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FNCE30011 Essentials of Corporate Valuation Class 1
Professor John Handley
THE FRAMEWORK FOR VALUATION
Class Outline
• Course Outline
• The Concept of Valuation
• The Spectrum of Financial Securities
• Regulatory Applications
• The Premium for Control
References
Allens, 2021, The Allens Handbook on Takeovers in Australia, 10 February.
Australian Securities and Investments Commission, 2020, Regulatory Guide 111 – Content of Expert
Reports, October.
Grant Samuel & Associates Pty Limited, 2019, MYOB – Independent Expert’s Report, 13 March.
2
OBJECTIVES FOR TODAY
• What is this course about ?
• What is valuation and why is it important ?
• What is the fair value of an asset and how is it determined ?
• What role does valuation play in takeovers ?
• What is meant by voting control ?
• What is an Independent Expert Report and when is one needed ?
• What is a control premium ?
3
1. COURSE OUTLINE
A High-Level Preview of the Course
This course is about key concepts and methodologies used in the valuation of
corporations and other business interests including …
• cash flow based approaches
• multiples based approaches
• the replication approach
We will examine key issues which often arise in practice including …
• forecasting cash flows and earnings
• estimating discount rates and multiples
• adjusting for leverage
• imputation effects
The concepts will be well-grounded in theory and we will also …
highlight the intuition
demonstrate how to use them in practice
4
Course Structure
There are three hours of class per week comprising …
• a 2-hour lecture (Mondays at 9:00am and repeated Mondays at 12:00pm)
• a 1-hour workshop (commencing in week 2)
Class materials consist of …
lecture slides
… includes extension notes as optional extras
problem sets & solutions
… designed for self-study (or by study groups) outside of class time
workshop materials
… for group discussion of key concepts, mini-cases and applications
5
All class materials will be available on the class website on Canvas
There is no prescribed text but there are links to several references texts
… use these when and as you think is necessary
We will cover a lot of material – much of which is quantitative – and so you are
strongly encouraged to …
work consistently throughout semester
attend class
Classes are delivered F2F on-campus and lectures are recorded
6
Assessment
individual take home exam (10%) and group assignment during semester (25%)
3-hour end-of-semester exam (65%)
Teaching Assistants
There are three teaching assistants (Eric, Nancy and Robert) who will each …
• deliver three on-campus workshops per week
• offer optional weekly zoom consultations on a “drop-in” basis
I am also available for consultation by appointment – just send me an email
Full details are set out in the subject guide
7
2. THE CONCEPT OF VALUATION
What Is Valuation About ?
Valuation is a fundamental concept in finance and essentially asks the question…
What is an asset worth ?
There is more than one concept of value in finance …
• Time Value of Money
… a dollar received today is worth more than a dollar received later
• Present Value
… the equivalent value today of a cash flow in the future
• Option Value
… the value today of having a choice to do something in the future
8
There are two types of asset …
• a real asset is an item used to produce goods and services in the economy, such
as land, buildings, plant and equipment, raw materials and knowledge
• a financial asset is a claim on the future cash flow generated by a real asset
We will focus on financial assets and the key idea is …
the value of an asset
is determined by the
amount, timing and risk of its future cash flows
This means that valuation is essentially a process of mapping (or translating) a set
of cash flows in the future into an equivalent cash amount today
W 1
9
The value of an asset (determined this way) …
• is variously called the fundamental value, true value, intrinsic value, underlying
value, fair value or market value of the asset
• is generally taken to represent the amount that would be agreed between a buyer
and seller who are …
• well informed;
• willing but not anxious; and
• acting at arm’s length
• depends on the circumstances concerning the asset and its future cash flows
Extension Note: For example, an asset or business may have a “going concern value” assuming it continues
operating and a “liquidation value” assuming it is wound up. In some cases, an asset or business may have
additional “special or synergistic value” to a potential buyer.
Value is a fundamental item of interest to many players in financial markets
including individuals, firms, financial intermediaries and governments and is at the
core of investment decision making
10
What Are The Common Approaches To Valuation ?
The three valuation methodologies most often used in practice are …
• discounted cash flow
• earnings multiples – also called capitalization of earnings
• option pricing models – such as the Black-Scholes and Binomial models
Extension Note: Other valuation methodologies include the Residual Income approach and the Economic Value Added
approach which are both variations of the discounted cash flow approach.
If an asset is traded in a financial market then we can observe its market price
… and so valuation is related to the concept of market efficiency – does the
market price equal the (fair) value of the asset ?
Extension Note: A market is informationally efficient if security prices correctly reflect all information available to
investors at that time. This means that efficiency is conditional on which market, which set of investors, what information
and at what point in time we are considering. Importantly, a market can only be efficient if there is competition among
investors who, in their belief that the market is inefficient, impound new information in their search for mis-priced assets.
