The report on independent experts’ reports – time for change

Independent experts’ reports are coming under increasing ASIC scrutiny, often leading to significant changes to methodology and valuation. Such changes can lead to delays in transaction timetables and even execution uncertainty. Market participants are now calling for ASIC to improve its policy guidance on the tests for ‘fairness’ and ‘reasonableness’.

ASIC policy requires an expert to determine whether an offer or transaction is ‘fair’ and ‘reasonable’ in the context of a takeover bid, scheme of arrangement, and shareholder approved acquisition over 20%. In ASIC’s view, as set out in Regulatory Guide 111, these two terms are distinct and are to be considered by the expert separately.

Under the policy, an offer is only ‘fair’ if its value (whether in the form of cash or scrip) is equal to or greater than the value of the securities the subject of the offer. An offer is ‘reasonable’ if there are reasons to accept it, even if it is not fair, but having regard to a number of other factors. An offer will be reasonable if it is fair, but it may be reasonable even if it is not fair.

Should a control premium always be payable?

ASIC’s interpretation of ‘fairness’ requires the payment of a control premium whenever there is a control transaction. This is a transaction where an entity (and its associates) acquires control of more than 20% of the target or alternatively if they already hold over 20% in the target then an incremental holding more than 3% is acquired. In these circumstances, ASIC requires a valuation to be done on a 100% basis and to incorporate a control premium, regardless of the actual effect on control.

In many instances a full control premium, or any control premium, is not appropriate:

• a bidder with existing control seeks an additional minority parcel
• a selective buyback would incrementally increase someone’s voting power
• a bidder acquires more than 20% of a target but lacks practical control (eg if there is another controlling shareholder in existence or the opportunities for that bidder to increase to a controlling position are limited), or
• there is a merger of equals or a reverse takeover.

In these instances, ASIC’s policy can have the effect of significantly inflating the premium that would need to be offered to make the offer ‘fair’.

Clearly the policy should not require a full control premium to be applied where there is no acquisition of control. If there is a shift in control, the control premium required by ASIC should be pro rated to reflect the resulting level of control.

It also distorts the assessment of a ‘merger of equals’ because bidders and targets are valued on different bases, although they may participate more or less equally. While targets are valued purely on a control basis, bidders are valued on a portfolio basis. This can result in value inequality between the party which acts as bidder and the target.

The policy can also be problematic in its application to reverse takeovers, where control may pass in both bidder and target. We would like to see a less rigid approach applied to these circumstances.

Valuation ranges and methodologies

ASIC policy notes that an expert should usually provide a range of values, but that a broad value range can undermine the usefulness of the expert opinion. In moderate to highly geared entities, the range of equity values is usually wider than for lower geared entities. However, ASIC does not provide guidance on when a range is too wide to be useful. Can the offer be one cent above the low end of the range or is something closer to the midpoint of the range more appropriate? More guidance would be helpful.

ASIC policy also lists a number of possible methodologies. An expert’s decision to use a discounted cash flow valuation methodology over an earnings multiple can yield very different results. The court has held the selection of methodology is the expert’s decision, but that the expert’s choice will be overturned if it is so manifestly unreasonable no competent professional could honestly have made it. ASIC should confirm that its policy is to act consistently with this authority.

Synergies

There is no consensus, and no guidance from ASIC, as to whether synergies should be included in a calculation of what is ‘fair’. At least once, in the case of the bid for WMC Resources, the Takeovers Panel has approved the incorporation of available synergies and cost savings within an independent expert’s valuation.

ASIC’s policy would be more helpful if it expressly stated that:

• where synergies are unique to one bidder, they should not be reflected in the valuation, given that other interested suitors will not pay for them, and
• if synergies are to be included, their value should be discounted by:
  • the risks of implementation
  • the costs of generating the synergies, and
  • the time and likelihood that the bidder can truly generate those synergies.

ASIC or the Takeovers Panel?

ASIC’s review of an expert’s report is generally a private process between ASIC and the expert. Partly for this reason, some market participants have called for a shift of the role of supervising independent experts’ reports from ASIC to the Panel.

Those participants argue that ASIC’s core function is to oversee process and disclosure rather than regulating on commercial merit, and appear to assume that ASIC does not have the requisite skill set to review questions of valuation. On the contrary, the review of experts’ reports is within ASIC’s remit and its competence, as it is part of the oversight of process and disclosure.

The Panel has members with the expertise to properly assess experts’ reports. It has some record of reviewing valuations, including in connection with the bids for Bowen Energy and Goodman Fielder. For the Panel to undertake the routine review of experts’ reports, however, would require the Panel to take on a ‘vetting’ role, rather than its proper role of dispute resolution.

Perhaps the issues are best addressed with a review of the existing policy. ASIC would no doubt consult widely as part of the process and has a strong history of responding to market feedback. In applying its policy, ASIC should consider taking test cases to the Panel for decisions on particularly difficult or unusual valuation questions.

One way or the other, we can expect to see policy change in this area.

This article was written by Nicola Yeomans, Partner, Sydney and George Durbridge, Special Advisor, Melbourne.

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