The ongoing MAB delisting project on the Paris Stock Exchange, where an independent expert has certified the fairness of an offer to which no shares have been tendered, with a final stock price 22 % above the offer price, has been the catalyst for a number of reflections inspired by our activities as investment bankers and investors, past and present, which have given us the opportunity to work in this profession for several decades.

 

Why is it difficult to be an independent expert in stock market transactions?

It's a difficult job, because if the intervention of an expert is required by regulations or prudence, it's always because there is a real or potential problem of conflict of interest between shareholders, between shareholders and management, or even between lenders and shareholders. An independent expert is never called in when there is no conflict of interest, just for the sake of her company! For example, when a management team forms an alliance with an investment fund that wants to take 100% of the capital and delist the company. Or when a majority shareholder wants to buy out the remaining capital. Or when there is a change of control in which the current majority shareholder buys back assets from the company it used to control. In all these examples, which are not exhaustive, the interests of the majority shareholders are opposed to those of the other shareholders. The former have a financial interest in undervaluing the listed company or the asset, so that the transaction is more favourable to them. The other shareholders do not.

An independent expert is then called in to certify, for the benefit of the other shareholders, that the financial characteristics of the transaction in question are being carried out under normal conditions, without the minority shareholders being adversely affected. This is the first difficulty in the work of the independent expert, because he is at the heart of conflicts of interest. Hence the term ‘fairness opinion’, which is always intended for minority shareholders, because it is they who may be adversely affected, not the majority shareholder or the management team!

How is the independent expert appointed when his involvement is required?

More often than not, a mini RFP (request for proposal) is made: 2 or 3 independent experts, whose names have been suggested by the legal or financial advisers of the operation, are approached. These experts are rarely involved in the life of a company, so they are not well known to directors or managers, but they are well known to lawyers specialising in stock market law or bankers specialising in stock market engineering.

If possible, an ad hoc committee made up of a majority of independent directors is set up to interact with the independent expert for the duration of his work.

The second difficulty in his work is the time available, which is actually quite short for some cases, during which he has to get to know the company, its sector and its dynamics, as well as those of its competitors and their valuation.

Most of the time, he has little or no knowledge of the company and its sector. He must also form an opinion as to whether the business plan is realistic, reasonable or pessimistic, and must consider how, if necessary, to adjust the valuation to produce a relevant estimate of the target based on a document that has been carefully prepared to understate the enterprise value.

Of course, the expert benefits from the valuation work carried out by the advisory bank or banks prior to his or her own; but being independent, she must not allow himself or herself to be impressed by their results. Unlike the independent expert, the financial adviser advises one of the parties (the bidder), whose interests he defends, and is paid by that party. This is probably why, in transactions subject to AMF supervision in France, the expert has to analyse the differences between his work and that of the financial adviser.

The third difficulty is the business model, which means that they are either paid by the offeror (eg for Euronext Access) or more generally by the target company, which is more or less the same when the target company is already controlled by the offeror. And some offerors, particularly in the world of listed small caps, believe that the person who pays the musicians also chooses the score...

This difficulty is compounded by the fact that, in order to be appointed as an independent expert in stock market transactions, an expert's name must be included in the shortlist drawn up by the legal and financial advisers. But these advisers work for the offeror. When they are aware that the financial conditions of a transaction are tense, they at least pre-select an expert who is reputed to be flexible, malleable and even complaisant. Are they to blame for this? Not really, because they are defending what they perceive to be their clients' interests.

A first example

For example, in the case of MAB, where the majority shareholder wanted to delist the company at the lowest possible price, the financial advisor included in his list an expert who had already made a name for himself in this field. In 2014, he had attested to the fairness of expropriating the shareholders of a company growing at 15% per annum at a price representing 4.4 times EBITDA (sic), while at the same time buying a few percent of the capital of its competitor on the stock market at 9 times EBITDA. One of us enlightened the AMF, which refused the expropriation. A year later, the share price had tripled.