11
3. THE SPECTRUM OF FINANCIAL SECURITIES
Financial Security
A legally binding contract which evidences the rights and obligations of the issuer
and the investor(s) in relation to …
voting rights (in the issuing firm)
cash flow rights (with respect to both income and capital)
cash flow risk
Also called a financial instrument or financial asset
Financial securities are used to raise capital and or manage risk W 2
12
What Is The Spectrum ?
There are two pure types of financial security – debt and equity
… and in between is a vast collection of hybrid securities – which are effectively
part debt and part equity
Debt Equity
bank
loans
junior
bonds
convertible
bonds
ordinary shares
common stock
senior
bonds
junk
bonds
preference shares
preferred stock
higher risk investment
In practice, all debt is subject to default risk except debt issued by some
governments
Why ?
13
Extension Note: The return on a risk-free bond is risky if it is sold prior to maturity.
How Does Debt Differ From Equity ?
Key Features Debt Equity
Voting Rights
Cash flow Rights
Cash flow Risk
Relatively low
Issuer is contractually obliged
to pay cash to investors
over time
Relatively high
Issuer is not contractually
obliged to pay cash to investors
over time
Let’s take a closer look …
14
Key Features of Debt Securities
no voting rights in the issuing firm
… unless there is a default
priority claim on the cash flow of the firm
… ranks ahead of equity investors and other lower ranked securities
fixed claim on the cash flow of the firm
usually there is a fixed maturity date for repayment of capital
… this exposes the issuer to refinancing risk at maturity
15
Key Features of Equity Securities
full voting rights in the issuing firm
… this determines who controls and therefore who owns the firm
subordinated claim on the cash flow of the firm
… ranks last after all other claimants have been fully paid
residual claim on the cash flow of the firm
… entitled to any surplus profits (after payment of interest and all other
expenses) generated by the firm but also first to bear any losses
no fixed maturity date for repayment of capital
… but investors can usually exit by selling their shares to other investors in the
secondary market
limited liability – equity investors own the firm but are not personally liable for
the debts of the firm
16
4. REGULATORY APPLICATIONS
Valuation plays an important role in several regulatory settings including …
• Takeovers
• Independent Expert Reports
• Accounting Standards
4.1 Takeovers
What Is A Takeover ?
A takeover occurs when a person acquires voting control of a company
… the person acquiring control may be an individual, another company, a hedge
fund, a private equity fund or some other entity
… the term merger is often used to describe an agreed or friendly acquisition of
one company by another company in order to form a single combined business
entity
17
Takeovers in Australia are governed by a body of rules collectively determined by…
• Corporations Act 2001 – sets out the statutory rules governing takeovers
• Australian Securities and Investments Commission (ASIC) – the national
companies regulator with responsibility to administer the Corporations Act and
determine regulatory policy
• Takeovers Panels – a specialist tribunal largely comprised of takeover experts
with responsibility for resolving takeover disputes
• Courts
Extension Note: Takeovers involving competition (anti-trust), foreign investment or certain industries are subject to
additional legislation and supervision by government regulators. Takeovers involving listed companies are also subject
to the ASX Listing Rules including rules dealing with continuous disclosure obligations.
The takeover rules apply to acquisitions of voting control in Australian
(incorporated) companies which are either listed on the Australian Securities
Exchange (ASX) or are unlisted but have at least 50 shareholders
18
Most takeovers in Australia occur by either …
• an off-market takeover bid (used for hostile and some friendly deals)
… the bidder issues a bidder’s statement which includes the offer terms and
other information and in response, the target issues a target’s statement
which includes the recommendation(s) from the target directors
Extension Note: In an off-market takeover bid all offers must be the same – that is, all target shareholders receive
a written offer from the bidder to buy all their shares (or the same proportion of their shares) at the same price.
A less common approach is a market takeover bid in which the bidder appoints a broker to stand in the ASX market
and acquire target shares at a specified price on their behalf.
• a scheme of arrangement (used for most friendly deals)
… the bidder and target enter a scheme implementation agreement and the
target then prepares the scheme booklet which sets out the details of the
scheme and the recommendation(s) from the target directors
Extension Note: The bidder typically provides the target with an indicative and non-binding proposal as the first
step in negotiations of a scheme. If the target is interested it then grants the bidder confidential access to its books
to allow it to conduct its due diligence. There are many issues to consider in choosing the best structure and
strategy for a takeover – see for example chapters 6 – 12 of Allens (2021).
19
What is Voting Control ?
Different levels of voting control confer different rights and obligations
including…
• ≥ 5% must disclose your identity as a substantial shareholder
• > 10% can block a compulsory acquisition
• > 20% the takeover trigger … more on this soon
• > 25% can block a scheme of arrangement or special resolution
• > 50% can pass an ordinary resolution
• ≥ 75% can pass a special resolution
• ≥ 90% can compulsorily acquire minority shareholdings
• = 100% full control … it’s all yours !!
