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Valuation of Dual Class Shares

Authors:
  • Sutter Securities Financial Services, San Francisco

Abstract

Valuations of high-vote and low-vote shares are a subset of valuations applying control premiums, minority discounts, and marketability discounts. The premium for voting control should not be calculated on a per-share basis but instead should be determined as a percentage of the value of the entire company allocated to the class of high-vote shares.This article discusses empirical evidence as to premiums paid for classes of high-vote shares.
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BUSINESS
VALUATION UPDATE
TIMELY NEWS, ANALYSIS, AND RESOURCES
FOR DEFENSIBLE VALUATIONS
Vol. 23, No. 10, October 2017
Reprinted with permissions from Business Valuation Resources, LLC
Valuation of Dual Class Shares
By Gilbert E. Matthews, CFA,
Sutter Securities Inc. (San Francisco, Calif., USA)
The high-prole class action lawsuit between mi-
nority shareholders and Hollywood icon Jeffrey
Katzenberg over the additional consideration being
paid to him in the sale of DreamWorks to Comcast
1
puts the spotlight on “dual class” companies. Dual
class companies have classes of common shares
with unequal voting rights but equal or similar eco-
nomic interests (entitlement to earnings). For U.S.
companies, high-vote shares commonly have 10
times the votes but the same economic interest as
low-vote shares. In some cases, the superior class
elects a majority of the board and the class sold
to the public elects a minority of the board. In this
article, “dual class” includes companies with two
classes of common stock or more, and “low-vote”
shares include nonvoting shares.
Companies that choose a dual class structure
often posit that it enables the management to
take a long-term view by insulating it from the
pressures of meeting the market’s quarterly ex-
pectations. This protects the control sharehold-
ers, usually the founders, who own the high-vote
shares and retain voting control. The structure
serves to protect management from the possibility
of a hostile takeover (for better or worse). In recent
years, numerous companies, particularly in the
high-tech area, have elected to set up dual class
1 See Stephen Davidoff Solomon, “Lawsuit Aims at
Jeffrey Katzenberg and His Dual Class Shares,” New
York Times, July 8, 2016, available at www.nytimes
.com/2016/07/09/business/dealbook/lawsuit-aims-at-
jeffrey-katzenberg-and-his-dual class-shares.html.
structures and to issue low-vote shares when they
go public in U.S. markets.
Listing dual class shares in the U.S. The New
York Stock Exchange (NYSE) prohibited the listing
of nonvoting common shares from 1926 to 1985,
but it sometimes permitted low-vote shares, e.g.,
Ford Motor Co. In 1976, the American Stock Ex-
change (AMEX) permitted the listing of low-vote
shares provided that they could elect at least 25%
of the board and that the voting ratio was no worse
than 10 to 1. In the mid-1980s, high-vote shares
began being used as an anti-takeover device. The
NYSE responded in 1985 by permitting the listing
of low-vote shares with the AMEX limitations.
Several listed companies took advantage of this
rule change by creating a class of high-vote shares
through exchange offers or recapitalizations.
Since 1994, the NYSE has prohibited listed com-
panies from creating dual class shares or reducing
the voting rights of existing shares. Prior dual class
listings are grandfathered. Importantly, companies
that have dual class structures when they go public
may be listed, and nonvoting shares are no longer
banned. (Nasdaq now has the same standard.)
Opposition to high-vote shares. There is growing
opposition to dual class structures from institu-
tional investors. Major money managers in the U.S.
have begun to campaign actively against high-vote
shares. Sixteen rms managing over $17 trillion
in assets (including BlackRock, Vanguard, State
Street, and CalPers) recently formed the Investor
Stewardship Group, which indicated that it would
push for a ban on dual class shares and would seek
to have existing dual class structures phased out.
2 Business Valuation Update October 2017
VALUATION OF DUAL CLASS SHARES
Reprinted with permissions from Business Valuation Resources, LLC
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BUSINESS VALUATION UPDATE
R. JAMES ALERDING, CPA/ABV, ASA
ALERDING CONSULTING LLC
INDIANAPOLIS, IN
CHRISTINE BAKER, CPA/ABV/CFF
CHARTER CAPITAL PARTNERS
GRAND RAPIDS, MI
NEIL J. BEATON, CPA/ABV, CFA, ASA
ALVAREZ & MARSAL VALUATION SERVICES
SEATTLE, WA
JOHN A. BOGDANSKI, ESQ.
