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Organismo Italiano di Valutazione
Organismo Italiano di Valutazione
Annual International Conference
October 22, 2012
SUTTER SECURITIES GIL@SUTTERSF.COM
1 -415-352-6336
1
The points I will be discussing are:
Levels of value
The three meanings of the phrase “control
premium”
Evolving views on control premiums
Evolving views on control premiums
The statistical bias in acquisition premium
studies and the misuse of control premiums
How to quantify a control premium
Control premiums for private companies
Control premiums for high-vote shares
2
Levels of Value
Levels of ValueLevels of Value
Levels of Value
Levels of Value
Levels of ValueLevels of Value
Levels of Value
3
Control Value
Marketable Minority Value
Nonmarketable Minority Value
4
The levels of value chart in Pratt’s
Valuing a Business
Valuing a BusinessValuing a Business
Valuing a Business
shows five levels of value for publicly traded
companies:
Synergistic (strategic) value
Value of control shares
Value of control shares
Market value of freely traded minority shares
Value of restricted stock
Value of non-marketable shares
5
Strategic Control Value
Strategic Control ValueStrategic Control Value
Strategic Control Value:
the company’s value to a party that could achieve
synergistic benefits if it had control.
Financial Control Value
Financial Control ValueFinancial Control Value
Financial Control Value:
value without anticipated synergies, but including “the
value without anticipated synergies, but including “the
ability of a specific buyer to improve the existing
operations or run the target company more efficiently.”
Marketable Minority Value
Marketable Minority ValueMarketable Minority Value
Marketable Minority Value:
market value of freely traded minority shares.
Nonmarketable Minority Value
Nonmarketable Minority ValueNonmarketable Minority Value
Nonmarketable Minority Value:
market value of illiquid minority shares
6
Mercer presents his
revised levels of value
diagram in his book,
Business Valuation
Business Valuation Business Valuation
Business Valuation : An
Integrated Theory
Integrated TheoryIntegrated Theory
Integrated Theory
Integrated Theory
Integrated TheoryIntegrated Theory
Integrated Theory
It shows Marketable
Minority Value over-
lapping Financial
Control Value.
Source: Z. Christopher Mercer and Travis W. Harms, Business
Valuation: An Integrated Theory, 2nd Edition (Wiley, 2007), p. 71.
7
Mercer explains :
[U]nless there are cash flow-driven differences between
the enterprise’s financial control value and its marketable
minority value, there will be no (or very little) minority
interest
discount
.
interest
discount
.
Since most public companies are not taken over, . . . the
marketable minority and financial control value of most
public companies approximate each other.”
◦Mercer and Harms, Business Valuation: An Integrated Theory
, Business Valuation: An Integrated Theory, Business Valuation: An Integrated Theory
, Business Valuation: An Integrated Theory, 2nd Ed., p. 81.
8
Mercer points out that public market prices may
exceed Strategic Control Value at a level he calls
“Apparently Irrational.”
We have all seen numerous examples of this,
such as the “dot.com” bubble in the late 1990s.
9
10
Mercer, Business Valuation: An Integrated Theory
Business Valuation: An Integrated TheoryBusiness Valuation: An Integrated Theory
Business Valuation: An Integrated Theory, 1st Ed.
The Three Meanings of
The Three Meanings of The Three Meanings of
The Three Meanings of
The Three Meanings of
The Three Meanings of The Three Meanings of
The Three Meanings of
“Control Premium”
“Control Premium”“Control Premium”
“Control Premium”
11
Acquisition Premium
Strategic
Control
Premium
Strategic Control Value
Acquisition Premium
Strategic
Control
Premium
Financial
Control
Premium
Financial Control Value
Public M arket Value
12
The phrase “control premium with 3 different is used
to describe three different concepts.
Meaning #1: Acquisition Premium = Acquisition
Premium = difference between Strategic Control
Premium = difference between Strategic Control
Value and Public Market Value.
•Acquisition Premium is the only data point that is
directly observable in the market.
•It is the number used in acquisition premium
studies.
13
Meaning #2: Financial Control Premium
= difference between Financial Control Value and
Public Market Value
= the inverse of minority discount.
14
= the inverse of minority discount.
