bank Specialists 5 38 2 11.1 4.4
Firms with Four or Fewer Opinions 34 43 11* 38.6 12.5
Total 113 135 23 41.7 8.5
* Including two opinions that used the build-up method.
Table 12
Terminal Value Calculations
Basis of Calculation of Terminal Value
Financial Institutions Other Companies Total
Number Percent Number Percent Number Percent
Multiples Only 93 93.0 95 59.4 188 72.3
Growth Model Only 5 5.0 60 37.5 65 25.0
Both Multiples and Growth Model 2 2.0 5 3.1 7 2.7
Subtotal 100 100.0 160 100.0 260 100.0
‘‘Future Acquisition Value’’ 101
Not Disclosed 1 0 1
Product Life (No Terminal Value) 0 10 10
Total 102 170 272
Page 128 Ó2016, American Society of Appraisers
Business Valuation Reviewe
and 14. (Some opinions used more than one data point,
and some did not disclose the basis.)
EBITDA (or a variant thereof) was used in seventy-six
of the ninety-two multiple-based terminal value calcula-
tions for companies other than financial institutions.
EBITDA is not a meaningful data point for valuing
financial institutions because interest income and interest
expense are components of their operating income.
Terminal value calculations for financial institutions
relied predominantly on multiples of net income,
sometimes in conjunction with multiples of TNW.
Growth-rate-based terminal value calculations for nonfi-
nancial institutions were primarily based on free cash
flow.
Terminal Value: Growth Rates Used in Calculations
We reviewed the growth rates applied in calculating
terminal value in the growth model. In almost all cases, a
range of growth rates was used. The midpoints of the
ranges are shown in Table 15.
19
Although 3.0% was the perpetual growth rate most
often used, the median and mean growth rates were only
2.0%.
Multiples Used in the Market Approach
Multiples Used for Financial Institutions
The multiples applied in comparable company and
comparable transaction analyses of financial institutions
are shown in Tables 16 and 17, respectively. (Most
opinions used more than one data point.)
Table 13
Basis of Calculation of Terminal Value: Multiples
Data Point
Financial Institutions Other Companies
Using DCF Using DDM Using DCF Using DDM
Revenues NA 1 –
EBITDA NA 69 –
EBITDAR (EBITDA þRent Payments) NA 5
EBITDAX (EBITDA þExploration Expenses) NA 2
Broadcast Cash Flow NA 1
Cash Flow 2
Distributable Cash Flow 2 1 2
Net Operating Profit After Tax (NOPAT) 2
Net Income 52 31 8
Dividend 1 2 7 4
Tangible Net Worth (TNW) 21 8 3
Table 14
Basis of Calculation of Terminal Value: Growth Model
Data Point
Financial
Institutions
Other
Companies
Using
DCF
Using
DDM
Using
DCF
Using
DDM
Free Cash Flow (FCF) 1 58
Net Income – 2 – –
Dividends 3 3 4
Table 15
Midpoints of Growth Rates Used in Growth Models
Growth Rate Target Acquirer Total Percent
Negative 5 4 9 7.1
0% 2 2 4 3.2
.0%, ,1% 3 4 7 5.6
1% 7 6 13 10.3
.1%, ,2% 9 7 16 12.7
2% 12 7 19 15.1
.2%, ,3% 7 7 14 11.1
3% 15 13 28 22.2
.3%, ,4% 3 3 6 4.8
4% 1 2 3 2.4
.4%, ,5% 2 2 4 3.2
5% 2 2 1.6
.5% 1 1 0.8
65 57 122 100.0
Not Disclosed 3 1 4
71 59 130
19
Financial institutions are not shown separately because only four of the
opinions used a growth model.
Business Valuation Reviewe— Winter 2016 Page 129
Stock-for-Stock Mergers: An Empirical Study of Fairness Determinations in Fairness Opinions
An overwhelming majority of fairness opinions for
financial institutions considered multiples of equity value
both to tangible net worth and to net income. Multiples of
tangible net worth are commonly used for financial
institutions because banks’ earnings are a function of their
assets, and the earnings of insurance companies are a
function of the returns on investment permitted by
regulators. Yields on comparable companies’ shares were
used as a valuation standard in about 40% of bank
mergers but, surprisingly, yields were used in none of
comparable transaction analyses for financial institutions.
