To those reading these articles it may seem that we have a certain obsession with the report produced by the Independent Expert.
However, let's just briefly go back to the basics and understand why it is so important and why we might be very disappointed that we feel that we cannot rely upon the report produced by the Independent Expert.
The mechanics of a Scheme of Arrangement are that whilst the bidder (Qiagen) have offered to buy the Company, the actual Scheme of Arrangement is run and promoted by the target (Cellestis). Clearly, this means that both Companies are largely on the same side of the fence.
In an attempt to counteract the bias that might be seen to be operating under such an environment, the Scheme of Arrangement procedures call for a report by an Independent Expert to ostensibly ensure that we, the shareholders are not being unfairly treated by this Scheme of Arrangement.
That is, and should be, a huge responsibility on the shoulders of the Independent Expert. This is something that we would expect to be undertaken with the full recognition of this responsibility. As shareholders we are being asked to put a huge amount of faith in the Independent Expert. It is a central tenet of the entire procedure.
It is therefore absolutely essential that we all examine the procedures, assumptions and outcomes of the Independent Expert report with the greatest diligence. Without conducting such an intensive examination, how can we be assured, in our own minds, that a deal being offered is, in fact, fair?
Of course, we could just take it on face value. Perhaps many do.
I am disappointed that there are so many issues with the Independent Expert report that I cannot rely upon it to make a valid decision.
Dear Mr. Bula,
ReplyDeleteI have been following your blog for a few weeks now and I admire your effort on this topic. Nevertheless, a few things just don’t add up.
You asked: "Why do we care about the IE?"
I ask: Why not?!
I am not saying that either CSAG's or the IE'S opinion is right or wrong, but a few things in CSAG's assessment of the value of CST shares are just FACTUALLY wrong.
1. In the CSAG “valuation“, the net cash position of CST is not being added to the value of shareholders. The IE does this in his assessment and hence INCREASES the valuation of CST. As per CSAG’s assumption, the IE may or may not want to increase the value of CST, but still includes the net cash position of CST, because it is CORRECT (see scheme booklet 6.2.5.) while the CSAG’s method is NOT.
2. In addition, the CSAG valuation does not account for the dilution effect due to the options outstanding (see scheme booklet 6.2.4). This is also incorrect in the valuation framework used by CSAG.
3. Lastly, the calculation of the appropriate discount rate. The discount rate used by the IE is the weighted average cost of capital (WACC) of CST. The WACC is used to discount unlevered free cash flows of CST. Since CST has no debt, but rather net cash (see above) the WACC equals the Cost of Equity. How CSAG gets to a discount rate (i.e. Cost of Equity) for CST of only 8% while the Australian “risk-free” rate (i.e. 10yr Aussie Treasuries) is already 5.6% is hard for anyone to grasp. Why would any investor to invest her/his money in a high risk, early stage, one product company for a risk premium to the risk free rate of only 2.4%?
Even SABMiller does take a deal WACC for Fosters of 8.5-9.0% (see SABMiller’s CFO comments on deal conference call). Not only is the capital structure of Fosters different, but the predictability and stability of cash flows are vastly more certain than the ones of CST. To calculate the “correct” Cost of Equity, one should take the risk-free rate and add an adjusted risk premium to derive the cost of capital. Historically, the Equity Risk Premia (ERP) have been around 5-7% for the entire stock market. This ERP should be adjusted up- or downwards for each specific company depending on the perceived risk & volatility of the share vs the entire stock market.
By taking a discount rate of 8%, CSAG assumes that the shares of CST are LESS THAN HALF as risky & volatile as the entire Australian stock market….
I personally do not want to give a view on what the “correct” discount rate should be, but for anyone who wants to have some academic and entirely independent information on this should rather have a look here
http://pages.stern.nyu.edu/~adamodar/
Sad sad sad. How the mighty have fallen to $3.80 is beyond comprehension.
ReplyDeleteComments now closed, lets all move on.
ReplyDelete