Extension Note: Other important control thresholds are contained in foreign investment and industry regulations – for
example, there is a 15% limit on shareholdings in banks and other financial sector companies in Australia (unless a
higher percentage is approved by the Federal Treasurer on national interest grounds).
20
In practice, control loosely refers to a majority of votes in a firm but in some
cases, control may rest with even a small parcel of shares …
Assume a firm has three shareholders:
A has 49% of the votes, B has 49% of the votes, C has 2% of the votes.
Does C have any influence over the decisions of the firm ?
But Who Really Controls a Firm ?
Voting control of a firm rests with the shareholders (“owners”)
Managerial control of a firm rests with the executives and directors (collectively
the “managers”).
There is a principal-agent relationship between the owners and the managers of most
firms and so a there is potential conflict of interest …
So what is more important – managerial control or voting control ?
21
What Are The Benefits of Control ?
Increasing your level of voting control can provide …
• greater influence over managerial decision-making
• greater influence over strategic and operational business decisions
Getting full voting control may also provide …
• freedom from constraints associated with minority shareholders (such as laws
protecting minority rights and the risk of greenmail)
• unrestricted access to the underlying cashflow of the firm (rather than just
access to the dividends paid from that cash flow)
• taxation benefits (such as grouping of tax losses)
• lower administrative costs
• synergy and efficiency gains
22
What Are The Rules Governing Takeovers In Australia ?
The legislation is detailed, technical and complex specifying who can do what
when.
But at a “big-picture” level, the takeover rules are based on three core principles …
• transfers of control occur in an efficient, competitive and informed market
• target shareholders and directors know the bidder’s identity and have
sufficient information and time to assess the merits of the bid
• target shareholders are treated equally – that is, there can be no special deals
for individual target shareholders
Extension Note: Schemes (but not takeover bids) can allow for different shareholders to be treated differently if
approved by all other target shareholders.
Both residents and non-residents of Australia must comply with the takeover rules
The most important takeover rule is next …
23
The 20% Rule
The key idea …
Investors are free to acquire up to 20% voting control in a firm but any
acquisition beyond that must follow the takeover rules
More formally …
A person cannot acquire a relevant interest in the voting shares of a company
if this would cause that person’s or some other person’s voting power in the
company to exceed 20%
unless
a takeover bid, a scheme, a creep acquisition (no more than 3% every six
months) or one of the other exceptions to the 20% rule is used
Extension Note: The 3% creep exception allows a person to gradually increase their voting power over time since it
gives other persons affected by the increase in voting control sufficient time to consider its impact. See Allens (2021)
for other exceptions to the rule including acquisitions with target shareholder approval (where no votes are cast by the
acquirer or the seller). Special rules also apply when a person’s voting power reaches 90%..
24
To exceed 20% means …
• you start at or below 20% and finish above 20%; or
• you start above 20% and finish somewhere higher
W 3
A voting share …
• is an issued share which carries full voting rights
• does not include (most) preference shares, convertible notes, or rights and
options on unissued voting shares
Extension Note: Preference shares normally have a right to vote only in limited circumstances.
25
The rule is expressed in terms of a relevant interest in a share (rather than ownership
of a share) and in voting power (rather than number of voting shares) to widen its
application …
• you have a relevant interest in shares that you own
and also in shares that you do not own – provided you have direct or indirect
control over the voting or disposal of those shares
… this means that more than one person can have a relevant interest in the
same share at the same time
• your voting power is based on the total votes attached to your shares and also
to the shares of your associates
… this means that a group of persons who effectively act together for voting
purposes will be treated like a single person in applying the 20% rule
… this also allows for multiple classes of voting shares with differential voting
rights
26
Time To Pause And Reflect …
Consider an Australian company where …
A has 10% of the votes, B has 5% of the votes, C has 15% of the votes and
the remaining 70% is spread across hundreds of other small shareholders
Can A buy B’s shares now ?
W 4
Can A buy C’s shares now ?
W 5
Can A and C enter an agreement dealing with
how each will cast their votes ?
W 6
Can A buy some of C’s shares now and creep the rest ?
W 7
27
How Are Nominee Shareholders Treated ?
A nominee shareholder is a person who holds and administers shares on behalf of
another person – called the beneficial owner
A nominee shareholder …
• is the registered owner of the shares (according to the company’s records) but
only in the capacity of a trustee
• looks after the day-to-day management of the shares
• can deal with or vote a share only in accordance with instructions from the
beneficial owner
… which means nominees do not have a relevant interest in the shares registered
in their name
Often the largest shareholders in Australian listed firms are nominees and
nominees generally do not have to disclose the identity of the beneficial owner
28
Source: Woolworths Group Limited, 2023 Annual Report, page 176-178.