Multiples Used for Oil, Gas, and Coal Producers and
Pipelines
Analyses of extractive industries and pipelines often
use multiples that are not commonly applied to other
companies. Multiples applied in comparable company
and comparable transaction analyses of oil, gas, and coal
producers and pipelines are shown in Tables 18 and 19,
respectively.
The financial data points most commonly used for oil
and gas producers, coal companies, and pipelines were
multiples of enterprise value (EV) to either EBITDA or
distributable cash flow. Multiples of distributable cash
flow were primarily used by flow-through entities (LLCs
and limited partnerships). A measure sometimes used is
EV/EBITDAX (EBITDA plus exploration expenses),
which is a commonly used valuation measure for oil
and gas producers.
20
Net income was infrequently
utilized.
Table 16
Data Points Used in Comparable Company Analyses
of Financial Institutions
Data Point Banks
Other
Financial
Institutions Total Percent
Number of Opinions Using 87 11 98
Comparable Companies
Revenues NA 2 2 2.1
Net Income 83 7 90 91.5
Yield 39 2 41 40.4
TNW 85 10 95 96.8
Economic Net Income 2 2 2.1
Distributable Cash Flow 1 1 1.1
Table 17
Data Points Used in Comparable Transaction Analyses
of Financial Institutions
Data Point Banks
Other
Financial
Institutions Total Percent
Number of Opinions Using 70 11 78
Comparable Transactions
Revenues NA 1 1 1.3
Net Income 65 2 67 80.8
Yield 0 0.0
TNW 68 7 75 88.5
Table 18
Data Points Used in Comparable Company Analyses
of Oil, Gas, and Coal Producers and Pipelines
Data Point
Oil, Gas,
and Coal
Producers Pipelines Total Percent
Number of Opinions Using 18 6 24
Comparable Companies
EBITDA 9 4 13 41
EBITDAX 7 NA 7 29
Cash Flow* 10 4 14 44
Net Income 3 3 9
Yield 3 5 8 25
Production 10 NA 10 42
Reserves† 10 NA 10 42
* Primarily distributable cash flow.
† Including two using SEC PV10.
Table 19
Data Points Used in Comparable Transaction Analyses
of Oil, Gas, and Coal Producers and Pipelines
Data Point
Oil, Gas,
and Coal
Producers Pipelines Total Percent
Number of Opinions Using 13 7 20
Comparable Transactions
EBITDA 4 2 6 30
EBITDAX 4 NA 4 31
Cash Flow* 6 3 9 45
Net Income 0
Yield 1 3 4 20
Production 8 NA 8 62
Reserves 8 NA 8 62
* Primarily distributable cash flow.
20
Alex W. Howard and Alan B. Harp, Jr., ‘‘Oil and Gas Company
Valuations,’’ Business Valuation Review 28 (2009):30, 31.
Page 130 Ó2016, American Society of Appraisers
Business Valuation Reviewe
For extractive industries, a majority of the opinions
also considered production and reserves in comparable
company and comparable transaction analyses. Produc-
tion was valued using the ratio of enterprise value to
historical and/or estimated production, expressed in
dollars per barrel of oil equivalent ($/BOE) per day.
Reserves were valued using the ratio of EV to proved
reserves, expressed in $/BOE. Although asset-based
valuations of oil and gas companies usually included
probable and possible reserves, the valuations of
companies using the market approach relied solely on
proved reserves. It is likely that this limitation was
adopted because of limited data on probable and possible
reserves available from some of the comparable entities.
Multiples Used for Other Companies
The multiples used for all other companies are shown
in Tables 20 and 21, respectively. (The media category is
comprised of broadcasting, cable, and telecom.)
The principal multiple used in analyses of other
companies was EV/EBITDA (almost 75% of the
opinions). Revenues were used in 23% of the opinions.
P/E ratios were used in almost half of the comparable
company analyses, but only 19% of the comparable
transactions. The same anomaly was pointed out and
discussed in the 2012 Cash Transaction Study.