LEWIS & CLARK LAW SCHOOL
PORTLAND, OR
ROD BURKERT, CPA/ABV, CVA
BURKERT VALUATION ADVISORS LLC
MADISON, SD
DR. MICHAEL A. CRAIN, CPA/ABV, CFA, CFE
FLORIDA ATLANTIC UNIVERSITY
BOCA RATON, FL
MARK O. DIETRICH, CPA/ABV
FRAMINGHAM, MA
JOHN-HENRY EVERSGERD, ASA, CFA, MBA
PPB ADVISORY
SYDNEY, AUSTRALIA
NANCY J. FANNON, ASA, CPA/ABV, MCBA
MARCUM LLP
PORTLAND, ME
JAY E. FISHMAN, FASA, FRICS
FINANCIAL RESEARCH ASSOCIATES
BALA CYNWYD, PA
LYNNE Z. GOLD-BIKIN, ESQ.
WEBER GALLAGHER
NORRISTOWN, PA
LANCE S. HALL, ASA
STOUT RISIUS ROSS
IRVINE, CA
THEODORE D. ISRAEL, CPA/ABV/CFF, CVA
ISRAEL FREY GROUP LLP
SAN RAFAEL, CA
JARED KAPLAN, ESQ.
MCDERMOTT, WILL & EMERY
CHICAGO, IL
HAROLD G. MARTIN JR.
CPA/ABV/CFF, ASA, CFE
KEITER
GLEN ALLEN, VA
GILBERT E. MATTHEWS, CFA
SUTTER SECURITIES INC.
SAN FRANCISCO, CA
Z. CHRISTOPHER MERCER, ASA, CFA
MERCER CAPITAL
MEMPHIS, TN
JOHN W. PORTER, ESQ.
BAKER & BOTTS
HOUSTON, TX
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MBA, ASA, CPA/ABV, CVA, CFF
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LAKEWOOD, CO
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BRUEGGEMAN & JOHNSON
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TUCSON, AZ
On July 31, 2017, S&P Dow Jones Indices, which
manages the eponymous indices, announced
that companies with dual class structures would
no longer be admitted to the S&P 500, the S&P
MidCap 400, and the S&P SmallCap 600.2 A
few days earlier, FTSE Russell announced that it
would exclude companies from its indices unless
unrestricted shareholders held at least 5% of
voting rights. This decision will adversely affect
the market for companies with dual class struc-
tures because exchange-traded funds (ETFs) and
mutual funds based on these indices are major
participants in the market.
Market prices of high-vote shares are not in-
formative. Several studies have attempted to
determine the premium per share for high-vote
shares by comparing market prices of high-vote
and low-vote shares of the limited number of
U.S. companies where both classes are publicly
traded. These studies generally show that, on
average, high-vote shares sell at slightly higher
prices than low-vote shares of the same issuer.
However, the aggregate publicly traded high-
vote shares in the oat rarely can impact control
because the control party normally owns a major-
ity of the vote. Therefore, these studies are of little
value—if a company’s publicly traded high-vote
shares collectively cannot affect control, their
market-price shares cannot measure the value
of control.
Since the total number of publicly traded high-
vote shares are almost always a substantial
minority of the class, the market price of high-
vote shares seldom, if ever, is a direct func-
tion of the value of their voting power. Without
shares owned by insiders, purchasers of high-
vote shares in the market cannot acquire voting
control. It is not uncommon for high-vote shares
to sell at a discount to low-vote shares, primarily
due to the fact that, in most cases, the number
of publicly traded high-vote shares is materi-
ally lower than the number of publicly traded
2 Companies already in these indices were grandfa-
thered. The Dow Jones indices do not include any dual
class companies.
October 2017 bvresources.com 3
VALUATION OF DUAL CLASS SHARES
Reprinted with permissions from Business Valuation Resources, LLC
low-vote shares, and, therefore, the high-vote
shares are less liquid.
Premium in excess of economic interest. The
premium for voting control should not be calcu-
lated on a per-share basis but instead should be
determined as a percentage of the value of the
entire company allocated to the class of high-
vote shares. It is illogical to posit that the voting
premium per share is the same regardless of
the percentage of shares that are high-vote.