29
Do The Takeover Rules Apply To Options On (Issued) Voting Shares ?
Call options and put options can change the ownership of a voting share
… which means a party to an option contract on a voting share may have a relevant
interest in the underlying share
For options which are not traded on an exchange …
• the buyer of a call on a voting share (in which the seller of the call has a relevant
interest) acquires a relevant interest in that share at the time the option contract
is entered into
• the seller of a put on a voting share (in which the buyer of the put has a relevant
interest) acquires a relevant interest in that share at the time the option contract
is entered into
W 8
Extension Note: For options which are traded on an exchange, the relevant interest is acquired if and at the time the
option is exercised. This is based on the view that whilst exchange traded options are settled by physical delivery of the
underlying share, they are mostly used for hedging and speculation rather than for control purposes.
30
4.2 Independent Expert Reports
What Is An Independent Expert Report (IER) ?
An IER is a report prepared by a finance expert to assist shareholders affected by a
proposed corporate transaction (such as a takeover bid or scheme) to make an
informed decision
The expert must be independent of the entity which commissions the report to ensure
shareholders receive an independent analysis of the corporate transaction
An IER is required for an off-market takeover bid or a scheme if …
• the bidder has at least 30% voting power in the target; or
• the bidder and target have common directors
Why ?
Extension Note: Schemes are usually more complicated than takeover bids and so it is common practice and the
expectation of ASIC and the Courts for all schemes to have an IER.
31
What Is In An IER ?
ASIC has issued Regulatory Guide 111 which states that the expert should …
• focus on the substance (this is, the purpose and outcome) of the transaction
rather than the legal mechanism used to give it effect
• express an opinion on the transaction using specific language such as …
• whether a takeover is fair and reasonable
• whether a scheme is in the best interests of the members of the company
This means that the expert must undertake a valuation of …
• the target – for takeovers involving cash-based offers
• both the bidder and the target – for takeovers involving scrip-based offers
The expert usually determines a range of values (albeit as narrow as possible)
rather than just a single value to allow for uncertainty in the valuation process
32
Fair and reasonable comprises two criteria …
• an offer is fair if the value of the offer is greater than or equal to the value of
the target’s shares
… if a range of values is given, then in practice the offer is fair if the value of
the offer falls within or above the range
• an offer is reasonable if it is fair
• an offer can still be reasonable even if it is unfair provided the expert believes
shareholders should accept the offer for one or more other reasons including the
likely market price if the offer is unsuccessful, the likelihood of an alternative
offer and the bidder’s pre-existing voting power in the target
Extension Note: The expert will value the target assuming the offer is for 100% of its shares even if this is not the case
which means an offer can be fair only if it includes a control premium. In contrast an offer can be reasonable with or
without a control premium – for example the bidder may have substantial control of the target prior to making the offer.
Extension Note: In the U.S., corporate boards commonly engage investment bankers to provide Fairness Opinions which
set out their view on the financial fairness of a corporate control transaction.
Extension Note: The International Valuation Standards Council has issued a set of voluntary valuation standards as a
guide for valuation professionals globally.
33
4.3 Accounting Standards
Financial statements provide a rich source of information for investors in general
and especially for valuation purposes
… it is therefore important to be aware of the rules (called accounting standards)
governing how financial statements are prepared
Accounting standards in Australia are …
• issued by the Australian Accounting Standards Board (AASB)
• have the force of law under the Corporations Act 2001
• apply to public companies and to large (and some small) private companies
• are generally equivalent to international accounting standards issued by the
International Accounting Standards Board (IASB)
Extension Note: Australia has adopted international accounting standards – called International Financial Reporting
Standards (IFRS) since 2005. IFRS are increasingly being adopted in countries around the world (including the EU,
Canada and Hong Kong) but are not currently used in the U.S. where instead financial statements are prepared in
accordance with U.S. Generally Accepted Accounting Principles (GAAP).
Extension Note: Valuation plays a key role in several accounting standards including: AASB2 Share-based Payment;
AASB9 Financial Instruments; AASB13 Fair Value Measurement; and AASB136 Impairment of Assets.
34
5. THE PREMIUM FOR CONTROL
Control is valuable …
• all else equal, a controlling interest in an asset is more valuable than a non-
controlling interest in the asset
Perhaps this is most evident when we look at takeovers of listed firms since …
• stock market prices usually reflect trades in relatively small (that is, non-
controlling) parcels of shares
• a bidder must normally pay more than the market price of the target’s shares to
gain control of the target
• the difference between the offer price and the pre-bid stock price of the target is
then generally considered to represent a premium for control
Other measures of the target’s stock price may also be used – for example, to allow
for possible takeover speculation in the target’s stock price prior to announcement
of the bid.
