The pitfalls of using market price as a measure of value.

The Cellestis notice of proposed acquisition contains the following statements

Attractive premium of 24.3% to the 1 month VWAP and 31.5% to the 3 month VWAP of Cellestis shares up to 1 April 2011

This appears to be sufficient reason for the Company to state that

Cellestis Directors unanimously recommend that Cellestis shareholders vote in favour of the scheme

Deloittes said that

fair value is defined in Australian Accounting Standards as ‘the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction’.

Deloittes also advise that the above AASB guideline was to be revised

The core principle of the proposed new guidance is that ‘fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

This now moves the valuation method from an actual record of transaction to a hypothetical situation.

If one was to use market price as an indication of value one would probably be an advocate of the Efficient Market Hypothesis* which postulates that markets are "informationally efficient," markets are rational and that the current market price for a security is the best predicator of its future price.

This also supposes that all the shares are available to the market and that the market is "active and liquid" with no group or groups of shareholders having a blocking or controlling interest. Should the market not be "active and liquid" the share price could be subjected to a "control premium."

So what is and how much is a "control premium?" Grant Thornton advises

A control premium is an amount that a buyer is willing to pay over the current market price of a publically traded company.

Shares traded on stock markets like the Australian Securities Exchange are usually in minority parcels representing a very small portion of the total number of issued shares of a company. Investors trade these shares because they like the earnings profile, the dividends or the potential capital gains...

...When valuing the target on a 100% or control basis, the expert needs to incorporate a control premium which is commonly reflected in the multiples used in the valuation. 

The experts conclude the level of control premium used by using empirical evidence based on historical successful takeovers which states that the control premium is generally between 20% to 40%.

Accountancy firm RSM Bird Cameron analysed 212 successful takeover offers and schemes of arrangement over the 5 year period ending 30 June 2010 on the ASX and found that

as asset prices fell during the 2009 financial year on the back of the global economic downturn, control premiums soared in that period, rising by 16.5% in the financial year to an average of 42.1%. It appears that both purchasers and vendors recognised that during this period the market was severely undervaluing businesses and as result there was a need for a significant rise in the control premium offered to achieve a successful takeover.

This hypothesis holds true in the 2010 financial year, with average control premiums easing slightly to 40% as buyers factor in the recovery in share market prices into their offers.

It appears that with the Qiagen proposal what we have is an offer equating to the recent share price plus a control premium. Therefore it could be argued that, on the available evidence, both the acquirer and the directors relied solely on the EMH to determine what is fair and reasonable and in the best interests of Cellestis shareholders and that shareholders will have to patiently wait** for an Independent Expert to verify this opinion.

-----------

*after the collapse of banks, economies, sovereign states along with the stock market you would think that the EMH had about as much life left as a Norwegian blue parrot.

**Cellestis Chairman Ron Pitcher letter to shareholders