Meaning #3: Strategic Control Premium
= difference between Strategic Control Value and
Financial Control Value.
Ambiguity could be reduced if valuators,
commentators, and expert witnesses shared a
common language based on a commonly
-
shared
common language based on a commonly
-
shared
conceptualization.
15
Evolving Views on
Evolving Views on Evolving Views on
Evolving Views on
16
Evolving Views on
Evolving Views on Evolving Views on
Evolving Views on
Control Premiums
Control PremiumsControl Premiums
Control Premiums
Eric Nath’s conceptual breakthrough in 1990 was
widely criticized at the time.
[
A]n appraiser could utilize a control premium only if it could
be convincingly demonstrated that the comparative stocks
being utilized are undervalued, and a reasonable estimate of
17
being utilized are undervalued, and a reasonable estimate of
the magnitude of undervaluation can be established for each
stock, individually. This will be theoretically impossible in an
efficient market.
Eric Nath, “Control Premiums and Minority Interest Discounts in Private Companies,”
Business Valuation Review
, June 1990, p. 45
Another early criticism of the concept that all
transactions called for a control premium was
published in 1990.
Sometimes people attempt to determine the value of a
Sometimes people attempt to determine the value of a
corporation by adding an average acquisition premium to
the freely-traded value of a company’s common stock. ...
This procedure is usually unsound. An acquisition premium
is a result of factors unique to each transaction, and of the
degree of market undervaluation prior to the transaction.
Gilbert E, Matthews and M. Mark Lee, “Fairness Opinions & Common Stock Valuations” in
The Library of Investment Banking
The Library of Investment BankingThe Library of Investment Banking
The Library of Investment Banking,
Vol. IV
,
R. Kuhn, ed. (Dow Jones Irwin, 1990), p. 407
18
In 1993 Professor Bradford Cornell wrote:
[The fact that most companies do not receive takeover bids
companies do not receive takeover bidscompanies do not receive takeover bids
companies do not receive takeover bids
at premiums above market price indicates investors believe
that the shares of those companies are not worth
19
that the shares of those companies are not worth
significantly more than market price [emphasis in original].
Bradford Cornell,
Corporate Valuation
Corporate Valuation Corporate Valuation
Corporate Valuation
(McGraw Hill, 1993), p. 243.
Shifting from a position expressed in his 1996 3rd
Edition of
Valuing a Business
Valuing a BusinessValuing a Business
Valuing a Business
, Pratt wrote in 1999:
Valuation analysts who use the guideline public
-
company
20
Valuation analysts who use the guideline public
-
company
valuation method and then automatically tack on a
percentage ‘control premium’ … had better reconsider
their methodology.
Pratt, “Control Premiums? Maybe, Maybe Not – 34% of 3rd Quarter Buyouts
at Discounts,”
Business Valuation Update,
January 1999, pp. 1-2.
Pratt then wrote in 2001:
Out of the tens of thousands of public companies only a
small percentage actually are acquired each year. In recent
years the companies purchased have often been “best of
breed,” making them a very unique subset of the market.
21
breed,” making them a very unique subset of the market.
Statistically, it is unlikely that this small, select group is
universally representative of the market as a whole.
Pratt,
Business Valuation Discounts and Premiums (
Wiley, 2001), p. 60.
If there is no M&A market available to sell a company
at a premium to its stock market value, then there is
little or no acquisition premium, much less a “theoretical”
premium based on an average of acquisitions of dissimilar
companies.
M. Mark Lee, “Control Premiums and Minority Discounts: the Need for Economic Analysis,”
Business Valuation Update
, August 2001, p. 4
Lee pointed out, “Factors influencing the stock market often do
not coincide with those affecting the M&A market.”
He illustrated the fact with a diagram (on the next slide) showing
that the stock market and the M&A market are separate markets,
albeit with some overlap.
22
Acquisition Value
Exceeds Market Value
If A Buyer Exists
______________________
Acquisition Value
Equals Market
M&A Market
Equals Market
Value
______________________
Acquisition Value
Is Less than
Market Value
23
If all market prices were less than control value, then the M&A
market in Lee’s diagram would hover over the market like the
dot on an “i” instead of overlapping it.
