Appraisal Rights in South Africa - Part 2
This article explores appraisal rights in South Africa, with a primary focus on the pertinent principles of share valuation. This article further makes proposals for a faster and more efficient appraisal process for both companies and dissenting shareholders. This is Part 2 of a 3-part series.
So, what is fair value in the SA context?
Contemporary Company Law 3rd ed1, accurately captures the definition consistent with USA textbooks and USA legal precedents:
Delaware Law now clearly defines a dissenting shareholders' claim as a pro rata claim to the value of the company as a going concern. Thus, the underlying principle of an appraisal proceeding is to value the company itself and not the shares held by a particular shareholder and, importantly, to value it on a going concern basis and not on a liquidation basis. As for valuation methodology, the Delaware courts permit valuation by any techniques or methods that are generally considered acceptable in the financial community. This is very wide and flexible, and may consider market value, net asset value, earning prospects, dividends, the nature of the enterprise [and any other facts that throw light on the prospects of the merged company]. This includes discounted cash flow methodology.
I placed brackets around '...and any other facts that throw light on the prospects of the merged company...' as I respectfully differ with this part of the definition as the merged entity is not relevant - any benefits or features of the merger should be ignored - S164 (16) of the Act, and Pratt: Valuing a Business 6th ed.
Section 164 (16), states that:
The fair value in respect of any shares must be determined as at the date on which, and time immediately before, the company adopted the resolution that gave rise to a shareholder's rights under this section.
This suggests that:
- the appraiser is limited to information and events preceding the date of the special resolution of the triggering event;
- the subsequent effects of the transaction on profits and cash flows ought to be ignored; and
- the use of subsequent reported financial reports may introduce hindsight bias.
Other items that are excluded in determining going-concern value are prospective tax benefits, actions planned by a third-party acquirer, excessive compensation, and improperly issued shares.2
In BNS Nominees vs Arrowhead (2023)3, the court tentatively defined statutory Fair Value as:
'Fair value is the value a share would realise in an undistorted market, in the medium term, with free interaction between buyers and sellers with proper information, and without any exceptions being made for minority holdings or the effect of the corporate action which has led to the dissent'.
What is meant by 'without any exceptions being made for minority holdings'? This suggests that the court understands fair value to be a control value, without a discount for lack of control (DLOC).
The price at which a share trades on the securities exchange reflects transactions between minority market participants. While the share price may depict fair market value for the size of the particular transaction, it does not reflect the proportional value of a going concern, where an appraiser would assume a theoretical buyer of the entire business. Such a buyer would likely pay a premium on the share price.4
The tentative definition offered in Arrowhead does not address the "proportional value of a going concern" valuation theory. Also absent is reference to the marketability of the shares - the valuer must assume a willing buyer of the whole business; and the listed share price may be subject to a degree of lack of marketability reflected in the share price due to company size and share liquidity (discount for lack of marketability or DLOM).
Also note that the Arrowhead definition correctly states that the financial effects of the triggering transaction should be excluded.
Valuation methods / approaches
The most widely used valuation method is the Income Approach, specifically a discounted cash flow (DCF).
There are numerous variations of the DCF, but most practitioners determine the enterprise value (EV) (equity plus interest bearing debt) and market value of invested capital (MVIC)(EV plus surplus assets such as cash) on a control basis i.e., 100% of the business or going concern value. This is the value of the equity before shareholder level discounts (DLOC and DLOM). This is the appropriate level of value for S164.
The Market Approach is also used (using comparable listed companies' multiples (minority transactions) and adjusting to arrive at a control value).
The DCF is favoured by the USA courts over a market approach. Occasionally, the court assigns different weights to various valuation methods, with the DCF typically receiving a greater weight.
The Net Asset Value (NAV) method (assets less liabilities at market values) is typically not appropriate as the appraiser must assume the sale of the whole business as a going concern, as opposed to individual assets (orderly wind down / liquidation).
However, in cases where fixed properties represent the largest part of the assets (such as a Real Estate Investment Trust), the NAV approach adjusted for the present value of an assumed level of remaining corporate overheads after the triggering transaction may be appropriate.
Are fair and reasonable opinions not adequate?
In short, the expert performing this work normally considers a different transaction than a statutory fair value determination.
The independent expert's fair and reasonable report does not contain adequate detail and the calculations are not available to anyone wishing to dissent.
1 Chapter 16 footnotes 410 and 411
2 Pratt Valuing a Business 6th ed
3 BNS Nominees (RF) (Proprietary) Limited and Another (Breede Coalitions) v Arrowhead Properties Limited and Others (19/39482)  ZAGPJHC 848; 2023 (1) SA 478 (GJ) (2022)
4 Evaluation of recent mergers and acquisitions on the JSE indicate a wide range of premiums over stock exchange price with an average of circa 50%