We are all familiar with the traditional levels of value table which we imbibed when undertaking our basic training. With some modest variations, here it is:
| Strategic Value |
| Synergistic value |
| Control value |
| Control Premium/DLOC |
| Minority marketable |
| DLOM |
| Minority non-marketable |
The first concern I have with this structure is that it has at its core the concept of the control premium. Previously we all considered that the pricing of shares in the public markets reflected minority marketable value; that is still true in a literal sense. However the implication that there is a premium for control which sits above the marketable minority value is not sustainable.
Seminal work undertaken over the period since 1990 by Eric Nath and others has led in the USA to the Financial Reporting Advisory from The Appraisal Foundation “The Measurement and Application of Market Participant Acquisition Premiums” in the autumn of 2017. To summarise this Advisory: we should no longer assume that there is a premium for control of a public company. We should only consider such a premium if there is an identified market participant who can harvest more value than the rest of the market by increasing the cash flows or reducing the risks of the target.
This thinking now generally recognizes that observed bid premiums in the market are closer to being a synergy dataset; alternatively they represent unique circumstances in respect of market pricing or management quality which cannot be deemed to overlay the whole market.
If the control premium is now looked at askance, its inverted offspring, the DLOC, is equally fragile. The observable bid premiums cannot be assumed to reflect the shapeless and undefined benefits of control; in a similar way the data cannot be used, having been turned on its head, as the basis for a discount for lack of control.
My next problem with the table is that there is no link in the chain for the control holding in a private company. As our focus is on the valuation of shares in private companies this is more than unfortunate. As valuers we have in the past started with the concept of the control premium from the public markets with deductions then being required for the size and liquidity of the control holding in question. We therefore have to think of a spur off the conventional levels of control chart in order to embrace the control holding in a private company.
In addition to the above concerns, I am troubled by the terminology of the DLOM. Earnest discussions have been held as to whether or not a control holding in a private company merits a discount for lack of marketability. This ignores the simple truth that nearly all holdings in private companies suffer from an absence of liquidity.
We can define liquidity as the ability to sell a stock:
- For a known price;
- Quickly;
- With a minimal bid-offer spread;
- Without moving the market price; and
- With minimal transaction costs.
None of the above qualities can be attributed to holdings in private companies, whether we are dealing with a control or a minority holding. It is then also clear that minority interests have far less ability to take the company or their holdings to market than does the control shareholder.
In order to address the concerns above, I consider that a better representation of the levels of value is:
| Strategic value |
| Synergistic value |
| Liquid value |
| Discount for lack of liquidity/ liquidity premium |
| Controlling non-liquid value |
| Minority/ majority reduction/ increase value |
| Minority non-liquid value |
We can consider each of the layers in turn. Whether or not there is a strategic value above the synergistic value is debatable; its presence has no impact on the rest of the chart. The strategic value has been described as the value driven by management’s determination to buy the target regardless of the inconvenient views of the advisers that the price exceeds market levels.
As noted above, it is now the general view that the observable premiums offered and paid in the markets in takeovers are closest to a synergy dataset. These transactions are best thought of as comprising an exception report, rather than evidence of valuation truths to be applied to the whole market.
Next we have liquid value, being the value expressed by the market capitalisations in the public markets. These are the values of the public companies as represented by the aggregate of the smallest minority holdings as traded from day to day.
The discount for lack of liquidity or DLOL focusses on the qualities of liquidity, rather than marketability. The thinking here is more complex than it might first appear: we value on the cusp of a transaction, so liquidity in respect of that transaction should not feature in our thoughts. The discount relates to the innate qualities of the shares; in simple terms the buyer discounts the price due to the future costs and uncertainties he will incur in a sale, as does his buyer and so on into the unknown future.
Conceptually, for the largest private companies the DLOL for a majority holding will reflect the costs of going and staying public.
The inverse of the DLOL is the liquidity premium. There are various studies which are, in truth, measuring the reaction of the market to a liquidity deficit.
The controlling non-liquid value is the controlling interest in private companies. There is a very real value in control in many private companies due to the governance deficit. The precise value of that control will always depend on the circumstances of each private company. At one end are those private companies which act in a similar way to public companies. At the other end are the entities controlled in a despotic way. The controlling shareholder, with not a democratic thought in his head, gathers to himself and his family all of the perquisites of control.
This is therefore where an adjustment, previously considered as the DLOC/control premium, now resides. This is the difference between the control level and minority level in private companies. It should reflect the nature of the governance deficit when compared to public companies.
I have studiously avoided the terms “discount” and “premium” at this level. This is because most commonly the minority value should not be derived from the majority value: they are based on potentially very different cash flows.
As the governance of private companies varies so widely, it is not appropriate to cast the net for studies which provide external sources of standard discounts. Instead we should follow the cash flows.
The revised levels of value chart above relates to CoCo data at the “liquid value” level and to CoTrans data at the “controlling non-liquid value” level. Therefore both sources of data are envisaged in the chart above.
Andrew Strickland
Consultant