Valuation of Shares in Dual Class Companies

Abstract

This presentation discusses the use of dual class structures in various countries and the premiums paid to high-vote shares in acquisitions and recapitalizations in which high-vote shares received a premium.

Full text

Organismo Italiano di Valutazione
3rd Annual International Conference
19 January 2015
SUTTER SECURITIES GIL@SUTTERSF.COM
1 -415-352-6336
1

“Dual class” companies have common shares with
different voting rights
In most cases, low-vote shares either have (a) the same
economic interest as high-vote shares or (b) the same
economic interest plus a dividend preference
In a few companies (primarily Swiss), all shares have one
vote but the “high-vote” shares have lower par value,
e.g.
, 100 shares with SF10 par value have 100 times the
vote of 1 share with SF1000 par value
Notes re terminology:
“low-vote” shares include non-voting shares
“dual class” includes companies with multiple classes
2

Most countries permit some form of dual class shares
Exceptions include Spain, Portugal, Belgium, Japan
3

Some countries ban non-voting shares but permit
shares with multiple votes (usually with a maximum
10 votes),
e.g.
, U.K. and Sweden
Some, such as Italy, permit non-voting shares but
mandate a dividend preference for the non-voting
shares
Some limit the number of low-vote shares that can
be issued,
e.g.
, Germany and Italy, both of which
limit non-voting shares to 50% of equity
4

Some important stock markets, including London,
Hong Kong and Singapore, do not permit dual class
companies to be listed
The NYSE permits listing by companies that had dual
class structures before they went public, but prohibits
listed companies from creating dual class shares
In the U.S., dual class issues have surged – from January
2010 to March 2012, 20 of the 170 IPOs (primarily in the
technology sector) were low-vote shares in dual class
companies
The NYSE has welcomed dual class foreign companies
that could not list at home, such as China’s Ali Baba and
England’s Manchester United
5

Frequency of dual class structures (2001-2):
Sweden 62%
Switzerland 52%
Italy 43%
U.K. 25%
Germany 19%
U.S. 6%
France 3%
These numbers are above current levels, primarily because
of trend toward unification of dual class structures
6

“Loyalty shares” are shares with time-weighted voting rights,
i.e.,
shares within a class are given multiple votes after being
held in registered form by the same shareholder for a given
period of time (usually two years)
oLoyalty shares are not a “class” of shares – they lose their
extra votes upon transfer to a third party
Loyalty shares are widely used in France (usually with 2
votes) but are rare elsewhere
The NYSE will not list companies with loyalty shares, but three
companies are grandfathered
Art. 2437 of the Italian Civil Code now provides that
companies may authorize loyalty shares
o2 votes for listed companies
o3 votes for private companies
7

Several studies have concluded that companies with
dual class structures are valued at lower levels than
comparable companies
However, several other studies dispute this conclusion
8

In Germany, average premiums were about 40% in the early 1990s – a
decade later, average premiums were 10-15%
Norwegian high-vote shares sold at average
discounts
of about 10% in
the early 1990s – a decade later, average premiums were about 15%
Average premiums in Denmark were 35% in the early 1990’s and 5% in
the late 1990s
Brazilian high-vote shares had average premiums of 10% in 1994, 30%
in 1996, minus 10% in 2000, and 5% in 2004
Average premiums in Italy were low in the early 1980’s, rose to about
80% in the late 1980’s, fell to the 60% level in the 1990’s, declined to
the 20% level a decade later, and were about 3% at the end of 2008
9

10
Source: Caprio & Croce (2008)

Several studies have compared market prices of high-
vote and low-vote shares of the limited number of U.S.
companies where both classes are publicly traded
Basic flaw in these studies: the aggregate publicly
traded high-vote shares in the float rarely can impact
control because the control party normally owns a
majority of the vote
If the publicly traded high-vote shares of a company
collectively cannot affect control, how can the market
prices of those shares measure the value of control?
11

Themainsourceofvalueforvotingrightsisthepricea
prospectivebuyerwouldbewillingtopayabovethe
security value of voting shares in order to gain control of
the corporation and reap the ensuing private benefits. ...
The size of this voting premium will be related to both the
probability that voting shares will be demanded by the
buyer, and the amount of private benefits expected.
(Caprio & Croce, 2008)
12

Likelihood (if any) of affecting control
Potential premium (if any) in a unification or acquisition
Liquidity – a function of the size of the float
Dividend expectations
Limitations on transferability (for shares not publicly
traded)
Legal environment – voting premiums tend to be low in
countries with good legal protections for minority shareholder
and high in countries where legal protection is weaker
Institutional environment
t
13

Can the minority high-vote shareholders be
excluded from a premium paid to the controller in
an acquisition?
In many European countries, a party who buys a
certain percentage of shares becomes legally
obligated to bid the same amount for the remaining
shares of the class – in that case, the answer is “no”
In the U.S. and in Canada, the answer is “yes”
14

