Control premiums down—but size still matters:
Impact of M&A boom on valuation discounts

The M&A market is still in its boomer years: On a first quarter annualized basis, both the volume and value of domestic transactions for 2007 are on track to exceed 2006 levels—which topped 2005 levels by 13.6% (volume) and 26.6% (value).

“We are even with or higher than 1999 levels,” said Jennifer Muller, a director at Houlihan Lokey Howard & Zukin, speaking at last week’s “Current Topics in Business Valuation,” sponsored by the ASA’s LA Chapter.  The market’s main drivers are the “mega-deals” and the “clubbing” of private equity purchasers; the ten largest transactions in Q1 2007 accounted for over half (52%) of domestic M&A volume.

An important consideration for valuators: “Control premiums paid have been going down over time, as the public market has become fully-valued,” Muller noted.  “Buyers have less ability to pay more than is already in the public price.”

And size does matter, as larger companies continue to be valued at a premium to middle market companies.  “Smaller companies are not able to leverage their EBITDA in the current debt markets,” which—given the billion-dollar flush of private equity, currently offers these powerful purchasers looser debt covenants.  Leverage multiples (debt/EBITDA) are on the rise—but how will this impact internal rates of return and “market participant” evaluations, if the next buyer can’t sustain such leverage rates?  And the burning question: Is the boom about to bust?  Look for a discussion of these and more in an upcoming issue of Business Valuation Update™.

Liquidity analysis now available at BVR

By popular demand, we’ve made the “December 2002 Mean DLOL [Discount for Lack of Liquidity] for Smallest and Largest Stocks” analysis by Ashok Abbott (Business Valuation, LLC and West Va. Univ.) available as a free valuation download at BVResources.com.  Abbott wanted to demonstrate a “real world” DLOL for a given exchange and certain time period; his data and calculations weren't included because the file size would be huge—but anyone interested in seeing the supporting numbers can contact the editor. 

Professor Abbott’s analysis arose out of his two most recent telephone conferences, “Defining, Measuring & Defending Discounts for Lack of Liquidity” (April 25, 2007) with co-presenters Shannon Pratt and Rob Schlegel; and “Valuation of Illiquid and Hard-to-Value Securities” (May 9, 2007) with Espen Robak and Barry Silbert.

This summer, expect to hear something on Rule 2290

Remember when we wondered if NASD’s Rule 2290 on Fairness Opinions had fallen into a bureaucratic black hole?  (See BVWire™ # 54-4.)   At the ASA gathering in Los Angeles last week, Muller confirmed that after receiving comments on the proposed Rule in April 2006, the SEC extended the time period for taking any action.  The wait may soon be over, as something should happen in connection with Rule 2290 this July.  “It could be comments, revisions, finalization—or another extension,” she said.  “Stay tuned.”

In the meantime, the comments received were less than overwhelming.  The Wall Street banking community argued for the status quo, while the Council on Institutional Investors was the only “investor” to respond, supporting the proposed NASD Rule and any increased disclosures the SEC might propose (see next item).  For a recap of all comments from the DealLawyers blog, click here.

SEC posts FAQs on new exec. comp. disclosures

After generally expanding its disclosure requirements, the SEC has “noticed an increased trend in obtaining consent” per Rule 436, said Cheryl Tjon-Hing, a Valuation Specialist with the Office of the Chief Accountant at the SEC.  (When a registration statement or prospectus cites an expert report or legal opinion, Rule 436 requires filing the expert’s written consent.)

An exception: Last summer, the SEC adopted broad new disclosure rules in executive compensation, effective at the end of 2006 (final version of the rules available here.)  The new rules do not require expert consent in exec. comp. disclosures—but Tjon-Hing cautioned that this is the “only” exception to Rule 436.  The SEC has just posted an FAQ on the new rules along with an update to its Compliance and Disclosure Interpretations.

Note: An excellent summary, “SEC Amends Rules on Executive Compensation Disclosure,” is in the current Insights (Willamette Management Associates), which dedicates the entire issue to reasonable compensation economic analyses.

Is the BV profession incapable of self-regulation?

Last month the FASB held its long-awaited public hearing on its Invitation to Comment (ITC) on the need for valuation guidance.  Participants included representatives from the “Big 4” as well as the "big five" BV societies: Carla Glass (Appraisal Foundation), Bruce Bingham (ASA), Dan Noll (AICPA), Kristian Knibutat (CICBV), and Mark Hanson (NACVA).  The SEC’s Tjon-Hing was also there, along with the Public Company Accounting Oversight Board’s rep.

“The appraisal profession is at a tough time in terms of self-regulation,” Tony Aaron (Ernst & Young) told attendees at the LA ASA meeting.  “We have every standard available—but are being told we don’t have enough.”  Appraisers don’t have a best practices guide specific to financial accounting, and efforts by the Appraisal Foundation to develop one may be “too little too late,” Aaron said.  “FASB deliberations may overshadow the valuation profession’s efforts at self-regulation and marginalize them.” 

Notably, the FASB has posted the hand-outs to its April 30th roundtable in Norwalk, Connecticut, and an audio transcript of the meeting is available here.

Your opportunity to answer the ‘ultimate question’

The FASB’s ITC raises the “ultimate question” for BV appraisers, according to Aaron: “Should the FASB regulate the valuation profession with respect to financial accounting?”

We’d like to hear your answer in our latest on-line survey.  Click here to vote “yes” or “no” on the need for FASB valuation guidance and we’ll publish the survey results in an upcoming ‘Wire.

AICPA BV/FLS call for papers (and perhaps win a free trip, too)

The AICPA BV/FLS Committee is making its second annual call for papers on either a Business Valuation (BV) or Forensic Litigation Services (FLS) topic.  Submissions—which must be from current AICPA BV/FLS members—will be reviewed by the Committee.  Winners will present their papers at the 2007 AICPA Conference on Fraud and Litigation Services (in San Diego in September) and the 2007 AICPA National BV Conference (in New Orleans this December), and receive free conference registrations, travel and hotel.  Paper submissions must be received by June 30, 2007. For more information, click here.