M&A
M&A M&A
M&A
M&A
M&A M&A
M&A
market
marketmarket
market
Public
Public Public
Public
market
marketmarket
market
24
The legal community entered the fray in 2001:
[I]t is not necessarily the case that actual market price is
always less than fair market price. If it were, then there
would be no such thing as a fair market price.
Richard A. Booth, “Minority Discounts and Control Premiums in
25
Richard A. Booth, “Minority Discounts and Control Premiums in
Appraisal Proceedings,” 57 Business Lawyer 127, 130 (2001)
[A]lthough it is always appropriate to ask whether there is
some reason to distrust the market price in any given case,
it is clear that the market price is not always
alwaysalways
always low.
[Emphasis in
original]
... Indeed, in 1999 the Wall Street Journal reported
several takeovers at negative premiums. Apparently, in the
case of these companies the market had risen to a price in
excess of control value.
Id.
at. 149.
[C]ontrol premiums only occur in transactions involving a
transfer of control, where there are thought to be gains from
trade. . . . Even if all values, both present and potential, are
valued in the market price for the firm's shares, one would not
expect to find a discernible control premium in a widely held
firm that is well managed and appears to offer little probability
of a transfer of control.
Any small probability of a control
Any small probability of a control Any small probability of a control
Any small probability of a control
26
of a transfer of control.
Any small probability of a control
Any small probability of a control Any small probability of a control
Any small probability of a control
transaction will already be reflected in the market price
transaction will already be reflected in the market pricetransaction will already be reflected in the market price
transaction will already be reflected in the market price,
because absent a dominant shareholder, all shareholders
expect to have an equal opportunity to share in any such
premium, should it appear. Absent an actual transfer of
Absent an actual transfer of Absent an actual transfer of
Absent an actual transfer of
control, control premiums represent probabilities of a control
control, control premiums represent probabilities of a control control, control premiums represent probabilities of a control
control, control premiums represent probabilities of a control
transfer at a premium.
transfer at a premium.transfer at a premium.
transfer at a premium. Where the probability is close to zero,
so is the premium
[emphasis added]
.
William J. Carney & Mark Heimendinger, “Appraising the Nonexistent: The Delaware
Courts’ Struggle with Control Premiums,” 152 U. Pa. L. Rev. 845, 860 (2003).
x
Mercer, who had initially criticized Nath, came to
recognize that Nath was correct.
In the first edition of
The Integrated Theory of
Business Valuation
in 2004, Mercer discussed his
Business Valuation
in 2004, Mercer discussed his
past disagreement and his current view.
◦Mercer’s book included the modified levels-of-
value diagram that showed Marketable Minority
Value overlapping Financial Control Value.
27
The concept that market prices often include control
value is now widely accepted in the valuation
community.
The control value of a company may not differ greatly
Misuse of “Average”
Misuse of “Average” Misuse of “Average”
Misuse of “Average”
Misuse of “Average”
Misuse of “Average” Misuse of “Average”
Misuse of “Average”
Control Premiums
Control PremiumsControl Premiums
Control Premiums
29
“Average premiums” in acquisitions are statistically
biased.
Average acquisition premiums includes a substantial
built-in upward bias because databases consist
primarily of those companies which acquirers
primarily of those companies which acquirers
believe to be worth more than market price.
[T]he universe of guideline transactions includes companies
which were undervalued
undervalued undervalued
undervalued in the market but necessarily
excludes companies that acquirors consider overvalued
overvaluedovervalued
overvalued
[emphasis in original].
Matthews “Misuse of Control Premiums in Delaware Appraisals,”
Business Valuation Review,
Summer 2008, p. 118.
30
Professors Hamermesh and Wachter point out the
illogic of using average premiums:
[I]t is incorrect to make the logical jump that these
[acquisition] premiums reflect some kind of [implicit
minority discount]. The fallacy is obvious and analogous
minority discount]. The fallacy is obvious and analogous
to the “dogs that don’t bark” metaphor: there are lots of
dogs, and most of the time, most dogs are not barking.
Similarly, in any given year, the vast majority of companies
are not involved in a change of control transaction.