The Delaware Court of Chancery – the primary venue for U.S.
corporate litigation – decided in its 1988
Resorts
International
decision that minority 100-vote shares were
functionally equivalent to the 1-vote shares when corporate
control was in the hands of a single shareholder
It ruled that minority high-vote shareholders were not entitled
to a premium over the price paid to low-vote shareholders
The controller had received $135 per share and all other
shareholders of both classes received $36
The Delaware Supreme Court upheld the decision, stating that
the non-control high-vote shares had the same value as the
low-vote shares
15

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 dual class companies
Numerous U.S. corporations have combined high-vote and
low-vote shares into a single class
These are called usually “recapitalizations” or “reclassifications”
in the U.S. and “unifications” in Europe
The terms of these unifications provide useful data as to
relative value in various countries
In addition, there have been numerous U.S acquisitions of dual
class companies which provide useful data as to relative value
16

Some of the reasons – some country-specific and some
general – why companies unify dual classes,
e.g
.:
to eliminate dividend preference
to comply with change in law
because of changed criteria for inclusion in indexes
othe size of a class affects its inclusion in index funds and ETFs
to improve liquidity by having a single class
to improve pricing of new equity offerings
to eliminate perceived undervaluation
oa recent study (Lauterbach & Pajuste, 2014) concluded that
there is a correlation between media criticism and unifications
17

Studies have reviewed unifications in several
countries throughout the world
U.K. – a study showed that of 49 unifications, 45
paid special dividends to the high-vote shares
(Ang & Megginson, 1989)
Brazil – 25 of 30 reunifications from 2000 to
2008 were 1:1 (Bortolon & Câmara, 2014)
oWe also look at Israel, Germany, Italy, the U.S.,
and Canada
18

A 1989 change in Tel Aviv Exchange’s rules effectively
forced dual-class companies that wanted to issue new
shares to unify
In 84 dual class unifications from 1990 to 2000, 55%
compensated high vote shareholders (Hauser & Lauterbach,
2004)
The mean compensation to high-vote shareholders was
approximately 4%
On average, majority shareholders owned 86% of the
high-vote shares and 63% of the low-vote shares
Almost all the majority shareholders retained control of
their companies
19

AsubstantialmajorityofGermanunificationsappliedno
discounttothenon‐votingshares
Astudyofunificationsfrom1995through2002showed28
unifications(Dittmann &Ulbrich,2008)
4requirednon‐votingshareholderstomakeacashpayment
equaltoaportionofthedifferencebetweenthemarket
pricesofthevotingandnon‐votingshares
5cancelleddividendsthathadaccruedbutwereunpaid
becauseofinadequateearnings
19wereonashare‐for‐sharebasiswithnopayment
20

In 47 unifications in Italy from 1974 through 2008,
non-voting shareholders either paid cash to convert or
had an exchange ratio <1:1 in 13 cases (Bigelli, Mehrorta
and Rau, 2011)
In several cases of 1:1 unifications, control shareholders
bought low-vote shares, issued options to buy low-vote
shares, and sold high-vote shares prior to
announcement (
Id.
)
Within the past year, Exor, RCS Media Group, Indesit,
and UnipolSai have announced 1:1 unifications and
Italcementi used a 0.65:1 ratio
21

In about 85% of unifications and acquisitions of U.S. dual
class companies, both classes received the same
consideration
There are numerous reasons why the high-vote shares
might not be able to receive a premium in an acquisition
or unification
1. A requirement under the by-laws that multiple-vote shares
may not be transferred unless they are converted into one-
vote shares
2. A provision in the by-laws that high-vote shares will
automatically be converted into low-vote shares if
transferred to a party not in the control group
22

3. A commitment by high-vote shareholders prior to an IPO
that all shareholders would receive the same
consideration in an acquisition
4. A provision that consent of the low-vote class was
required for a merger
5. Prior to a change in accounting rules in 2001, the ability
to account for the transaction without booking goodwill
6. Control shareholder owned similar percentage of each
class
7. High vote shares collectively were less than 50% of total
vote
23

Thepremiumpershareforcontrolhigh‐votesharesisafunctionof
thepercentageofthecompany’ssharesrepresentedbythatclass
Itisillogicaltopositthatthevotingpremiumisthesamepercentage
regardlessofthepercentageofsharesthatarehigh‐vote
Ifonesharehad100%ofthevote,woulditcommandahighpremium?
Therelevantfactoristherelationshipbetweentheaggregateamount
ofthepremiumpaidtothehigh‐votesharesasaclassasapercentage
oftheaggregateequityvalueofthecompany(excludingthevalueof
anydividendpreference)
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”
24

A company with 60% high-vote shares and 40% low-vote
shares with no dividend preference unifies its shares on a
1.25:1 basis
The voting shares have a 60% economic interest before the
unification and 66.7% after the unification [1.25 x 60% ÷
(1.25 x 60%) + 40%) = 80% ÷ 120% = 66.7%
Thus, the premium in excess of economic interest is 6.7%
If the non-voting 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 is shared pro rata by the two classes
25