Professor John Handley
THE FRAMEWORK FOR VALUATION
Class Outline
• Course Outline
• The Concept of Valuation
• The Spectrum of Financial Securities
• Regulatory Applications
• The Premium for Control
References
Allens, 2021, The Allens Handbook on Takeovers in Australia, 10 February.
Australian Securities and Investments Commission, 2020, Regulatory Guide 111 – Content of Expert
Reports, October.
Grant Samuel & Associates Pty Limited, 2019, MYOB – Independent Expert’s Report, 13 March.
2
OBJECTIVES FOR TODAY
• What is this course about ?
• What is valuation and why is it important ?
• What is the fair value of an asset and how is it determined ?
• What role does valuation play in takeovers ?
• What is meant by voting control ?
• What is an Independent Expert Report and when is one needed ?
• What is a control premium ?
3
1. COURSE OUTLINE
A High-Level Preview of the Course
This course is about key concepts and methodologies used in the valuation of
corporations and other business interests including …
• cash flow based approaches
• multiples based approaches
• the replication approach
We will examine key issues which often arise in practice including …
• forecasting cash flows and earnings
• estimating discount rates and multiples
• adjusting for leverage
• imputation effects
The concepts will be well-grounded in theory and we will also …
highlight the intuition
demonstrate how to use them in practice
4
Course Structure
There are three hours of class per week comprising …
• a 2-hour lecture (Mondays at 9:00am and repeated Mondays at 12:00pm)
• a 1-hour workshop (commencing in week 2)
Class materials consist of …
lecture slides
… includes extension notes as optional extras
problem sets & solutions
… designed for self-study (or by study groups) outside of class time
workshop materials
… for group discussion of key concepts, mini-cases and applications
5
All class materials will be available on the class website on Canvas
There is no prescribed text but there are links to several references texts
… use these when and as you think is necessary
We will cover a lot of material – much of which is quantitative – and so you are
strongly encouraged to …
work consistently throughout semester
attend class
Classes are delivered F2F on-campus and lectures are recorded
6
Assessment
individual take home exam (10%) and group assignment during semester (25%)
3-hour end-of-semester exam (65%)
Teaching Assistants
There are three teaching assistants (Eric, Nancy and Robert) who will each …
• deliver three on-campus workshops per week
• offer optional weekly zoom consultations on a “drop-in” basis
I am also available for consultation by appointment – just send me an email
Full details are set out in the subject guide
7
2. THE CONCEPT OF VALUATION
What Is Valuation About ?
Valuation is a fundamental concept in finance and essentially asks the question…
What is an asset worth ?
There is more than one concept of value in finance …
• Time Value of Money
… a dollar received today is worth more than a dollar received later
• Present Value
… the equivalent value today of a cash flow in the future
• Option Value
… the value today of having a choice to do something in the future
8
There are two types of asset …
• a real asset is an item used to produce goods and services in the economy, such
as land, buildings, plant and equipment, raw materials and knowledge
• a financial asset is a claim on the future cash flow generated by a real asset
We will focus on financial assets and the key idea is …
the value of an asset
is determined by the
amount, timing and risk of its future cash flows
This means that valuation is essentially a process of mapping (or translating) a set
of cash flows in the future into an equivalent cash amount today
W 1
9
The value of an asset (determined this way) …
• is variously called the fundamental value, true value, intrinsic value, underlying
value, fair value or market value of the asset
• is generally taken to represent the amount that would be agreed between a buyer
and seller who are …
• well informed;
• willing but not anxious; and
• acting at arm’s length
• depends on the circumstances concerning the asset and its future cash flows
Extension Note: For example, an asset or business may have a “going concern value” assuming it continues
operating and a “liquidation value” assuming it is wound up. In some cases, an asset or business may have
additional “special or synergistic value” to a potential buyer.
Value is a fundamental item of interest to many players in financial markets
including individuals, firms, financial intermediaries and governments and is at the
core of investment decision making
10
What Are The Common Approaches To Valuation ?
The three valuation methodologies most often used in practice are …
• discounted cash flow
• earnings multiples – also called capitalization of earnings
• option pricing models – such as the Black-Scholes and Binomial models
Extension Note: Other valuation methodologies include the Residual Income approach and the Economic Value Added
approach which are both variations of the discounted cash flow approach.
If an asset is traded in a financial market then we can observe its market price
… and so valuation is related to the concept of market efficiency – does the
market price equal the (fair) value of the asset ?
Extension Note: A market is informationally efficient if security prices correctly reflect all information available to
investors at that time. This means that efficiency is conditional on which market, which set of investors, what information
and at what point in time we are considering. Importantly, a market can only be efficient if there is competition among
investors who, in their belief that the market is inefficient, impound new information in their search for mis-priced assets.