21
Since a
large portion of the comparable transactions used in the
Table 20
Data Points Used in Comparable Company Analyses of Companies Other than Financial Institutions, Oil, Gas, and
Coal Producers and Pipelines
Data Point* Airlines
Electric
Utilities Media REITs
All Other
Companies Total Percent
Number of Opinions Using Comparable Companies 5 22 16 17 75 135
Revenues 32 32 23.7
EBITDAR 5 1 3 9 6.7
EBITDA 16 16 9 58 99 73.3
EBIT 3 3 2.2
FCF 10 7 17 12.6
FF 16 5 21 15.6
Net Income 19 1 32 52 38.5
Cash EPS 4 4 3.0
P/E/G Ratio 1 2 3 2.2
Yield 7 7 5.2
TNW 1 1 5 7 5.2
* Omits data points that were used only in a single opinion.
Table 21
Data Points Used in Comparable Transaction Analyses of Companies Other than Financial Institutions, Oil, Gas, and
Coal Producers and Pipelines
Data Point*
Electric
Utilities Media REITs
All Other
Companies Total Percent
Number of Opinions Using Comparable Transactions 9 16 7 56 88
Revenues 20 20 22.7
EBITDAR 1 2 3 3.4
EBITDA 6 16 2 39 63 71.6
EBIT 2 2 2.3
Free Cash Flow (FCF) 4 2 6 6.8
Funds from Operations (FFO) 6 – 6 6.8
Net Income 6 11 17 19.3
TNW 1 4 4 5 5.7
* Omits data points that were used only in a single opinion.
21
2012 Cash Transaction Study, 70–71.
Business Valuation Reviewe— Winter 2016 Page 131
Stock-for-Stock Mergers: An Empirical Study of Fairness Determinations in Fairness Opinions
published fairness opinions were for public companies,
EPS data were available, and it is puzzling why so many
fairness opinion analyses failed to consider P/E ratios for
comparable transactions.
Because of the airlines’ extensive use of lease financing
for equipment and facilities, all of the airline opinions
relied solely on multiples of EBITDAR.
22
All of the
media companies were valued using multiples of
EBITDA. Many of these opinions also used multiples
of free cash flow. The bulk of the utility opinions relied
on multiples of both EBITDA and net income.
In REIT valuations, the primary multiple used was of
FFO (funds from operations), while EBITDA was
considered in about half of the opinions. Although REITs
are commonly purchased by investors as yield instru-
ments, few of the opinions valued them based on yield.
EBITDA was used in more than 70% of the valuations
in Tables 20 and 21. Both revenues and net income were
used in 43% of the comparable company valuations in
these opinions. In comparable transaction valuations,
revenues were used in 36%, but net income was used in
only 20%. In analyst reports, multiples of revenues are
frequently used as a valuation measure for companies
with no meaningful EBITDA, such as start-ups and
troubled companies. However, most of the opinions that
used revenue multiples also used EBITDA multiples, and
about half of them used P/E ratios. Unless there is a
strong correlation between revenues and profit margins,
the relevance of revenue multiples is questionable.
Fees Paid for Fairness Opinions
A substantial majority of the fairness opinions
reviewed were issued by firms who were financial
advisors to the target or acquirer and whose fees were in
whole or in part contingent on the completion of the
transaction. Only sixty-five (23%) of the opinions were
issued by firms engaged solely for the purpose of
opining as to the fairness of the transaction, including
twenty-four in which the firm was engaged by a special
committee of independent directors. When the advisor
was retained solely for a fairness opinion and not for
other services in connection with the transaction, the
entire fee became payable either on delivery of the
opinion or the signing of merger agreement in forty-six
(71%) of the sixty-five opinions, as shown in Table 22.
Only nine of the opinions, however, disclosed that the
opinion fee was payable regardless of the conclusion
reached. When financial advisors only become entitled
to their opinion fee when their opinion is positive, there
is a material economic disincentive to rendering a
negative opinion.
Advisors were retained by special committees for
thirty-four fairness opinions. In twenty-four they were
engaged solely for and opinion, and in ten, they provided
additional services, as shown in Table 23.
We reviewed the relationship between the size of
opinion fees and the equity value of the target companies.
