Not so Spotless – recent Panel developments in relation to undervalue statements

In the recent Australian Takeovers Panel decision in relation to Spotless, the Panel outlined further what kind of information is expected to support an undervalue statement in the absence of an independent expert’s report. In this article we consider the issues explored in the Panel's reasons. 

IN BRIEF

• Directors must tread carefully when supporting an undervalue statement in the absence of an independent expert’s report or an internal valuation range.
• In the Spotless decision the Panel found that medium to long-term qualitative factors may be used in support of an undervalue statement in certain situations, however the nexus between the statement and those factors should be as clear as possible.

PANEL APPLICATION

On 23 May 2017 the Australian Takeovers Panel (Panel) issued reasons for a decision in relation to an application by Downer EDI Services Pty Ltd (Downer) alleging unacceptable circumstances against Spotless Group Holdings Limited (Spotless).¹ It was the second Panel application arising out of Downer’s protracted hostile takeover of Spotless, though the first application had been brought by Spotless against Downer.

Downer sought an order requiring corrective disclosure from Spotless, alleging that the target’s statement failed to provide sufficient information to support the Spotless board’s recommendation to reject the offer. The Panel accepted that the target’s statement contained an undervalue statement, claiming “the strengths of Spotless’ core business, together with management’s execution of the strategy reset will deliver greater value to Spotless’ shareholders than the Downer offer in the medium term”.

The target’s statement included neither:

• an assessment of the value of the Spotless shares; nor
• an independent expert’s report (IER).

Spotless had, however, included in the target’s statement detailed disclosures in relation to its strategy reset, earnings guidance and other information about the operating health of Spotless in the medium to long term.

PANEL GUIDANCE ON UNDERVALUE STATEMENTS

In its reasons, the Panel reaffirmed its view that a Target board must, where it makes reference to a bid “undervaluing” the Company, be prepared to materially justify the statement. In particular, the Panel has long required a target board to support an undervalue statement with reasons that are clearly disclosed, and demonstrate to shareholders a sound basis for, and the reasonableness of, the statement.

The Panel may make a declaration of unacceptable circumstances, or require a party to provide corrective disclosure, in a situation where:

1. reasons for an undervalue statement are not clearly disclosed (or it has not been clearly stated that the reasons will be disclosed at a later date);
2. disclosure of reasons for a recommendation is not made in good faith;
3. the directors do not act promptly to ensure that reasons are disclosed as soon as reasonably practicable; or
4. the reasons are not soundly based or reasonable.

The Panel has expressed a preference that an undervalue statement be supported by some form of guidance as to value – usually by way of either detailed internal analysis by the directors or external advice, most commonly in the form of an IER.² Where there is no IER it is still possible to satisfy these requirements without directors including their own detailed internal value assessment, though they may face a greater challenge in demonstrating that there is a reasonable basis underpinning their analysis.

SUPPORTING AN UNDERVALUE STATEMENT

Eight years ago in the Tully Sugar matter the Panel found that while an IER resolved a number of the disclosure issues, it was not necessarily the case that directors were required to provide either an express statement of value or an IER in support of an undervalue statement. What is required is disclosure of "sufficient financial information that would enable a [target] shareholder and their professional advisers to make an assessment of the merits" of the bid.

Spotless sought to rely on Tully Sugar to support the proposition that neither a value range nor an IER was required, because their strategy reset, earnings guidance and other disclosures provided sufficient support for the reject recommendation.

While the Panel found that it was difficult to connect these detailed disclosures with the recommendation to reject the offer based on the undervalue statement, it did not consider the information provided by Spotless to be materially deficient in the circumstances. Given Spotless based its undervalue statement on the medium to long-term strategy reset, it would have been difficult for the directors to reasonably support parallel statements in relation medium to long-term prospective financial information.

Spotless did undertake to issue supplementary disclosure, though it was to correct a statement in relation to the broker forecasts - one of the factors they had used in support of the undervalue statement. The Panel required Spotless to correct a statement implying that updated FY18 earnings guidance would materially improve the broker valuations for Spotless. In this regard, Spotless had said that one of the reasons for the directors’ belief that the offer did not represent adequate value was that “Spotless’ earnings expectations are not fully reflected in current broker values”. Spotless compared its NPAT (pre-exceptional items) forecast for FY17 ($80-90 million) and FY18 ($85-100 million) to an average of broker forecasts for FY18 ($83 million).

COMMENTARY

The Spotless decision provides some clarity around what kinds of information the Panel expects in support of undervalue statements where a value range or IER is not provided.

On one view, Spotless seems to have been testing the outer limits of the extent to which, in the absence of an IER or valuation range, medium to long-term qualitative statements can be relied upon in support of an undervalue statement. The Panel, while stopping short of decrying the disclosure as defective, seemed to suggest that a nexus between the strategy reset disclosure and the undervalue statement could, and possibly should, have been more clearly articulated.

Directors should tread carefully where relying on medium to long-term forecasts and should appropriately weight factors used in support of an undervalue statement. Where appropriate or possible to do so, the safest course remains supporting an undervalue statement with an express statement of value or the support of an IER.