11
3. THE SPECTRUM OF FINANCIAL SECURITIES
Financial Security
A legally binding contract which evidences the rights and obligations of the issuer
and the investor(s) in relation to …
voting rights (in the issuing firm)
cash flow rights (with respect to both income and capital)
cash flow risk
Also called a financial instrument or financial asset
Financial securities are used to raise capital and or manage risk W 2
12
What Is The Spectrum ?
There are two pure types of financial security – debt and equity
… and in between is a vast collection of hybrid securities – which are effectively
part debt and part equity
Debt Equity
bank
loans
junior
bonds
convertible
bonds
ordinary shares
common stock
senior
bonds
junk
bonds
preference shares
preferred stock
higher risk investment
In practice, all debt is subject to default risk except debt issued by some
governments
Why ?
13
Extension Note: The return on a risk-free bond is risky if it is sold prior to maturity.
How Does Debt Differ From Equity ?
Key Features Debt Equity
Voting Rights
Cash flow Rights
Cash flow Risk
Relatively low
Issuer is contractually obliged
to pay cash to investors
over time
Relatively high
Issuer is not contractually
obliged to pay cash to investors
over time
Let’s take a closer look …
14
Key Features of Debt Securities
no voting rights in the issuing firm
… unless there is a default
priority claim on the cash flow of the firm
… ranks ahead of equity investors and other lower ranked securities
fixed claim on the cash flow of the firm
usually there is a fixed maturity date for repayment of capital
… this exposes the issuer to refinancing risk at maturity
15
Key Features of Equity Securities
full voting rights in the issuing firm
… this determines who controls and therefore who owns the firm
subordinated claim on the cash flow of the firm
… ranks last after all other claimants have been fully paid
residual claim on the cash flow of the firm
… entitled to any surplus profits (after payment of interest and all other
expenses) generated by the firm but also first to bear any losses
no fixed maturity date for repayment of capital
… but investors can usually exit by selling their shares to other investors in the
secondary market
limited liability – equity investors own the firm but are not personally liable for
the debts of the firm
16
4. REGULATORY APPLICATIONS
Valuation plays an important role in several regulatory settings including …
• Takeovers
• Independent Expert Reports
• Accounting Standards
4.1 Takeovers
What Is A Takeover ?
A takeover occurs when a person acquires voting control of a company
… the person acquiring control may be an individual, another company, a hedge
fund, a private equity fund or some other entity
… the term merger is often used to describe an agreed or friendly acquisition of
one company by another company in order to form a single combined business
entity
17
Takeovers in Australia are governed by a body of rules collectively determined by…
• Corporations Act 2001 – sets out the statutory rules governing takeovers
• Australian Securities and Investments Commission (ASIC) – the national
companies regulator with responsibility to administer the Corporations Act and
determine regulatory policy
• Takeovers Panels – a specialist tribunal largely comprised of takeover experts
with responsibility for resolving takeover disputes
• Courts
Extension Note: Takeovers involving competition (anti-trust), foreign investment or certain industries are subject to
additional legislation and supervision by government regulators. Takeovers involving listed companies are also subject
to the ASX Listing Rules including rules dealing with continuous disclosure obligations.
The takeover rules apply to acquisitions of voting control in Australian
(incorporated) companies which are either listed on the Australian Securities
Exchange (ASX) or are unlisted but have at least 50 shareholders
18
Most takeovers in Australia occur by either …
• an off-market takeover bid (used for hostile and some friendly deals)
… the bidder issues a bidder’s statement which includes the offer terms and
other information and in response, the target issues a target’s statement
which includes the recommendation(s) from the target directors
Extension Note: In an off-market takeover bid all offers must be the same – that is, all target shareholders receive
a written offer from the bidder to buy all their shares (or the same proportion of their shares) at the same price.
A less common approach is a market takeover bid in which the bidder appoints a broker to stand in the ASX market
and acquire target shares at a specified price on their behalf.
• a scheme of arrangement (used for most friendly deals)
… the bidder and target enter a scheme implementation agreement and the
target then prepares the scheme booklet which sets out the details of the
scheme and the recommendation(s) from the target directors
Extension Note: The bidder typically provides the target with an indicative and non-binding proposal as the first
step in negotiations of a scheme. If the target is interested it then grants the bidder confidential access to its books
to allow it to conduct its due diligence. There are many issues to consider in choosing the best structure and
strategy for a takeover – see for example chapters 6 – 12 of Allens (2021).
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What is Voting Control ?
Different levels of voting control confer different rights and obligations
including…
• ≥ 5% must disclose your identity as a substantial shareholder
• > 10% can block a compulsory acquisition
• > 20% the takeover trigger … more on this soon
• > 25% can block a scheme of arrangement or special resolution
• > 50% can pass an ordinary resolution
• ≥ 75% can pass a special resolution
• ≥ 90% can compulsorily acquire minority shareholdings
• = 100% full control … it’s all yours !!