The average opinion fee was approximately 0.5% of
equity value for transactions at the $25 million level,
declining to about 0.25% at $100 million, 0.1% at $1
billion, and 0.03% at $10 billion. Figure 2 shows the
opinion fees as a percentage of equity value in cases
where the advisor provided no other services. For
opinions where the financial advisor was paid a merger
advisory fee contingent on closing, Figure 3 shows the
portion, if any, of the fee (as a percentage of equity value)
that was described as being payable for the opinion.
23
We
observe that the trend lines in the two figures are
substantially identical.
We also reviewed the relationship between the fee paid
for the fairness opinion and the total fee paid to the
financial advisor in cases where the financial advisor was
Table 22
Advisor Engaged for Fairness Opinion Only
Percent of Fee Not Contingent on Closing
100 46*
50 to 80 8
30 to 40 3
19 to 29 3
0to15 3
Not Disclosed but .0 and ,100 2
65
* Includes nine not contingent on conclusion.
Table 23
Advisor Engaged by Special Committee
Percent of Fee Not
Contingent on Closing
Opinion
Only
Opinion þ
Advisory Services
100 12* 0
50–80 6 1
30–40 0 2
19–29 3 1
0–15 3 6
24 10
* Includes three not contingent on conclusion.
22
When calculating this multiple, practitioners should include the
capitalized value of the leases in the numerator. See ibid., 71–72.
23
No fee was paid for fifty-seven of the fairness opinions; the entire fee
for the opinion and the M&A advisory services was contingent on
closing. No breakdown of the fee was provided for thirty-one opinions.
Page 132 Ó2016, American Society of Appraisers
Business Valuation Reviewe
Figure 2
Opinion Fee as a Percentage of Equity Value of Target Company (No Advisory Fee)
Figure 3
Opinion Fee as Percentage of Equity Value of Target Company (Opinion Fees as Part of Advisory Fee)
Business Valuation Reviewe— Winter 2016 Page 133
Stock-for-Stock Mergers: An Empirical Study of Fairness Determinations in Fairness Opinions
not retained solely for a fairness opinion. Excluding the
transactions where either no opinion fee was specified or
there was no payment for the opinion, the average
opinion fee was 20% of the total fee and the mean was
19%. However, there was a substantial dispersion of the
data, as shown in Table 24. The portion of the fee
attributed to the fairness opinion was contingent on the
conclusion in all but five of these engagements.
Conclusions
The following conclusions are based on our review of
290 fairness opinions in stock-for-stock transactions:
1. Most fairness opinions rely on the primary quanti-
tative approaches: discounted cash flow, compara-
ble companies, and comparable transactions.
2. Importantly, because target shareholders continue to
be equity investors in the combined company, most
fairness opinions in stock-for-stock transactions also
use one or more relative measures of fairness: a
contribution analysis, an accretion/dilution analysis,
and/or a comparison of historical market prices.
3. Even though the ‘‘ premiums paid’’ method is
flawed, it nonetheless is used as a valuation standard
in a substantial minority of the opinions reviewed.
4. Other approaches sometimes used are (a) a
comparison with target prices of security analysts,
(b) asset or liquidation value, (c) the present value
of projected future price, and (d) a sum-of-the-parts
analysis.
5. DCF valuations in investment banks’ fairness
opinions more often calculate terminal values with
multiples (usually of EBITDA) than with a growth
model.
6. The ratio of EV to EBITDA (or a variant thereof) is
the primary multiple used for comparable company
and comparable transaction analyses, other than for
financial institutions, where it is inapplicable.
7. For financial institutions, the primary multiples used
for comparable company and comparable transac-
tion analyses are P/E ratios and the ratios of price to
book value or net asset value.
8. Fees for fairness opinions are, on average, about
20% of investment bankers’ fees for transactions.
9. A substantial portion of fairness opinion fees are
contingent on favorable opinions.
