Derek Ryan, DIRECTOR E: dryan@pkf.com.au M: 0408 635 107

Paul Lom, DIRECTOR E: plom@pkf.com.au M: 0408 586 672

Liam Murphy, DIRECTOR E: liam.murphy@pkf.com.au M: 0414 384 667

John Bell, DIRECTOR E: jbell@pkf.com.au M: 0413 448 552

Rick Hopkins, DIRECTOR E: rhopkins@pkf.com.au M: 0411 490 666

FIND US ON

ON CORPORATE FINANCE

www.pkf.com.au

ISSUE 17

QUARTERLY INSIGHTS INTO KEY FINANCE

MATTERS AFFECTING YOUR BUSINESS

IN THIS ISSUE• STRUCTURING

A TAKEOVER• INCREASED

ASIC SCRUTINY OVER FORECASTS IN EXPERT REPORTS

GLOBAL DEAL FLOW:

SIGNIFICANT INCREASE IN AUSTRALIAN M&A VOLUME

focus | on corporate finance

DEAL FLOWGlobal deal value and volume in the 2016 calendar year fell short of the record levels achieved in 2015 with the value of merger and acquisition (“M&A”) deals falling 18.1% for the period to US$3.2 trillion. Volume also declined to 17,369 deals (18,039 in 2015) according to Mergermarket data.

Decline in global deal flow can largely be attributed to a range of factors including equity market volatility, political uncertainty in the lead up to the US federal election, slowing growth in China, persistent concerns over global financial sector health, the UK referendum and subsequent Brexit.

This decline in deal value was in part offset by the announcement of several megadeals in the final quarter of 2016, including AT&T Inc’s acquisition of Time Warner Inc for US$105.0 billion, Sunoco Logistics’ US$51.4 billion takeover of Energy Transfer Partners and the $45.9 billion technology bid by Qualcomm Incorporated for NXP Semiconductors NV.

North America maintained its traditional dominance in terms of M&A value with 47.8% of the global total whilst Europe attracted the most number of deals at 6,756, compared to 5,585 in North America and 4,107 in Asia according to a Mergermarket report.

Set out below is a summary of global M&A activity by value and volume:

After early doubt over what a Trump presidency would mean for the global economy, growing confidence of stronger growth

Source:Mergermarket & Merrill Corporation, (January 2017), Monthly M&A Insider, A Mergermarket Report on Global M&A Activity, viewed 30 January 2017Mergermarket & Merrill Corporation, (January 2016), Monthly M&A Insider, A Mergermarket Report on Global M&A Activity, viewed 30 January 2017

2,000

1,549.2

83.9

888.7797.5

944.9

613.0

45.7 88.3100.4

65.1

500

1,000

1,500

2,000

2,500

NorthAmerica

Central & South America

Middle East & Africa

Asia Pacific Australia

20152016

Europe

US$

bili

on

82.9

Global M&A Deal Value 2016 v s 2015

8,000

7,000

6,000

5,000

4,000

3,000

2,000

1,000

5,9835,585

519

6,7636,756

4,2204,107

422 402 468 486600

Num

ber o

f Dea

ls

NorthAmerica

Central & South America

Middle East & Africa

Asia Pacific Australia

20152016

Europe

Global M&A Deal Volume 2016 v s 2015

Australia’s political leaders voiced differing views as Prime Minister Malcolm

Turnbull considers bringing China into a revised TPP

to replace the US and opposition leader Bill Shorten has proclaimed the TPP as

“dead in the water”.

in the world’s largest economy seems to be offsetting lingering uncertainty regarding border policies and trade agreements with Asia. This optimism has been supported by gains in key global stock markets.

The US election may have some positives for Australian M&A, with President Trump announcing a number of “pro-business” policies. However, large cross-border deals exposed to the United States and China may be held up while uncertainty continues as to whether Trump’s decision to withdraw from the Trans-Pacific Partnership (“TPP”) will impact regional trade. Australia’s political leaders voiced differing views as Prime Minister Malcolm Turnbull considers bringing China into a revised TPP to replace the US and opposition leader Bill Shorten has proclaimed the TPP as “dead in the water”.

Australia had an economic environment ripe for M&A activity in 2016 with low interest rates, low inflation and favourable

international competitiveness given the exchange rates. Despite these factors, M&A activity has remained at broadly consistent levels to 2015 with a 3.8% increase in deal volume according to a Mergermarket report.

Australia is still adjusting to decreased M&A activity from a previously dominant mining market whose exports fuelled China’s rapid industrialisation over the past two and a half decades. In light of falling commodity prices and the slowing

valuation work well in advance of any bids to ensure they are able to have an independent reliable valuation benchmark from which they can confidently dismiss any non-binding indicative offers that are materially inadequate.

