Business Law Currents: To start, tell us a little about your expertise.
YAS: I specialize in M&A valuation, advising boards of directors and companies on valuation and solvency in connection with proposed transactions. This often entails providing fairness and solvency opinions. I play a similar role in M&A litigation. As either a consulting or testifying expert, I provide opinions of value or solvency for disputed transactions. At times the opinions are retrospective, as I may be asked in post-closing litigation to provide an opinion of value or solvency at the time of the transaction.
Business Law Currents: The role of the financial adviser has come under scrutiny since the financial crises and the Del Monte ruling from the Delaware Chancery Court. What trends are you seeing for financial advisors, particularly in light of reform measures passed by Congress?
YAS: In an M&A context, financial advisors are operating in an uncharted environment regarding disclosures of financial analysis, conflicts of interests and substantive critique of financial analysis. It’s important to note that in the last few years, the source of the most demanding scrutiny has shifted from the Securities and Exchange Commission to the Delaware courts. Thus, unlike other reform measures impacting financial institutions, changes to the M&A landscape have not been primarily driven by regulatory or legislative changes.
Proxy statement disclosure of the financial analysis underlying a fairness opinion has become more expansive as a result of shareholder litigation adjudicated in Delaware. For example, M&A practitioners used to debate whether management’s financial projections needed to be disclosed at all. Today, the debate centers instead on which versions of management’s projections need be disclosed and in what level of detail.
Heightened scrutiny of conflicts of interest has proved most vexing for financial advisors, though. The reason is two-fold. First, the courts have taken a broader view – as compared to the historical view – of what constitutes a conflict. Second, in instances in which the court is troubled by a perceived lack of objectivity on the part of the financial advisor, it has demonstrated a greater willingness to critique the substantive financial analysis. For example, the Delaware court has called into question various analytical assumptions and methodologies used by the bankers in rendering fairness opinions.
Business Law Currents: Can you give us a background on the Fair Summary requirement?
YAS: [In re Pure Resources, Inc. S’holders Litig., 808 A.2d 421 (Del Ch. 2002)] established dictum in Delaware that shareholders are entitled to a “fair summary” of the financial analysis upon which a fairness opinion is premised. In that case, the court rejected the notion that only the analytical conclusions needed to be disclosed. However, subsequent court rulings on disclosure-related matters have highlighted the difficulty involved in reconciling a “fair summary” requirement with Delaware’s historical “materiality” standard.
Delaware courts have found a fact “material” if including the omitted fact would significantly alter the total mix of information available to shareholders. Fiduciaries, financial advisors and legal counsel must decide on a case-by-case basis whether information that might reasonably be included in a “fair summary” also rises to the level of materiality. Then they have to hope that the court agrees with their assessment.
Business Law Currents: How are financial advisors responding to heighted scrutiny, especially in light of conflicting guidance?
YAS: Financial advisors are responding in two ways. First, financial advisors are disclosing a broader array of relationships, conduct, and financial interests that could be construed as conflicts by the court. Banks are making these disclosures both independently and in response to specific inquiry from potential clients. Increasingly, these disclosures are being made by the financial advisor to the company or its legal counsel prior to being retained. Disclosure does not cure all conflicts, but fulsome, frank and early disclosure is still viewed favorably by the court.
The second way in which financial advisors are responding is with a renewed focus on litigation risk management. This entails combining legal and financial expertise to minimize negative outcomes in the M&A litigation process. As part of this effort, banks are placing more importance on the implementation and documentation of the financial analysis underlying its advice to fiduciaries and companies. Examples include greater technical consistency across client matters, more careful preparation of board books to improve their accuracy and ability to function as stand-alone documents in litigation, and better contemporaneous documentation of professional analytical judgments.
For some banks, this involves a change in culture. Traditionally, banks have paid more attention to the sales and negotiation process in M&A transactions than to performing and documenting the analytical process.
Business Law Currents: How would you categorize the current valuation trends? Are you seeing some sectors more stable than others?
