The spotlight is on valuations: How will you deal with the challenges?

A number of recent issues have put the spotlight firmly on business and equity valuations.  This article recaps some of the pertinent issues and fundamental complexities that are being faced.

Recent issues that have brought the robustness of valuations (or lack thereof) into the forefront of corporate Australia include:

  1. The drama surrounding Blue Sky Alternative Investments

In recent months, US-based activist hedge fund Glaucus released a white paper and numerous communications into the market challenging Blue Sky Alternative Investments’ valuations of its underlying investments, on which its management fees are in turn based.

In the mayhem that ensued, Blue Sky shares, which were trading at around $11.50 in late March, are now trading at around $1.50 per share.

Aside from claims of misleading conduct and the polar opposing views of Blue Sky and Glaucus, the recent standoff has illustrated that judgement is required at many points in a valuation.

[http://www.afr.com/business/banking-and-finance/hedge-funds/glaucus-targets-blue-sky-alternative-investments-as-next-australian-short-20180328-h0y2bg]

  1. High profile impairments and ASIC’s public interventions

ASIC’s recent public intervention into Myer’s $515 million impairment loss has made the broader market aware of its keen interest and active involvement in the area.  This wasn’t a stand-alone occurrence either – we’re seeing increasing activity from ASIC in questioning impairment testing processes and conclusions.

ASIC’s message is clear – impairment is present, and is poorly dealt with by corporate Australia.

  1. Public scrutiny and regulatory action in relation to Independent Expert’s Reports (IERs)

IERs are independent reports to shareholders on the value (fairness) and other advantages and disadvantages (reasonableness) of certain public company transactions.  They are designed to protect shareholders by providing relevant information and value-centric analysis to assist them in voting for or against a proposed transaction.

IERs are typically required by the Corporations Act or ASX Listing Rules, or are embarked upon due to commercial necessity or shareholder protection measures.

FY18 saw HLB Mann Judd and BDO dragged over hot coals in relation to IERs.  In summary, ASIC subjected HLB Mann Judd to a permanent ban on producing IERs, and BDO were sued over an allegedly misleading and deceptive report.

As these examples illustrate, ASIC, corporate Australia and their advisory networks are all keenly watching.

  1. Accounting standards are increasingly requiring subjective valuation assessments

Recent years have seen an increasing transition to accounting standards which require subjective valuation assessments.  Some examples include:

  • Fair valuing financial instruments
  • Fair valuing physical assets
  • New revenue accounting standards
  • Embedded derivatives.

These changes mean less reliance is placed on historical cost and other traditional accounting treatments.  Key areas of consideration from a valuation perspective include:

  • Determination of reasonable cash flows
  • Determination of appropriate discount rates, often for assets or securities that do not trade in active markets
  • Adopting complex and sometimes “black box” valuation calculations.

A traditionalist might ask ‘whatever happened to the importance of reliably measurable?’

  1. Increasing ATO scrutiny of valuations

We’ve seen increased activity from the ATO in relation to critiquing valuations across a broad range of issues, including but not limited to:

  • Small business tax concessions
  • Corporate restructures
  • Available fractions for loss utilisation
  • Formation of tax consolidated groups
  • Changes in residency.

To maximise the chances of a smooth and cost effective ATO journey, a full scope of work consistent with the ATO’s market value for tax purposes guidelines is recommended.

Below are 10 recommendations in dealing with valuation complexities whilst under the microscope:

  1. Engage with an appropriately qualified expert.
  2. Ensure your valuer is operating under the relevant regulatory or other frameworks, of which there are many.
  3. Ensure the purpose, scope, perspective and premise of value is relevant and clearly defined upfront (as value can vary wildly, and even absolutely, depending on these items).
  4. Ensure the valuation is approached from multiple angles.
  5. Challenge the primary valuation approach and methodologies adopted.
  6. Check the factual accuracy of the key assumptions on which the valuation is based.
  7. Understand the impact and sensitivities of the key assumptions.
  8. Consider counter arguments and rebuttals to challenge the initial conclusions (use professional scepticism).
  9. Ensure the ultimate conclusions are commercially sound as well as being technically robust.
  10. Ensure the exercise is adequately documented.

If you would like to discuss these issues further, please feel free to contact me directly, at [email protected] or +61 2 9619 1783.

Nathan Timosevski

Partner – Corporate Finance