Extension Note: Other important control thresholds are contained in foreign investment and industry regulations – for
example, there is a 15% limit on shareholdings in banks and other financial sector companies in Australia (unless a
higher percentage is approved by the Federal Treasurer on national interest grounds).
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In practice, control loosely refers to a majority of votes in a firm but in some
cases, control may rest with even a small parcel of shares …
Assume a firm has three shareholders:
A has 49% of the votes, B has 49% of the votes, C has 2% of the votes.
Does C have any influence over the decisions of the firm ?
But Who Really Controls a Firm ?
Voting control of a firm rests with the shareholders (“owners”)
Managerial control of a firm rests with the executives and directors (collectively
the “managers”).
There is a principal-agent relationship between the owners and the managers of most
firms and so a there is potential conflict of interest …
So what is more important – managerial control or voting control ?
21
What Are The Benefits of Control ?
Increasing your level of voting control can provide …
• greater influence over managerial decision-making
• greater influence over strategic and operational business decisions
Getting full voting control may also provide …
• freedom from constraints associated with minority shareholders (such as laws
protecting minority rights and the risk of greenmail)
• unrestricted access to the underlying cashflow of the firm (rather than just
access to the dividends paid from that cash flow)
• taxation benefits (such as grouping of tax losses)
• lower administrative costs
• synergy and efficiency gains
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What Are The Rules Governing Takeovers In Australia ?
The legislation is detailed, technical and complex specifying who can do what
when.
But at a “big-picture” level, the takeover rules are based on three core principles …
• transfers of control occur in an efficient, competitive and informed market
• target shareholders and directors know the bidder’s identity and have
sufficient information and time to assess the merits of the bid
• target shareholders are treated equally – that is, there can be no special deals
for individual target shareholders
Extension Note: Schemes (but not takeover bids) can allow for different shareholders to be treated differently if
approved by all other target shareholders.
Both residents and non-residents of Australia must comply with the takeover rules
The most important takeover rule is next …
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The 20% Rule
The key idea …
Investors are free to acquire up to 20% voting control in a firm but any
acquisition beyond that must follow the takeover rules
More formally …
A person cannot acquire a relevant interest in the voting shares of a company
if this would cause that person’s or some other person’s voting power in the
company to exceed 20%
unless
a takeover bid, a scheme, a creep acquisition (no more than 3% every six
months) or one of the other exceptions to the 20% rule is used
Extension Note: The 3% creep exception allows a person to gradually increase their voting power over time since it
gives other persons affected by the increase in voting control sufficient time to consider its impact. See Allens (2021)
for other exceptions to the rule including acquisitions with target shareholder approval (where no votes are cast by the
acquirer or the seller). Special rules also apply when a person’s voting power reaches 90%..
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To exceed 20% means …
• you start at or below 20% and finish above 20%; or
• you start above 20% and finish somewhere higher
W 3
A voting share …
• is an issued share which carries full voting rights
• does not include (most) preference shares, convertible notes, or rights and
options on unissued voting shares
Extension Note: Preference shares normally have a right to vote only in limited circumstances.
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The rule is expressed in terms of a relevant interest in a share (rather than ownership
of a share) and in voting power (rather than number of voting shares) to widen its
application …
• you have a relevant interest in shares that you own
and also in shares that you do not own – provided you have direct or indirect
control over the voting or disposal of those shares
… this means that more than one person can have a relevant interest in the
same share at the same time
• your voting power is based on the total votes attached to your shares and also
to the shares of your associates
… this means that a group of persons who effectively act together for voting
purposes will be treated like a single person in applying the 20% rule
… this also allows for multiple classes of voting shares with differential voting
rights
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Time To Pause And Reflect …
Consider an Australian company where …
A has 10% of the votes, B has 5% of the votes, C has 15% of the votes and
the remaining 70% is spread across hundreds of other small shareholders
Can A buy B’s shares now ?
W 4
Can A buy C’s shares now ?
W 5
Can A and C enter an agreement dealing with
how each will cast their votes ?
W 6
Can A buy some of C’s shares now and creep the rest ?
W 7
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How Are Nominee Shareholders Treated ?
A nominee shareholder is a person who holds and administers shares on behalf of
another person – called the beneficial owner
A nominee shareholder …
• is the registered owner of the shares (according to the company’s records) but
only in the capacity of a trustee
• looks after the day-to-day management of the shares
• can deal with or vote a share only in accordance with instructions from the
beneficial owner
… which means nominees do not have a relevant interest in the shares registered
in their name
Often the largest shareholders in Australian listed firms are nominees and
nominees generally do not have to disclose the identity of the beneficial owner
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Source: Woolworths Group Limited, 2023 Annual Report, page 176-178.