Valuations form a core part of PKF Corporate Finance’s service offering alongside Corporate Advisory and Transaction Services. During the final quarter of 2016 the team has been engaged and completed numerous valuation exercises including:

• Valuation of one business operation of a leading global mining group;

• Valuation and provision of an Independent’s Expert Report with respect to the proposed takeover of Australian Renewable Fuels Limited;

• Valuation and provision of an Independent’s Expert Report with respect to the proposed takeover of Hasting’s High Yield Fund;

• Valuation and provision of an Independent’s Expert Report with respect to the proposed reverse takeover of Freshtel Holdings Ltd by Field Solutions Group Pty Ltd;

• Valuation to support the purchase price allocation of a business in the credit management sector; and

• Valuation of a business that is one of the world’s leading designers of software for electronic gaming machines.

In additional to the above we note the completion of the following deals as part of our multi-disciplinary service offering:

• Lead Adviser for Plutora Pty Limited on the $18.5 million investment by a Macquarie Group Private Equity fund;

• Investigating Accountant for the reverse takeover of Hillcrest Litigation Services Limited by Bubs Australia Limited raising $5.2 million and re-listing on the ASX; and

• Investigating Accountant for the reverse takeover of Namiban Copper Limited by Ausnet Financial Services Limited raising $5.8 million and re-listing on the ASX.

M&A activity has remained at broadly consistent levels to 2015 with a 3.8%

increase in deal volume Chinese economy, Australia has sought growth from other industries. Whilst mining remains a significant segment of the economy, Australia is more balanced than other commodity-exporting nations with strengths in industries such as technology, healthcare, agriculture and financial services.

Notable Australian transactions during 2016 included Industry Funds Management and Australia Super’s US$12.6 billion (50.4%) investment in NSW Government’s Ausgrid, one of Australia’s largest electricity distribution businesses and the US$9.4 billion acquisition of Asciano Limited, one of Australia’s largest port and rail operators, by a Consortium led by Canada Pension Plan Investment Board, Global Infrastructure Partners and British Columbia Investment Management Corporation according to Mergermarket data.

North American bidders dominated inbound investment into Australia during the 2016 calendar year in light of the attractive Australian dollar relative to prior years and the resurgence of the North American economy. Buyers from the United States were followed by United Kingdom as the most active in terms of inbound activity whilst Asian buyers were less active than the previous year.

Global factors are not seen as an impediment to domestic M&A activity with the principal drivers of M&A activity continuing to be companies looking for growth through acquisition and/or identifying opportunistic undervalued companies. Whilst the global market deals with political uncertainties inbound investment is expected to remain strong as the Australian market is seen as a safe and low-risk economy.

Food for thoughtIt is important for companies to carefully consider any offers to acquire their businesses and ensure that they have a thorough understanding of the value of their business, the key value drivers and the potential value of synergies to each acquirer. The prospect of more opportunistic bids means targeted companies need to be proactive in undertaking

on corporate finance | focus

STRUCTURING A TAKEOVER – THE CONTROL PREMIUM CONUNDRUM

PKF Corporate Finance is often asked to act as an Independent Expert in relation to takeover transactions, usually relating to publicly listed companies.

One issue which we are often required to address as an Independent Expert, but which is often overlooked by parties involved in the transactions, relates to the impact of control premiums and minority discounts on a transaction and in particular, our conclusions regarding “fairness” of a transaction. Getting this wrong can result in an unexpected negative opinion being expressed by the Independent Expert and as such, it is it important to seek professional advice when structuring any takeover offer prior to release to the market.

What is a “control premium” and “minority discount”?When looking at the price that a company’s shares are trading at on a stock exchange, they represent prices that are being exchanged for minority interests in that company, i.e. equity interests which represent a very small portion of the company’s overall voting interests.

These values represent the fact that owners of these shares do not gain control of the company and do not, by themselves, have any control over the company’s cash flows, operations or dividend policies, to name a few.

A control premium represents the additional value that an acquirer is willing to pay over and above these minority values. This premium represents the fact that the acquirer will gain full control over the finances and operations of the target company. It may also represent some or all of the synergistic value that an acquirer expects to obtain from the acquisition. Conversely, a minority discount represents the discount to the control value which is applied when valuing minority voting interests in a company.

The range of control premium and/or minority discount will vary from case to case. In Australia, it is typical to see control premiums ranging between 25% and 40%.

Cash vs scrip takeover offers – it does make a difference!Understanding the difference that a cash vs scrip offer will have on the analysis undertaken by an Independent Expert is an important factor for takeover advocates.

Let’s have a look at the following example:

• Company A is proposing to acquire 100% of the issued shares of Company B.

• Company A has an equity value of $8m while Company B has an equity value of $2m. Both of these values incorporate a premium for control.

• Company A has offered $2m in cash to the shareholders of Company B.

In the above scenario, an Independent Expert is likely to conclude that the takeover offer is “fair” because the cash being offered is equal to the control value of Company B’s shares.

Now let’s assume that instead of cash, Company A offers shares in itself to the shareholders of Company B. The number of shares to be offered will represent 20% of the combined entity which was worked out by adding the equity values of Company A and Company B together (i.e. $8m + $2m = $10m) and working out the portion that Company B contributes the combined entity (i.e. $2m/$10m = 20%).

