Introduction to Fairness Opinions

What is a fairness opinion?

A fairness opinion evaluates the financial fairness of the price an acquirer is offering a target during a transaction seeking to take control of the target (acquisition, takeover, merger, etc.). [i] A fairness opinion may also be used when a public company is divesting one of its divisions or business lines, or a company is experiencing a bankruptcy or restricting scenario.

As the fairness opinion reviews the transaction from a financial point of view, the advisor must look at the price offered, agreement terms, additional consideration, and how comparable market transactions were priced and structured.[ii]

A fairness opinion is provided by an independent financial advisor (typically an investment bank or professional services firm) to the target company’s board of directors. A fairness opinion may be provided to the acquirer from a separate financial advisor as well.

When should it be used?

Board members owe a fiduciary duty to their shareholders. Hiring an independent financial advisor to perform a fairness opinion is evidence the board upheld its fiduciary duty of care.

Some additional circumstances where a fairness opinion should be used include:

The target has received competing bids with different pricing and deal structures
Conflict among the board of directors
The offer is unsolicited/hostile
Shareholders of different classes have received varying offers[iii]

What is it used for?

A fairness opinion aids board members in decision making and mitigating personal liability risks. To be more specific, a fairness opinion provides directors insights into the intrinsic value of their company/the target company. The fairness opinion therefore significantly improves the board’s decision-making ability. The clarification provided by the fairness opinion is essential to understand if the consideration offered will improve shareholder value. With this information a transaction can be completed quicker indicating a fairness opinion can prevent significant transaction time and cost delays.[iv]

In 2014, lawsuits were filed in 93% of M&A transactions worth north of $100MM[v]. The board of directors owes a duty of loyalty (acting in good faith towards the best interest of the corporation/shareholders) and a duty of care (directors must use the same care a neutral third-party would/inform themselves of “all material information reasonably available to them”)[vi]. The fairness opinion mitigates the director’s personal liability risk as it proves the board upheld its fiduciary duty of care and therefore mitigates their legal risk.[vii]

Fairness Opinion History: Smith v. Van Gorkom

The Delaware Supreme Court’s 1985 ruling of Smith v. Van Gorkom is a timestamp for fairness opinions and their prominence in M&A transactions.

To summarize the lawsuit, the case started in 1980 with Marmon Group proposing a leveraged buyout (LBO) of TransUnion. TransUnion’s CEO Jerome Van Gorkom proposed a price of $55 per share without the expertise of financial advisors. Instead, he only consulted with the company’s CFO to determine a share price that would work for the LBO. Although the transaction was contingent to the board’s approval, many important financial documents/plans were not thoroughly discussed. None the less, the board still approved the LBO transaction.[viii]

The Supreme Court ruled against the board’s LBO vote due to the absence of a financial advisor’s expertise. Without a fairness opinion, the TransUnion directors were unable to thoroughly assess the fair value of their company. The Supreme Court cited that the directors had a fiduciary duty to the TransUnion shareholders to confirm Marmon Group’s consideration was fair.[ix]

Example Fairness Opinion: Syngenta AG Acquisition

In February 2016 China National Chemical Corp (commonly referred to as ChemChina) agreed to buy Syngenta AG (a Switzerland-based pesticide/seed maker) for $465 USD per share[x].

Financial advisor/investment bank N+1 Swiss Capital (now Alantra) was hired by Syngenta to provide a fairness opinion to Syngenta’s board of directors. The fairness opinion had four key subsections an introduction, company description, valuation considerations, results of the fairness opinion (as well as an appendices).

Introduction

The introduction section started with a quick description of the company (market capitalization, number of employees, key financials, key business lines, etc.). The introduction also included the fact that Syngenta received an unsolicited bid in the previous year (note: the bid was rejected by Syngenta’s board) which led to takeover speculation.

The introduction then goes into how a fairness opinion works, N+1’s evaluation procedure, and its legalities (how N+1 would be compensated, the board of director’s mandate, etc.).

Company Description

This section starts with restating the company’s market caps, key financials, etc. Directly after N+1 breaks down the major business lines, key geographical areas, and finally the business model. N+1 also dives into Syngenta’s sales and profitability before taking a step back and looking at the general seeds/crop protection business worldwide (market drivers, risks, Syngenta’s market position, etc.).

Valuation

The Valuation section begins with stating the methodology N+1 will use, the number of shares outstanding, and the valuation date. The section then summarizes a DCF and market-based valuation methods, and finally the takeover premium.

The DCF section includes a derivation of the weighted average cost of capital (WACC) by analyzing the cost of equity (risk free rate, beta, and market risk premium), cost of debt (pre-tax cost of debt, tax rate), and finally setting a target capital structure. Financial assumptions are then input. This is essentially a normal DCF that has been further summarized to include Syngenta’s business plan, key drivers/valuation parameters, and relevant market dynamics. It should be noted that the derivation of some of these valuation parameters are further explained in the Appendices section instead of the Valuation section.

The valuation section then pivots to equity research analyst price targets and an analysis of comparable companies. The section is then completed with an analysis of precedent transactions (complete with takeover premiums in Switzerland).

Results

The final section summarizes the previous sections as well as the valuation range provided by the three methods on a football field chart. Finally, N+1 states to fairness opinion’s readers (Syngenta’s board of directors) whether or not they thing the price offered by the acquirer (China National Chemical Corp) is financially fair or not.

[i] https://corporatefinanceinstitute.com/resources/knowledge/deals/fairness-opinion-overview/

[ii] https://mercercapital.com/article/the-importance-of-fairness-opinions-in-transactions/

[iii] https://mercercapital.com/article/the-importance-of-fairness-opinions-in-transactions/

[iv] https://www.pwc.com/ca/en/services/deals/whats-the-deal-blog/2017-05-a-question-of-balance-the-trend-towards-independent-flat-fee-fairness-opinions.html