We have reviewed all U.S. transactions in the past 40 years in
which high-vote shares received greater consideration than
low-vote shares
For each transaction, we calculated the premium in excess
of economic interest
In the 1980’s, extremely high premiums in excess of
economic interest were paid for high-vote shares
Since 1990, these premiums have been about 3%
The median and mean premiums in acquisitions since 1990 are
3.4% and 3.8%
The median and mean premiums in unifications since 1990 are
2.1% and 2.4%
26

27
0%
3%
6%
9%
12%
15%
18%
21%
24%
1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014
Unifications
Acquisitions

Determine the value of low-vote class’s dividend
preference, if any, and apply it to the low-vote class
Determine the going-concern value of the company’s
equity (net of the dividend preference)
Then apply the appropriate “premium in excess of
economic interest” to equity value net of the preference
Premium is currently about 2½% - 3% in U.S.
Probably materially higher in Italy
The premium is added to the high-vote class’s
economic interest
⇒
28

The balance of the equity value is then divided pro
rata between the two classes in proportion to the
number of shares
The value per share of each class is calculated by
dividing the equity value attributed to each class by
the number of shares in each class
Add the per share value of any dividend preference to
the low-vote share value
If appropriate, the resultant values for non-control
shares are adjusted for marketability discounts
29

30
Shared
economic
interest Portion of
company value
shared pro rata
by high-vote and
low-vote shares
Value of control
shareholder[s]
votes
Value of non-control
shareholders votes
Value of dividend
preference

Company has 1 million voting shares and 1 million non-
voting shares with preference valued at € 1 million
Going-concern value of equity is € 61 million
Appropriate premium in excess of economic interest is 10%

Ergo
:
Premium to equity value for control is € 6 million
Balance of equity value is € 54 million
Value of voting class is €6 million + 50% of € 54 million
= $33 million = €33 per share
Value of non-voting class is € 1 million + 50% of € 54
million = $28 million = €28 per share
31

Premiums have been paid for high-vote shares in
several Canadian acquisitions
Most Canadian unifications have given no premium to
the high-vote shares
However, in the unification of Magna International, the
control shareholder received a huge premium –
approximately C$1 billion
The premium in excess of economic interest paid to
Magna’s control shareholder was 10% of the equity
value of Magna
32

Magna’s control shareholder owned 0.6% of the equity
but had 66% of vote
Litigation against the transaction was unsuccessful
The premium in excess of economic interest paid to
Magna’s control shareholder was 10%
Despite the overpayment and negative publicity, Magna
shareholders benefitted from a higher stock price
33

If the low-vote shares are entitled to a dividend
preference, this preference has a positive impact on
their value
The market premium in many studies has been
calculated based on the difference between the market
prices of shares of each class, with no adjustment for
any dividend preference
To calculate the market premium accurately, the price
of the low-vote shares should be appropriately
adjusted for the risk-adjusted present value of any
dividend preference
34

Valuation of high-vote shares depends on their ability to
affect control and/or participate in benefits to controller
1. Highest level –value in hands of controller
2. Major shareholder with partial or shared control
3. Potential swing vote with no single controller
4. No current value to voting right but potential for
participation in future premium
5. Lowest level – no reasonable expectation of receiving
higher price than low-vote shareholders
Purpose of valuation can be relevant –
e.g.,
is the
valuation for tax purposes or for a fairness opinion?
35

Importantly, the extra votes to which loyalty shares are
entitled are not transferable to third parties
The valuation of a control block of loyalty shares is the
same as a valuation of a control position in a company
without loyalty shares, unless there is a possibility that
a third party could accrue enough extra votes to
impact control by building up its holdings
Valuation of shares in a potential contest for control is
a complex and fact-specific issue that depends on the
probability of various factors
36

Loyalty shares owned by shareholders who are not
part of the control group are worth no more than
other minority shares
37

Dual class valuations are country-specific
Dual stock valuations must reflect the legal and social
factors that affect the value of control
To determine how a market values high-vote and low-
vote shares, it would be helpful to study and analyze not
only relevant stock market prices, but also the relative
prices paid in acquisitions and unifications
Most available studies generally do not provide data that
is useful to valuators
Some studies,
e.g.,
Dyck & Zingales (2004), look at
premiums paid for control blocks, which could provide
useful guidelines
38

Valuations of high-vote and low-vote shares are a subset of
valuations applying control premiums, minority discounts
and marketability discounts
Valuators should ask themselves whether their conclusions
as to the value of specific shares are consistent with the
conclusions they would have reached had the company not
had more than one class of shares
Valuators should ask themselves whether their conclusions
reflect prices that are consistent with what a willing buyer
might pay and a willing buyer might accept
39

High-vote and low-vote shares should be valued as a
class before calculating value per share
Appropriate adjustments must be made for dividend
preferences
Minority high-vote shares that cannot influence control
merit little or no premium over low-vote shares
A valuation should be consistent with the underlying
facts and circumstances
Do not use rules of thumb
Data used should be relevant to the transaction
40

I would like to thank
Prof. Bini and the OIV
for inviting me again
to this professional gathering
and for the opportunity
to share ideas with you
Your questions and comments are welcome
41

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42

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