Table 24
Opinion Fee as Percent of Total Fee: Advisor Not
Retained Solely for Fairness Opinion
50% or more 6
40–49% 3
30–39% 16
25–29% 19
20–24 22
15–19% 28
10–14% 21
3–9% 23
Subtotal 138
Undisclosed but .0% 21
Undisclosed 6
0% 57
Total 222
Page 134 Ó2016, American Society of Appraisers
Business Valuation Reviewe
Presentation
Full-text available
Topics: 1. The perpetual growth rate and firm mortality 2. The relationship between capital expenditures and depreciation 3. The appropriate treatment of amortization 4. Projections, normalization, and steady state growth 5. The trend toward using lower long-term growth rates 6. The relevance of multiples for terminal value
Presentation
Full-text available
This presentation examines several factors that impact terminal value and how to address them: (i) the final year of the projection, (ii) the trend toward using lower long-term growth rates, (iii) the “perpetual” growth rate and firm mortality, (iv) the use of multiples for terminal value, (v) the relationship between capital expenditures and depreciation, and (vi) the appropriate treatment of amortization
Presentation
Full-text available
Topics: 1. The perpetual growth rate and firm mortality 2. The relationship between capital expenditures and depreciation 3. The appropriate treatment of amortization 4. Projections, normalization, and steady state growth 5. The trend toward using lower long-term growth rates 6. The relevance of multiples for terminal value
Chapter
Full-text available
A fairness opinion is a special form of valuation report, usually a letter, that is often viewed as a "shield" against potential legal damages. It states that, in the view of the investment banker, based upon certain procedures followed and assumptions made, a specific transaction at a specific price is fair, from a financial point of view, to specific parties. This chapter is organized in two major parts, (l) the definition of the engagement, and (2) valuation methodology. In most assignments, defining the valuation takes far less time than doing it. Nevertheless, a misunderstanding at the beginning of the engagement can •lead to wasted time and effort. At worst, it can cost the client millions of dollars and tarnish an investment banker's reputation.
Article
Full-text available
In statutory appraisal cases, Delaware Courts sometimes apply premiums that are based on questionable reasoning. They commonly adjust guideline company valuations for an ‘‘implicit minority discount’’, they apply acquisition premiums to subsidiaries, and they often rely upon average premiums in acquisitions as a basis for calculating control premiums. This article discusses the flaws in the reasoning underlying these adjustments.
Article
Full-text available
in a merger, a stockholder often has a statutory right of dissent and appraisal under which the stockholder may demand to be paid fair value exclusive of any gain or loss that may arise from the merger itself. Most courts and commentators agree that a dissenting stockholder should ordinarily receive a pro rata share of the fair value of the corporation without any discount simply because minority shares lack control. In several recent cases, the courts have indicated that a minority stockholder is thus entitled to a share of the control value of the corporation even though the merger does not constitute a sale of control (as in a going private transaction) and even though control of the subject corporation is not contestable (as where a single stockholder owns an outright majority of shares). In a similar vein, several courts have ruled that reliance on market prices for purposes of appraisal results in an inherent minority discount, thus requiring that a premium for control be added. In short, the emerging rule appears to be that fair value is the price at which a controlling stockholder could sell control because failure to do so amounts to imposition of a minority discount. It is the thesis here that the routine addition of a control premium is inconsistent with settled corporation law and good policy because (among other reasons) it is based on the unwarranted assumption that the source of a control premium must be a minority discount. To be sure, the courts should adjust for a minority discount if one is found. But the routine addition of a control premium as part of fair value creates a windfall for dissenting stockholders and infringes the legitimate rights of majority stockholders.
Article
The "implicit minority discount," or IMD, is a fairly new concept in Delaware appraisal law. A review of the case law discussing the concept, however, reveals that it has emerged haphazardly and has not been fully tested against principles that are generally accepted in the financial community. While control share blocks are valued at a premium because of the particular rights and opportunities associated with control, these are elements of value that cannot fairly be viewed as belonging either to the corporation or its shareholders. In corporations with widely dispersed share holdings, the firm is subject to agency costs that must be taken into consideration in determining going concern value. A control block-oriented valuation that fails to deduct such costs does not represent the going concern value of the firm. As a matter of generally accepted financial theory, on the other hand, share prices in liquid and informed markets do generally represent that going concern value, with attendant agency costs factored or priced in. There is no evidence that such prices systematically and continuously err on the low side, requiring upward adjustment based on an "implicit minority discount."Given the lack of serious support for the IMD in finance literature, this Article suggests that the Delaware courts may be relying on the IMD as a means to avoid imposing upon squeezed-out minority shareholders the costs of fiduciary misconduct by the controller. Where either past or estimated future earnings or cash flows are found to be depressed as a result of fiduciary misconduct, however, or where such earnings or cash flows fail to include elements of value that belong to the corporation being valued, the appropriate way to address the corresponding reduction in the determination of "fair value" is by adjusting those subject company earnings or cash flows upward.This approach to the problem of controller opportunism is more direct, more comprehensive in its application, and more in keeping with prevailing financial principles, than the implicit minority discount that the Delaware courts have applied in the limited context of comparable company analysis. The Delaware courts can therefore comfortably dispense with resort to the financially unsupported concept that liquid and informed share markets systematically understate going concern value.
