The evolution of independent adviser reports and the use of “fairness”

Published 1 September 2007

When the Code started in operation in 2001, the concept of a “merits” report was new to most advisers. The experienced advisers had been routinely involved with reporting to the New Zealand and Australian stock exchanges as independent appraisers on transactions where the usual requirement of the respective listing rules was that the appraiser should express a view on the “fairness” of transactions to the relevant shareholders.

For Code purposes, the advisers’ reports typically open with a discussion of the offer and of the target company and its sector of operations. They usually include a valuation of the target company, generally using the recognised valuation method considered most appropriate by the adviser. The reports generally conclude with an evaluation of the “merits” of the offer. Up until recently the first, and usually highlighted, part of the merits section of the report involved a comparison between the adviser’s valuation of the target company and the offer price. If the offer price came within the adviser’s valuation range then the adviser would describe the offer as “fair”. If the offer price was below the adviser’s valuation range then the offer would be described as “not fair”.

This approach influenced the takeovers market in a number of ways:

  • the advisers’ emphasis on offer price versus assessed value as the determinant of “fairness” made price appear to be the most important issue in a takeover, rather than being just one of a number of merits;
  • independent directors of a target company generally would not recommend acceptance of an offer that was “not fair”. In a number of cases the consideration given under takeover offers was increased to within the independent adviser’s valuation range so that the target company’s independent directors could then recommend the offer to shareholders – largely ignoring consideration of the wider merits of the offer;
  • offerors would use a conclusion of “fair” in relation to an offer price as an argument for shareholders to accept their offer despite the offer otherwise being considered unmeritorious by the independent directors.
  • there is anecdotal evidence that directors of some companies have been relying too heavily on the analysis work of the adviser rather than developing their own fully considered views on a particular offer.
  • the media would generally concentrate on the summary statement by the adviser that “the offer is fair” (or “not fair”) when reporting on an offer. Few would pay much attention to the other merits of an offer;
  • there is anecdotal evidence to suggest that the “fair” description is quite influential with many shareholders when deciding whether or not to accept an offer. It seems to be difficult for a shareholder not to accept an offer when he or she is told by an independent adviser that it is “fair”.

Because of these influences the Panel became increasingly concerned at the emphasis in independent adviser reports on the “fairness” of offers.

The Panel recently began encouraging independent advisers to discontinue referring to and emphasising the “fairness” of offers and instead to present a more balanced view of the merits (that is, the pros and cons) of the offer. Encouragingly, most recent independent adviser reports on takeover offers have avoided use of the term “fairness” when opining on the price given under an offer.

While the price offered by a bidder as compared with the adviser’s assessment of the value of a target company will always be an important merit of an offer, it should not necessarily be the determining factor of acceptance or rejection. For example, the ceding of both immediate and potential future control to the bidder, particularly in the case of partial offers, may well be far more important than the price which the bidder is proposing to pay to achieve that level of control. (Partial takeovers are discussed in more detail later in this article.)

The Panel looks to the directors of target companies to also, themselves properly address the merits of the offer and give comprehensive and helpful recommendations in the target company statement that is sent to their shareholders. The Panel sees this as an important part of the duties of target company directors.

The Panel’s guidance note has been amended to suggest to advisers that they not refer to the “fairness” of an offer in their Code reports except in circumstances where the primary purpose of the report is in relation to the consideration that is likely to be payable on the compulsory acquisition of shares in the target company.