Minority with no dividends · Window Period Residual Value

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Minority With No Dividends

Here is an all too familiar story of possible abuse of small shareholders. It is one of the reasons that I never take a minority stake in a non-listed company.

A company has many minor shareholders and a few large ones. The company's operations had, in the past, produced sound profits and the company had paid generous dividends. Two of the large shareholders got together, passed a resolution to sell the business and instead of paying the proceeds to the shareholders, invested in vacant land with 'good' potential. The company was, therefore, transformed into a non–dividend paying company and the two major shareholders now want to make an offer to acquire the minority shareholders. You have been approached to do a fair and reasonable valuation for the purpose of the takeover. The question is: 'How do you value such a shareholding?' One should distinguish between a fair value and a negotiated price. If you are asked to perform a fair value, you should not take into account the relative negotiating powers of the parties who are to do the deal.

If I were to do a valuation of a majority share in a company that owned vacant land, I would value the land, add any other sundry assets and deduct any borrowings and sundry creditors. This would be the majority valuation. I would not take into account the tax payable on liquidation and the costs of liquidating as these costs need not be incurred by the majority shareholders. If one adjusts for the tax payable on liquidating the asset and distributing the proceeds to the shareholders one would arrive at the floor valuation of the share to the majority shareholder.

The minority shareholders also hold a share in the value of the land so, theoretically, we should arrive at the same value as one does for a majority holding. The problem is that the minority shareholders are not in control of their destiny. If the minority shareholders wanted out and the majority shareholders did not have the cash to pay them, the company would have to be liquidated, costs would have to be incurred and taxes would have to be paid. These outflows would reduce the going concern value of the company. A fair value for the minority shareholders, therefore, would be the floor value above.

However, the minority shareholders do not have the power to liquidate the company and if the majority shareholders are not interested in a deal, they will have to sit tight hoping that their value will be realised sometime in the future. Such time may never happen.

Because it is the right to the asset that we are valuing, the lesser rights of the minority shareholders have to be taken into account when valuing their investment. This is usually accounted for by applying a discount to the majority valuation. Circumstances in each case will determine what the view is on this discount. One cannot calculate such a discount – one must look at the facts and take a view. For example, if the land has been proclaimed and sales are imminent and the policy of the major shareholders will be to pay the shareholders back in the near future, this discount will be less than if there were no plans to develop the property at this stage. I have seen discounts ranging from 50% to 20% in practice.

One additional point to make here: The value to the majority shareholder is a majority value and the value to the minority shareholder is a minority value. A fair negotiated price would be half-way between the two values. If the minority are desperate to cash in, the value will be lower than the middle value. If the majority are desperate to acquire the shares, the value would be higher.

Catching Up

Professor Aswath Damodaran says that applying arbitrary discounts and premiums to a well thought out valuation for control or for liquidity undermines the valuation. He suggests that if a company is poorly managed, it will have a lower value and if it is well managed it will have a higher value. Instead of applying an arbitrary discount or premium for control, one should study the facts. Similarly, the type of assets, the financial health and the size of a company all play a part in determining the effect of liquidity. He suggests that arbitrary premiums and discounts come in handy for divorce cases and for valuations for tax purposes where there is a motivation to arrive at high or low values, depending on the circumstances. (CFA Magazine, Nov 2004, page 7).

No matter how well regulated an industry is, there is no substitute for ethics. The following basic ethical rules should govern any valuation you do:

  • Be professional and ethical at all times
  • Be independent and objective
  • Act with skill, competence and diligence
  • Provide timely and accurate communication

(CFA Magazine, Nov 2004, page 25)