The relevant factor is the relationship between
the aggregate premium paid to the high-vote
shares as a class as a percentage of the aggre-
gate equity value of the company. We describe
the aggregate premium for the high-vote class
divided by the equity value of the company as
the “premium in excess of economic interest.
In the 1998 acquisition of Giant Food Inc. by
Royal Ahold N.V., the voting shares, which were
only 0.4% of the outstanding shares, received
a premium of 870% per share but an aggre-
gate premium in excess of economic interest
of 3.5%.
The “premium in excess of economic interest” in
a transaction is the difference between the con-
sideration the high-vote class would have received
with no premium and the consideration it received
in the transaction.3
As an example of the calculation of premium
in excess of economic interest, assume that a
company has 25% high-vote shares and 75% low-
vote shares and it exchanges high-vote shares for
low-vote shares on a 1.2-to-1 basis.
1.2 × 25% =30%
30% (high-vote) + 75% (low-vote) = 105%
30%/105% = 28.6%
The voting shares as a class have a 25% eco-
nomic interest before the transaction and 28.6%
3 If the nonvoting shares have a dividend preference, the
risk-adjusted present value of the preference is a prior
charge and should be excluded from the economic
interest that the two classes share pro rata.
after the unication, i.e., a 3.6% premium over
economic interest:
Data re: relative value of classes. To obtain data
that can be useful in determining the relative value
of high-vote and low-vote shares, we look at data
available from corporate events in U.S. dual class
companies. Some U.S. corporations with dual
class structures have been acquired; others have
combined high-vote and low-vote shares into a
single class through recapitalizations or reclas-
sications. Acquisitions and recaps of U.S. dual
class companies provide useful data as to relative
value in the U.S.
Historical data are available as to premiums
paid in acquisitions and in recapitalizations.4
In about 85% of acquisitions and recapital-
izations of U.S. dual class companies in the
past 30 years, both classes received the same
consideration. In this period, high-vote shares
received a premium in an average of 1.1 trans-
actions per year in the U.S. These transactions,
although a small sample, provide relevant and
useful data.
Why many high-vote shares have not received
premiums. The high-vote shares might not receive
a premium in an acquisition or recapitalization for
several reasons:
1. The by-laws require that high-vote shares
may not be transferred unless they are con-
verted into one-vote shares;
2. The by-laws provide that high-vote shares
will automatically be converted into low-
vote shares if transferred to a party not in
the control group;
3. Prior to an IPO, high-vote shareholders made
a commitment that all shareholders would
receive the same consideration in an acqui-
sition;
4 The benets of control and the legal standards differ by
country, so any analysis should be country-specic.
4 Business Valuation Update October 2017
VALUATION OF DUAL CLASS SHARES
Reprinted with permissions from Business Valuation Resources, LLC
4. The by-laws provide that consent of the low-
vote class was required for a merger;
5. Prior to a 2001 change in GAAP, an acquisi-
tion could be accounted for as a pooling of
interests;
6. The control shareholder owns a similar per-
centage of each class; and
7. High-vote shares collectively own materially
less than 50% of the total vote.
However, a few acquirers have paid premiums
even though the high-vote shares are receiving
a higher price to which they may not be entitled.
Courts have sometimes failed to enjoin acquisi-
tions by third parties who are paying a substan-
tial premium for low-vote shares. In some cases
where high-vote shareholders received a ques-
tionable premium, buyers have settled litigation by
agreeing to make additional payments to low-vote
shareholders, e.g., Afliated Computer Services,
Delphi Financial, and Robert Mondavi Corp.
In the recent sale of DreamWorks Animation SKG
Inc. to Comcast Corp., co-founder Jeffrey Kat-
zenberg received the same price per share as
low-vote shareholders. The Class B shares have
15 votes, and the Class A shares have one vote.
Katzenberg owns all of the DreamWorks’ Class B
stock and, with his Class A shares, owns 11.5%
of the shares but 60% of the vote. DreamWorks’
charter provides that minority shareholders
should receive the same treatment in a merger as
Katzenberg. However, he also received a “con-
sulting agreement” that gives him a potentially
highly lucrative participation in future prots of
certain operations. Class action litigation is in
progress.