YAS: M&A valuations are benefitting from two interrelated factors. First, there is greater convergence on value between buyers and sellers. In the immediate aftermath of the financial crisis buyers and sellers had sharply divergent views on value. The next evolution was an over-reliance on contingent consideration in an effort to strike deals. Now we are seeing differences in value that are being appropriately driven by deal-specific factors such as due diligence and the quantification of contingent risks.
Second, M&A valuations have improved due to greater available capital. On the equity side, many strategic buyers are finally deploying the large cash balances accumulated during the crisis. On the debt side, both senior credit and leveraged financing markets have improved significantly. As a result, valuations are more consistently reflecting what the target is worth, and not simply the amount of financing the buyer has available or the desperation of a seller who needs capital to stay afloat.
A few sectors are experiencing more idiosyncratic trends. Healthcare valuations, for example, are being impacted by continuing regulatory uncertainty. Conflicting opinions about the ultimate scope of U.S. healthcare reform is leading to some dislocation in deal pricing. A similar regulatory uncertainty is impacting valuation of for-profit educational facilities. On the other hand, valuations in the financial services sector have become more stable. Compared to a few years ago, shocks like the failure of MF Global tend to be more confined and have less of a sector-wide impact.
Business Law Currents: What should buyers be looking for in current valuation models?
YAS: Valuation models tend to influence the perspective of targets more than acquirers. The buyer’s perspective on value tends to be myopic: What is the value of the target to me? In contrast, the target is generally asking if the buyer’s proposal is the best deal they can get. Thus, targets are generally seeking to maximize value across a broader solution set.
Valuation analysis, including the underlying models, can be an integral tool for target fiduciaries if the fiduciaries are engaged in a fully informed dialogue with the target’s financial advisors. For example, a few key questions that target board members may pose to the advisors are: Were the transaction projections prepared by the same people, using the same process as the projections by which the company is ordinarily managed? Does the valuation analysis sufficiently consider the value of not entering into a transaction? Will the target be fairly compensated for deal synergies?
Business Law Currents: What are you seeing in terms of private deals versus public deals? Is there more activity in the PE space and why?
YAS: Better access to the credit markets, improved business fundamentals and the re-emergence of strategic buyers are having a positive impact on private company deals. The market for private-targetdeals had been dominated by distressed transactions, where a large number of the deals were actually financial sponsors re-upping earlier investments. Healthier private companies were waiting on the sidelines for valuations to improve. Today, we are seeing a more robust private company market with a relative shift of negotiating leverage more in favor of target companies.
More broadly, the PE space continue to be dominated by a sluggish IPO market that limits exit opportunities, a leveraged finance market that remains receptive to dividend recaps and investment funds that exceed opportunities. The result appears to be a steady, if relatively moderate, flow of PE transactions. There are few “break-out” PE deals in the current market.
Business Law Currents: To close, tell us a little bit about your involvement with the ABA.
YAS: I have been an associate member of the American Bar Association for nearly 10 years. I am most active in the M&A Committee. Last year, the committee published the Model Merger Agreement for the Acquisition of a Public Company, for which I authored an appendix on merger exchange ratios.
Recently, I was appointed co-chair of the ABA’s Financial Advisor Task Force. This is an interdisciplinary group whose membership includes corporate attorneys, financial advisors and litigators. We are emerging as a clearinghouse for thought leadership on the intersection of M&A jurisprudence and financial analysis.
This interview was conducted by Christopher Longley, a Senior Relationship Director at Thomson Reuters.
Yvette Austin Smith is a managing director at Stout Risius Ross, a financial advisory firm specializing in investment banking, valuation and dispute advisory. She is based in the firm’s New York office. She regularly advises boards of directors and companies on valuation and solvency issues in M&A transactions and M&A litigation. She is an active associate member of the American Bar Association and was recently appointed co-chair of the ABA’s Financial Advisor Task Force.
Ms. Austin Smith is a frequent speaker and author on M&A valuation and has developed multiple continuing legal education seminars on related topics. She also publishes a series of valuation tutorials that examine specific valuation topics that figure prominently in high-profile M&A litigation. Copies of the M&A Valuation Tutorials and Ms. Austin Smith’s complete bio can be found at www.srr.com.
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