Whilst on the face of it this offer would appear to be “fair”, it is likely that an Independent Expert would conclude the opposite due to the fact that in a scrip-for-scrip takeover transaction, regulations imposed by the Australian Securities & Investment

focus | on corporate finance

Commission (“ASIC”) require the Independent Expert to compare (i) the equity value of Company B on a controlling interest basis with (ii) the equity value of the combined entity on a minority interest basis. This form of analysis recognises the fact that shareholders of Company B (collectively) are giving up a controlling interest (which they may otherwise be able to dispose of in a cash takeover offer) in exchange for a minority interest (individually) in the combined entity (which they will likely only be able to sell on the stock exchange for minority values).

In the above example, the Independent Expert would therefor conclude that as the equity value of Company B on a controlling interest basis (i.e. $2m) is less than a minority interest in the combined entity (i.e. 20% x $10m x minority discount), the takeover offer is “unfair”.

The above requirements can often be a trap for takeover advocates who believe that offering like for like value, will result in a “fair” opinion from an Independent Expert.

The Independent Expert may then determine that the offer is not fair but reasonable taking into account other factors including the minority valuation of Company B’s shares.

Exceptions to the rule.ASIC regulations allow for one exception to the rule, and that is in the case of a merger of entities of equivalent value when control of the merged entity will be shared equally by between the bidder and the target.

It will be up to the Independent Expert to exercise his judgement and justify using an equivalent approach to valuing the securities of the bidder and the target.

Pre-Existing Bidder Interests – Another Common TrapAnother trap commonly missed, is in the situation where the bidder already holds a controlling interest in the target.

In this scenario, one might reasonably assume that as the bidder is only making an offer in relation to a minority interest of the target (even on a combined basis), the bidder does not need to offer a control premium as it already has control.

ASIC regulations require the Independent Expert to ignore existing ownership interests that the bidder holds in the target and enforces the rule that in valuing the securities of the target, it should be done so on a controlling interest basis. This applies to cash and scrip takeover offers.

What can takeover advocates do?Independent Experts are prohibited from assisting takeover parties in relation to the structuring of transactions – an Independent Expert’s role should be just that, independent, and limited to reviewing the transaction proposal put forward to them.

Accordingly, when formulating a takeover offer, it is important for Boards to seek advice from financial professionals who are familiar with the requirements imposed on Independent Experts and valuation principals in general, prior to submitting the takeover proposal.

STRUCTURING A TAKEOVER – THE CONTROL PREMIUM CONUNDRUM

CONTINUED

PKF International Limited administers a network of legally independent firms and does not accept any responsibility or liability for the actions or inactions of any individual member or correspondent firm or firms.

Our Corporate Finance Team

Andrew Jones, DIRECTOR E: ajones@pkf.com.au M: 0403 302 971

If you would prefer to receive your newsletter via email, please contact your local Corporate Finance representative.To download a soft copy of this newsletter please visit: www.pkf.com.au/Our-Services/Corporate-Finance

Derek Ryan, DIRECTOR E: dryan@pkf.com.au M: 0408 635 107

Michael JonesE: mjones@pkf.com.au M: 0411 885 129

Simon Rutherford, DIRECTORE: srutherford@pkf.com.au M: 0425 266 123

Steven Perri, DIRECTORE: sperri@pkf.com.au M: 0402 032 148

Paul Lom, DIRECTOR E: plom@pkf.com.au M: 0408 586 672

Liam Murphy, DIRECTOR E: liam.murphy@pkf.com.au M: 0414 384 667

John Bell, DIRECTOR E: jbell@pkf.com.au M: 0413 448 552

Rick Hopkins, DIRECTOR E: rhopkins@pkf.com.au M: 0411 490 666

We are often engaged to prepare an independent expert’s report setting out our opinion as to the fairness and reasonableness of a proposed transaction involving a publicly listed company.

Such transactions include takeover offers, reverse takeovers and transactions involving related parties.

In considering whether the proposed transaction is fair and / or reasonable we are often required to review prospective financial information of the company and where relevant, the proposed transaction and consider whether there is a reasonable basis for the assumptions underlying the prospective financial information.

ASIC Guidance Note RG170: Prospective Financial Information provides guidance as to what may be considered reasonable grounds for inclusion of prospective financial information in an expert’s report. The guidance is extensive but the overriding test is that there must be some fact or circumstances existing at the time of publication of the report on which the expert and directors of the company have relied which are objectively reasonable.

ASIC have expressed the importance of compliance with the requirements of RG 170 with respect to Independent Expert Reports. We expect that this will come under increased scrutiny from ASIC in the future. It is therefore critical that when preparing for a transaction that will likely require a fairness / reasonableness opinion from an independent expert that the directors and management of the company ensure that there is a reasonable basis for the assumptions underlying the prospective financial information provided to the independent expert.

INCREASED ASIC SCRUTINY OVER FORECASTS IN EXPERT REPORTS