U.S. transactions in which a premium was paid
for high-vote shares. We have compiled a da-
tabase of U.S. transactions since 1974 in which
high-vote shares were offered more than low-vote
shares and have calculated the premium in excess
of economic interest for each transaction. Exhibit
1 summarizes the premiums by decades.
In the 1980s, extremely high premiums in excess
of economic interest were paid for some high-
vote shares. Since 1990, the median premiums
are 2.3% and the means are 2.8%. On average,
since 1990, premiums are about 1% higher for
acquisitions than for recapitalizations. The data
are summarized in Exhibit 2.
Can minority shares in a high-vote class be
left out in the cold? Minority high-vote share-
holders can be excluded from a premium paid
to the control shareholders in an acquisition. The
Delaware Court of Chancery—the primary venue
for U.S. corporate litigation—decided in Resorts
Internatio nal 5 that minority high-vote shareholders
were not entitled to a premium. It ruled that the
minority’s Class B shares were functionally and
economically equivalent to the Class A shares,
which had only 0.01 votes per share, because cor-
porate control was in the hands of the shareholder
who owned a majority of the Class B. The control
shareholder had received $135 per share, and
all other shareholders of both classes received
only $36 per share. The Delaware Supreme Court
upheld the decision, agreeing that the noncontrol
high-vote shares had the same value as low-vote
shares.
The Simplot case. Premiums for a high-vote
class were addressed in a 1999 Tax Court case,
in which the court concluded that a class of
voting shares that owned less than 0.1% of the
5 In Re: Resorts International Shareholders Litigation,
1988 Del. Ch. LEXIS 130 (Sept. 9, 1988); aff’d, 570
A.2d 259 (Del. 1990).
Exhibit 1. Premiums Paid for High-Vote Shares
(Summary by Decade)
Period
Mean
Premium Median Premium Transactions
1975-1989 14.0% 15.0% 5
1990-1999 2.8% 2.1% 16
2000-2009 3.8% 3 .1% 11
2010-2017 1.4% 1.5% 7
October 2017 bvresources.com 5
VALUATION OF DUAL CLASS SHARES
Reprinted with permissions from Business Valuation Resources, LLC
total equity was worth a premium of 3% of the
total value of the subject company. J.R. Simplot
Co. had 141,289 Class B nonvoting shares and
only 76½ Class A voting shares (rounded). One
family shareholder owned 22½ voting shares,
and three (including the decedent) each owned
18 voting shares. The expert witnesses agreed
that a premium was applicable to voting shares
but disagreed as to the size of the premium.
The Tax Court rejected the estate’s position
that the premium should be calculated on a
per-share basis and stated that the premium
for the voting rights “should be expressed in
terms of a premium of the equity value.”
6 It
concluded, based on testimony as to publicly
available information on transactions in which
6 Estate of Simplot, 112 T.C. 130, 173 (1999). The writer
was an expert witness for the IRS in this case.
premiums had been paid for high-vote shares,
that a 3% premium applied to the voting shares
as a class.
The 9th Circuit rejected the premium the Tax Court
applied because the decedent’s minority block of
shares did not have control. In a 2-1 decision, it
decided that it was inappropriate to value a minor-
ity block of voting shares in relation to the value of
the entire class, since the minority could not elect
a director and could get no economic benet. The
majority decision did not discuss the Tax Court’s
determination that a premium is applicable to an
entire class of voting shares. It valued the estate’s
block of voting shares as economically equal to
nonvoting shares, stating:
There was no basis for supposing that what-
ever value attached to complete control[,] a
Exhibit 2. Premiums in Excess of Economic Interest Received by U.S. High-Vote Shares
0%
3%
6%
9%
12%
15%
18%
21%
24%
1975 1981 1987 1993 1999 2005 2011 2017
Recapitalizations
Acquisitions
6 Business Valuation Update October 2017
VALUATION OF DUAL CLASS SHARES
Reprinted with permissions from Business Valuation Resources, LLC
proportionate share of that value attached to
each fraction of the whole.7
The Tax Court’s view as to the possible “swing
vote” value of the estate’s 18 voting shares was
dismissed as speculative. The dissenting opinion,
however, argued that the estate’s voting rights had
incremental value even though the other family
members collectively had control and concurred
with the Tax Court.