Lawrence A. Hamermesh & Michael L. Wachter, “The Short and Puzzling Life of the
‘Implicit Minority Discount’ in Delaware Appraisal Law,” 156 U. Pa. L. Rev. 1, 33 (2007).
31
The use of average acquisition premiums as a
measure of value has been mistakenly accepted by
many in the financial community.
Many investment bankers include average
acquisition premiums as a standard in fairness
acquisition premiums as a standard in fairness
opinions.
A review of 346 published fairness opinions in
cash acquisitions during two 12 month periods
(Sept. 2007 – Aug. 2008 and Sept. 2010 – Aug.
2001) showed that almost half (48.3%) used
average premiums paid as a standard of fairness!
32
Quantifying
Quantifying Quantifying
Quantifying
Quantifying
Quantifying Quantifying
Quantifying
Control Premiums
Control PremiumsControl Premiums
Control Premiums
33
Do not rely on average premiums in other
transactions.
In determining a Financial Control Premium, the key
factor is the relation between market multiples and
factor is the relation between market multiples and
transaction multiples.
quantify Financial Control Premium by comparing
multiples of guideline with multiples of guideline
transactions.
if available, examine data for relevant transactions
in which large minority interests are acquired.
34
Financial Control Premium should be applied only if
justified by specific data
◦Without evidence that the prices of guideline
companies include minority discounts, there is no
companies include minority discounts, there is no
reason to apply it.
◦However, the market is sometimes inefficient, so
that it may arise.
Synergistic Control Premium, if applicable, must be
quantified based on judgment as well as an
appropriate analysis.
35
Adjustments are required for comparing
transactions that were priced at earlier dates under
different market conditions.
If there are no recent guideline transactions,
market prices of guideline companies are probably
not at levels that are attractive to acquirers.
If so, it is difficult to justify any premium.
36
Control Premiums in
Control Premiums in Control Premiums in
Control Premiums in
Control Premiums in
Control Premiums in Control Premiums in
Control Premiums in
Private Companies
Private Companies Private Companies
Private Companies
37
Control premium may be determined by reference
to multiples of public companies and publicly-
disclosed transactions.
disclosed transactions.
Control premium, if any, should be determined in
relation to "public market equivalent value.
.
38
Possible reasons why a private company might
command a lower price than a similar public
company include:
quality of management
quality of management
limited availability and/or higher cost of debt
financing
quality of accounting information
may be less well known to potential investors
than similar public company.
.
39
Control Premiums for
Control Premiums for Control Premiums for
Control Premiums for
Control Premiums for
Control Premiums for Control Premiums for
Control Premiums for
High
HighHigh
High-
--
-Vote Shares
Vote Shares Vote Shares
Vote Shares
40
If a company has both high-vote and low-vote
shares, a control premium may be applicable to
high-vote class.
... but only if the holders of high
-
vote shares
... but only if the holders of high
-
vote shares
have the ability to transfer their control position.
In a majority of American public dual-class
companies, the value of high-vote shares is
limited by a legally binding provision which
prevents the sale of control at a premium to the
price received by other shareholders.
41
The relative market prices of high-vote and low-
vote shares does not indicate the value of control.
High-vote shares often have thin markets, and
may sometimes times trade at a lower price
may sometimes times trade at a lower price
than low-vote shares because of illiquidity.
Because a majority of high-vote class is
virtually always owned by control
shareholder[s], the high-vote shares have no
greater value than low-vote shares for minority
holders.
42
The premium for voting control should not be
calculated on a per-share basis.
It should be determined as a percentage of the
value of the entire company, which is then
value of the entire company, which is then
allocated to the high-vote shares as a class.
Based on U.S. transactions, premium for high-vote
shares is 2% to 3% of equity value.
43
Summary
SummarySummary
Summary
Summary
SummarySummary
Summary
44
Distinguish between Acquisition Premiums, Financial
Control Premiums and Strategic Control Premiums.
Understand that actively traded shares often sell at or
close to Financial Control Value.
Recognize that average premiums in other
Recognize that average premiums in other
transactions are not a valid measure of control
premiums.
Consider differences in multiples between guideline
companies and guideline transactions.
Use judgment, not formulistic calculations, to
determine an appropriate control premium – if any.
45