) at *83–*84. 15 See, e.gFairness Opinions and Common Stock ValuationsControl Premiums and Minority Interest Discounts in Private Companies
  • E Gilbert
  • M Mark Matthews
  • Lee
) at *17–18, quoting Muoio & Co. v. Hallmark Entm't Invs. Co., 2011 Del. Ch. LEXIS 43 (Mar. 9, 2011) at *83–*84. 15 See, e.g., Gilbert E. Matthews and M. Mark Lee, ''Fairness Opinions and Common Stock Valuations,'' in The Library of Investment Banking, vol. IV, ed. R. Kuhn (Homewood, Ill.: Dow Jones Irwin, 1990), 407; Eric Nath, ''Control Premiums and Minority Interest Discounts in Private Companies,'' Business Valuation Review 9 (1990):41–43; Bradford Cornell, Corporate Valuation (New York: McGraw Hill, 1993), 243;
Business Valuation UpdateMinority Discounts and Control Premiums in Appraisal Proceedings Business Valuation and Taxes Business Valuation: An Integrated TheoryThe Short and Puzzling Life of the 'Implicit Minority Discount' in Delaware Appraisal Law
  • P Shannon
  • A Pratt Richard
  • Davis Booth
  • Shannon P Laro
  • N J Pratthoboken
  • N J Hoboken
  • W Lawrence
  • Michael L Hamermesh
  • Wachter
Shannon P. Pratt, ''Control Premiums? Maybe, Maybe Not—34% of 3rd Quarter Buyouts at Discounts,'' Business Valuation Update (January 1999):1–2; Richard A. Booth, ''Minority Discounts and Control Premiums in Appraisal Proceedings,'' Business Law 57 (2001):127, 148–51 (2001); Davis Laro and Shannon P. Pratt, Business Valuation and Taxes (Hoboken, N.J.: Wiley, 2005), 314–315; Z. Christopher Mercer and Travis W. Harms, Business Valuation: An Integrated Theory, 2nd ed. (Hoboken, N.J.: Wiley, 2007), 81; Lawrence W. Hamermesh and Michael L. Wachter, ''The Short and Puzzling Life of the 'Implicit Minority Discount' in Delaware Appraisal Law,'' University of Pennsylvania Law Review 156 (2007):23–24; Gilbert E. Matthews, ''Misuse of Control Premiums in Delaware Appraisals,'' Business Valuation Review 27 (2008):118; Pratt, Business Valuation Discounts and Premiums, 2nd ed. (Hoboken, Ill.: Wiley, 2009), 29–36; 2012 Cash Transaction Study, 60–61.
and a comparable companies analysis (looking at trading comparables/multiples)-to triangulate a value range, as all three methodologies individually have their own limitations
transaction comparables), and a comparable companies analysis (looking at trading comparables/multiples)-to triangulate a value range, as all three methodologies individually have their own limitations.''Merion Capital, L.P. v. 3M Cogent, Inc., 2013 Del. Ch. LEXIS 172 (July 8, 2013) at *17-18, quoting Muoio & Co. v. Hallmark Entm't Invs. Co.,
  • Del
  • Ch
Del. Ch. LEXIS 43 (Mar. 9, 2011) at *83-*84.
Control Premiums? Maybe, Maybe Not-34% of 3rd
  • P Shannon
  • Pratt
Shannon P. Pratt, ''Control Premiums? Maybe, Maybe Not-34% of 3rd