Any views expressed in this article are those of the author and should not be interpreted as ICAEW views or guidance.
Brothers at War
One surprising outcome of the former case was that the Judge determined that the fair price to be paid for a minority holding of some 19.9% was the market value of that holding plus half of the marriage value arising as a result of the acquisition of the shares by a person owning 5.28% of the shares but controlling a total of 74.5%.
The 2019 hearing dealt with the assessment of quantum. There were some very significant values involved. Some startlingly novel valuation concepts surfaced and had to be addressed by the Judge. The expert evidence neatly divided between the valuation of the hotels as assets of the group, and the valuation of the various shareholdings in the holding company.
The Valuation of the Hotels
Two specialist real estate valuers gave evidence, supporting values of £1.2 billion and £1.4 billion respectively. The major area of difference was whether a portfolio premium of 10% (£127 million in this case) should be added on the assumption that a group of hotels would be more attractive in aggregate than when each was viewed in isolation.
This was not accepted by the Judge on the basis of a lack of evidence; he considered that it was too speculative a component for inclusion. The hotels were also too diverse to form a natural block for purchase, with one flagship property and the others at a different price point.
The point was then argued in an alternative: it was stated that both real estate valuers had valued the hotels net of the purchaser’s costs. If the shares in the holding company were acquired, stamp duty land tax would be avoided and would be replaced by stamp duty of only 0.5%. Therefore this saving could be added to the values. Again, the Judge was not persuaded by this argument.
The Judge settled on a valuation of £1,275,400,000 for the hotel portfolio.
Share Valuation Experts
One expert adopted a novel approach to the valuation of a minority holding of 19.9%. The evidence was a combination of the newly formed, but using elderly ingredients. He argued that there were three factors which produced the net discount percentage:
- A discount for lack of control (20%) (source: Damodaran 2005);
- A premium for a realisation benefit (£73.7 million);
- A discount for an absence of liquidity (30%) (source International Private Equity Valuation Guidelines 2006);
The outcome of the above three adjustments equated to a very modest discount of 18.7%. The first and third of these adjustments are concepts which we can all recognise. They reflected a discount of 44%. We therefore need to delve into the notion of the realisation benefit.
The £73.7 million was the net present value of £324.3 million, being the difference in year 20 between the projected pro rata value of the shares (£759.3m) and the then market value of a minority holding with no exit prospect (£435m). The assumptions on which these figures were based were not stated, but the discount rate is some 7.7% a year.
The Judge recognised that the realisation premium could only be added if the DLOC and DLOM could be deemed to strip out the prospect of an uplift on realisation. As this was not the case, he did not accept that it was appropriate to add the realisation premium.
DLOC and DLOM
The other expert recognised the concepts of DLOC and DLOM but did not seek to apply separate discounts due to the close relationships between the two concepts. He considered that an overall discount should be in the range from 50% to 70%, with a best estimate of 60%. Sterling efforts were made to bring some objective evidence to bear to support these figures including HMRC guidance, a KPMG Australia Valuation Practice Survey and the use of one of the Finnerty option pricing models. It was perhaps inevitable that this evidence supported a range, rather than a single discount rate.
The Judge was clearly uncomfortable in this area, but eventually decided on a discount of 45% for DLOC and DLOM in this case.
Premium for Control?
One of the experts argued that the discount which afflicted the minority holding had an equal and opposite doppelganger, the value of which had to be added to the control holding. We can all recognise that the minority discount will include within it the exposure to the risk of unfair prejudice. To this extent there is some merit in the argument that the controlling shareholder has the mirror image benefit. Some of the perquisites of control are to the disadvantage of the minority. However there are other aspects which make up the discount such as a greater absence of liquidity, an inability to determine the size and timing of dividends, and an information deficit. These are not reflected in an enhanced value to the controlling shareholder.
The Judge recognised that both majority and minority interests represented some degree of constraint on the exercise of power. There was no expectation that the values of shareholdings in these circumstances would aggregate to the total value of the assets held by the company. The discount for a holding of just under 75% was set at 10%, with 2.5% applied to a 95% holding.
The Nature of Instructions
It is clear that expert witnesses are not instructed as to what their opinions should be. However there can be occasions when experts are instructed to make certain assumptions. It is clearly important that their reports should be wholly transparent in this regard.
In this case one of the experts was instructed to consider the following impacts on the valuation:
- A reduction in the cash assets of £30 million;
- A reduction in the value of the stock from £1.1 million to £nil;
- An increase in the bank borrowings by £3.7 million to the mid point in the year;
- The removal of the bank funding arrangement fee asset of £2.1 million;
- The inclusion of an off-balance sheet hedging asset of £200,000.
We can have considerable sympathy with some of these adjustments: there is a lacuna between a valuation of a hotel on the basis of DCF and the separate inclusion of assets such as cash and stocks. If the cash is wasting cash as defined by Professor Damodaran (cash which has to be held for operational purposes with no prospect of a return) then it is strongly arguable that the value of that cash, and the inventories within the hotels, must be enfolded within the DCF valuation, or they are otherwise operational assets which yield no return. However the Judge rejected this argument as the two hotel valuers had not included these assets in their valuations.
The bank funding arrangement fee asset was also addressed in another hotel case of Destiny Investments and TH Holdings (EWHC 657) [2017]. In that case the Judge was persuaded that it should not be included in the value as the prospect was for realisation of assets and settlement of debt.
In this case the Judge did not feel inclined the overturn the measurements of generally accepted accounting practice. There was no prospect of realisation in the short term in this case.
Quantum
The calculations valued a combined holding of 25.18% on the basis of the holder having 95% control and then deducted a value of a standalone minority of 19.9% and a holding of 5.28% which had just under 75% control. The value for the outgoing shareholder was £137.4 million compared to a standalone minority value of £97.9 million. The pro rata valuation was 177.9 million.
Andrew Strickland, Consultant
Scrutton Bland
