Majority of Fairness Opinions Are Robust, Offer Useful Advice
NEW YORK – MARCH 28, 2017 – Most fairness opinions use a robust set of methodologies to produce a useful range of valuations, according to a new study of more than 3,000 publicly disclosed fairness opinions by Duff & Phelps, the premier global valuation and corporate finance advisor.
This conclusion disproves claims made by critics who – triggered by certain well-publicized transactions — argue that fairness opinions provide little utility for boards analyzing potential transactions, either because the valuation range in the opinion appears overly broad, or the analysis is mechanical and is produced with little rigor. This new study, “In Defense of Fairness Opinions – An Empirical Review of Ten Years of Data,” represents Duff & Phelps’ effort to answer the critics through analysis, proving that those instances are outliers, caused more by peculiarities in circumstances than faults in the process.
Duff & Phelps conducted a thorough analysis of more than 3,000 fairness opinions filed with the U.S. Securities and Exchange Commission on forms 14D and DEFM14A during the 10-year period ending in 2016. Key findings include:
- Value for Corporate Boards: The vast majority of fairness opinions deliver a range of valuations that is sufficiently narrow – within 10 to 15 percentage points on either side of a midpoint – to serve as a valuable tool for evaluating purchase offers.
- Sophistication in Multiple Methodologies: Fairness opinion advisors provide multiple perspectives and analyses in assessing valuations: 91 percent of the fairness opinions reviewed used multiple methodologies to arrive at valuations. In 75 percent of the opinions, advisors used three or more methodologies. In 43 percent of the filings we analyzed, fairness opinion advisors presented multiple cases of discounted cash flow analysis.
- DCF Reliability: Discounted cash flows provided the narrowest range of values among the prevailing methodologies in the fairness opinions reviewed.
- Choice of Advisor Matters: The choice of an advisor impacts the precision of a given fairness opinion. Among the most active providers, the tightest average range, at 23 percentage points, is nearly half the broadest average range of 41 percentage points.
The analysis demonstrates that fairness opinion advisors use robust, sophisticated methods to reach valuations that provide a reliable means for corporate boards and executives to evaluate purchase offers.
Fairness Opinions 2006-2016
Most fairness opinions use a robust set of methodologies to produce a useful range of valuations, according to Duff & Phelps’ study of more than 3,000 publicly disclosed fairness opinions.
Those conclusions disprove periodic criticisms that fairness opinions generally provide little utility for boards analyzing potential transactions. Specifically, some critics have asserted that fairness analyses produce valuation ranges too wide to provide meaningful information and that, because most fairness opinions are based in part on DCF analysis, the opinions are too reliant on financial projections that have been produced by management and left unscrutinized by the fairness advisor.
We agree that narrower valuation ranges are, intuitively, more useful to boards than wider ranges. However, some deals are likely to produce wide ranges because the companies themselves are difficult to value. The real question is whether wide ranges are pervasive. And while we would also agree that relying solely on DCF analysis (that uses projections company management has fed to the fairness advisor) can be problematic, the follow-up should be to ask: is that really happening?
In an effort to answer those questions, assess the validity of periodic criticisms and determine the overall usefulness of fairness opinions, Duff & Phelps conducted a thorough analysis of more than 3,000 fairness opinions filed with the SEC during the ten-year period ending in 2016. Specifically we looked at forms 14D and DEFM14A, which companies are required to file when they are the target of a purchase offer or require a shareholder vote.
A Valuable Tool for Boards
To test whether wide ranges are pervasive, we analyzed publicly disclosed fairness analyses over the last ten years. Our analysis confirms that on average, fairness opinions deliver a range of valuations that is sufficiently narrow to serve as a valuable tool in evaluating purchase offers. And the average range grows narrower as deal size grows larger. Among deals we analyzed that carried a value of $10 billion or more, DCF analyses produced average price ranges between 78 percent and 106 percent of the offer price. Large-cap companies typically are more diversified and established, with more stable and predictable cash flows and broader equity-analyst coverage. Armed with multiple, reliable sets of financial projections and a variety of perspectives on the company’s future performance, fairness opinion advisors can be expected to produce more precise valuation ranges than when this information is absent.
In the charts above and below, valuation ranges are expressed as average percentages of the implied share prices as compared to the offer price. The average range widened only slightly for deals valued at less than $10 billion but more than $100 million. For deals valued at less than $100 million, DCF analyses produced average price ranges between 65 percent and 105 percent of the offer prices. The difference in average valuation ranges for micro-cap companies versus large-cap companies is even more pronounced when we analyze the dispersion of fairness opinion ranges. As the chart below illustrates, as company size decreases, the widest 25% of valuation ranges increases.
Our observation – wider and more disperse valuation ranges for smaller companies – is not all that surprising. This reflects the heightened complexity involved in valuing enterprises that are less mature, have less historical data to analyze and compare, or are growing at a rate that causes dramatic variances in expected cash flow.
In addition, voluminous published analyses, including our own Valuation Handbook — Guide to Cost of Capital1, have shown that discount rates decrease as company size increases due to the diminishing effects of small-stock premiums. That research helps explain our finding that micro-cap companies receive the broadest valuation ranges.
Methodologies: Rigor and Sophistication Apparent
The findings present clear signs of an industry standard at work among fairness opinion advisors. Counter to the criticism that fairness opinions rely too heavily on DCF analysis, we find that fairness advisors have been using multiple methodologies for some time. For instance, 91 percent of the fairness opinions we reviewed used more than one methodology to arrive at valuations. In 75 percent of the deals, advisors used three or more methodologies.
Moreover, we also observed a slight increase in the average number of methodologies since 2008, from an average of 3.3 methodologies to nearly 3.5 in 2016.
We argue that the use of multiple valuation methodologies also significantly mitigates the criticism that DCF analysis and therefore the opinion could be too heavily influenced by unrealistic company projections. The common pairing of public-company comparables and/or precedent transactions with DCF analyses, often supplemented by one or more additional methodologies, demonstrates that, in the vast majority of cases, fairness opinion advisors diligently consider