I do not believe that the majority’s conclusion
comports with economic reality…. The hypo-
thetical buyer and seller of 18 [Class] A shares,
reasonably informed of all relevant facts, would
be aware of the interests of [the other share-
holders], and would negotiate a price that would
reect them. Given these facts, … I would afrm
the Tax Court’s decision.8
Courts have criticized directors and advisors
for not considering relative fairness. The Dela-
ware courts have criticized directors who did not
consider relative fairness in transactions where
high-vote shares received greater consideration
than low-vote shares. They have similarly criticized
nancial advisors for not addressing the issue in
their fairness opinions.
In 2002, Reader’s Digest proposed a recap in
which about half of the voting shares would be
bought at premium and the balance would be
exchanged for 1.24 shares of common. The Dela-
ware Supreme Court said:
[T]he Special Committee never sought, nor did
its nancial advisor, Goldman Sachs, ever tender,
an opinion as to whether the transaction was fair
to the Class A shareholders.... Given the obvious
conicting interests of the shareholder classes,
the conceded absence of an evaluation of the
fairness of the recapitalization on the Class A
shareholders is signicant.9
7 Estate of Simplot, 249 F.3d 1191, 1195 (9th Cir. 2001).
8 Ibid. at 1195.
9 Levco Alternative Fund, Ltd. v. Reader’s Digest Assoc.,
Inc. (“Levco”), 803 A.2d 428 (Del. 2002), 2002 Del.
In 2005, Tele-Communications Inc. agreed to a
transaction in which the 10-vote shares (TCOMB)
would receive 10% more in cash than the one-vote
shares (TCOMA). The Court of Chancery wrote:
DLJ failed to opine upon the fairness of the
TCOMB premium to the TCOMA holders.... The
Levco Court mandated more than separate anal-
yses that blindly ignore the preferences another
class might be receiving ... [T]he premium re-
ceived by the TCOMA holders ... must be bal-
anced with the fairness and magnitude of the
10% TCOMB premium.10
The court explained:
DLJ had opined “that, with respect to the
holders of each series of [Tele-Communica-
tions] Common Stock …, the Exchange Ratio
relating to such series is fair to such holders
from a nancial point of view.” ... Notably, the
DLJ opinion does not discuss the effect of the
TCOMB premium upon the TCOMA holders, i.e.,
whether the TCOMB premium was fair to the
TCOMA holders. Unfortunately for defendants,
Levco appears to mandate exactly such an anal-
ysis: that the relative impact of a preference to
one class be fair to the other class.11
Dual class—statutory appraisal. In Delaware
and in most other states, common shareholders
seeking appraisal are entitled to “fair value,” i.e.,
a pro rata share of the company’s equity with no
discounts for minority interest or lack of market-
ability and no premium for control. Under a fair
value standard, voting rights are not considered.
Thus, no premium can be applied to high-vote
shares in a statutory appraisal.
Sanity check. Valuations of high-vote and low-vote
shares are a subset of valuations applying control
premiums, minority discounts, and marketability
LEXIS 488 (Del. 2002) at *5-*6. The writer was an
expert witness for plaintiff in this case.
10 In re Telecommunications, Inc. Sh’h Litig., 2005 Del.
Ch. LEXIS 206 (Dec. 21, 2005) at *54-*55.
11 Ibid. at *52-*53.
October 2017 bvresources.com 7
VALUATION OF DUAL CLASS SHARES
Reprinted with permissions from Business Valuation Resources, LLC
discounts. Valuators should consider whether their
conclusions as to the value of specic shares are
consistent with the conclusions they would have
reached had the company not had more than one
class of shares. They should also ask themselves
whether their conclusions reect prices that are
consistent with what a willing buyer might pay and
a willing seller might accept for control.
Gilbert E. Matthews, CFA, is chairman of the
board and a senior managing director of Sutter
Securities Inc. (San Francisco) and can be reached
at gil@suttersf.com. He has more than 50 years of
experience in investment banking and has spoken
and written extensively on fairness opinions, cor-
porate valuations, and litigation relating to valua-
tions.
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ResearchGate has not been able to resolve any references for this publication.