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Do The Takeover Rules Apply To Options On (Issued) Voting Shares ?
Call options and put options can change the ownership of a voting share
… which means a party to an option contract on a voting share may have a relevant
interest in the underlying share
For options which are not traded on an exchange …
• the buyer of a call on a voting share (in which the seller of the call has a relevant
interest) acquires a relevant interest in that share at the time the option contract
is entered into
• the seller of a put on a voting share (in which the buyer of the put has a relevant
interest) acquires a relevant interest in that share at the time the option contract
is entered into
W 8
Extension Note: For options which are traded on an exchange, the relevant interest is acquired if and at the time the
option is exercised. This is based on the view that whilst exchange traded options are settled by physical delivery of the
underlying share, they are mostly used for hedging and speculation rather than for control purposes.
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4.2 Independent Expert Reports
What Is An Independent Expert Report (IER) ?
An IER is a report prepared by a finance expert to assist shareholders affected by a
proposed corporate transaction (such as a takeover bid or scheme) to make an
informed decision
The expert must be independent of the entity which commissions the report to ensure
shareholders receive an independent analysis of the corporate transaction
An IER is required for an off-market takeover bid or a scheme if …
• the bidder has at least 30% voting power in the target; or
• the bidder and target have common directors
Why ?
Extension Note: Schemes are usually more complicated than takeover bids and so it is common practice and the
expectation of ASIC and the Courts for all schemes to have an IER.
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What Is In An IER ?
ASIC has issued Regulatory Guide 111 which states that the expert should …
• focus on the substance (this is, the purpose and outcome) of the transaction
rather than the legal mechanism used to give it effect
• express an opinion on the transaction using specific language such as …
• whether a takeover is fair and reasonable
• whether a scheme is in the best interests of the members of the company
This means that the expert must undertake a valuation of …
• the target – for takeovers involving cash-based offers
• both the bidder and the target – for takeovers involving scrip-based offers
The expert usually determines a range of values (albeit as narrow as possible)
rather than just a single value to allow for uncertainty in the valuation process
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Fair and reasonable comprises two criteria …
• an offer is fair if the value of the offer is greater than or equal to the value of
the target’s shares
… if a range of values is given, then in practice the offer is fair if the value of
the offer falls within or above the range
• an offer is reasonable if it is fair
• an offer can still be reasonable even if it is unfair provided the expert believes
shareholders should accept the offer for one or more other reasons including the
likely market price if the offer is unsuccessful, the likelihood of an alternative
offer and the bidder’s pre-existing voting power in the target
Extension Note: The expert will value the target assuming the offer is for 100% of its shares even if this is not the case
which means an offer can be fair only if it includes a control premium. In contrast an offer can be reasonable with or
without a control premium – for example the bidder may have substantial control of the target prior to making the offer.
Extension Note: In the U.S., corporate boards commonly engage investment bankers to provide Fairness Opinions which
set out their view on the financial fairness of a corporate control transaction.
Extension Note: The International Valuation Standards Council has issued a set of voluntary valuation standards as a
guide for valuation professionals globally.
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4.3 Accounting Standards
Financial statements provide a rich source of information for investors in general
and especially for valuation purposes
… it is therefore important to be aware of the rules (called accounting standards)
governing how financial statements are prepared
Accounting standards in Australia are …
• issued by the Australian Accounting Standards Board (AASB)
• have the force of law under the Corporations Act 2001
• apply to public companies and to large (and some small) private companies
• are generally equivalent to international accounting standards issued by the
International Accounting Standards Board (IASB)
Extension Note: Australia has adopted international accounting standards – called International Financial Reporting
Standards (IFRS) since 2005. IFRS are increasingly being adopted in countries around the world (including the EU,
Canada and Hong Kong) but are not currently used in the U.S. where instead financial statements are prepared in
accordance with U.S. Generally Accepted Accounting Principles (GAAP).
Extension Note: Valuation plays a key role in several accounting standards including: AASB2 Share-based Payment;
AASB9 Financial Instruments; AASB13 Fair Value Measurement; and AASB136 Impairment of Assets.
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5. THE PREMIUM FOR CONTROL
Control is valuable …
• all else equal, a controlling interest in an asset is more valuable than a non-
controlling interest in the asset
Perhaps this is most evident when we look at takeovers of listed firms since …
• stock market prices usually reflect trades in relatively small (that is, non-
controlling) parcels of shares
• a bidder must normally pay more than the market price of the target’s shares to
gain control of the target
• the difference between the offer price and the pre-bid stock price of the target is
then generally considered to represent a premium for control
Other measures of the target’s stock price may also be used – for example, to allow
for possible takeover speculation in the target’s stock price prior to announcement
of the bid.