In a way, this shortlisting by the financial advisor was wise given the majority shareholder objective. And the latter was not disappointed: unlike his two shortlisted colleagues, this expert agreed to work without an asset-by-asset property valuation, a first in at least 17 years for the delisting of a property company. And he has attested fair a value showing a rental yield of 20.8% for logistics and business warehouses in France, whereas the company itself is asking for around 8%!

A second example

As in any profession, black sheep are the exception and white sheep the rule, and the tree must not hide the forest.

Here's how another expert behaved when Vinci and Eiffage tried to delist their 66%-owned subsidiary SMTPC. One of us was a shareholder, and thought that the share, which was trading at around €18 in March 2021, was worth between €35 and €40. The withdrawal offer was announced at €21.1 at the end of March. The expert was appointed in July, and was able to start work in October when he received the business plan drawn up by SMTPC, whose manager was an employee of Vinci. The plan was abnormally more pessimistic than the previous version for 2019, which was available at the bottom of an Aix-Marseille Metropolitan Council website.

Alerted by one of us who had done a lot of work on the subject and put his writings in the public domain, the market became aware of the massive undervaluation of the share, and consequently pushed the price above €25. Obviously, the expert could not attest to the fairness of an offer of €21.1! So was he going to endorse the €35 to €40 range? No, because he would have ruined his reputation with lawyers and investment bankers, jeopardising his future pre-selections in other cases. He would then be seen as an intransigent expert adopting the viewpoint of minority shareholders.

So what did he do? First of all, he persuaded Vinci and Eiffage to raise their bids, because otherwise he could not certify that they were fair. But could Vinci and Eiffage go as high as €35-40? No, because even if they were caught red-handed in the jam pot, these major groups could not admit it. So they were not prepared to go beyond €27 (a 28% increase on the initial bid). At this price, the expert agreed to attest to the fairness of the offer, on condition that the right for squeeze out if the 90% threshold was exceeded was withdrawn. This was done. In his report, the expert justifies the price of €27, but appends, like a modern Procope[1], all the information needed to justify the price of €35 to €40. So anyone who wants to can make up their own mind and act accordingly.

Then the market spoke, and the offer was a resounding failure, with only 2% of the 34% free float being taken up. And the current share price, taking into account €5.9 in dividends paid, is 28% higher than the price of the second offer and 64% higher than the price of the initial offer, while the CAC Mid & Small index has since fallen by 11% and 7% respectively.

But the experts are not helpless either.

In France, since the work of the Philipponnat-Suet commission in 2019, of which one of us was a member, the name of the independent expert is disclosed to the public as soon as she is appointed. This means that shareholders can ask to meet her or write to her to express their views or concerns. The independent expert is required to report on these discussions in the final version of her report, a preliminary version of which is made public in the case of transactions supervised by the AMF (on Euronext or Euronext Growth). And an expert is not normally indifferent to well-supported arguments that may be relayed to the AMF, or even to the investment community, especially when they come from long-standing shareholders or professionals who know the company in question better than the expert.

Our experience shows that since the reform initiated by the Philipponnat-Suet commission, a useful dialogue has usually been established between the shareholders who have worked on their case and the experts. Long gone are the days when a (novice) independent expert replied to one of us who asked for a meeting: ‘I can't agree to it because it would compromise my independence’!

Even before this reform, and since then of course, courageous experts have not hesitated to point out to bidders, before offers are made public, that their bid are too low, and that they should raise it, at the risk of not being able to attest to their fairness. By definition, this work cannot be seen, but it is very real.

There is a real dichotomy between issues concerning groups, and those concerning small and mid-caps. In the case of the former, it is rare for the independent directors forming the ad hoc committee to be unaware of their responsibilities. This is all the more true given that the case often involves a change of control, and therefore a price paid by a third party, which is a priori more indisputable than a buyout of minority shareholders by the majority shareholder or the management team allied with an LBO fund. The latter are the most important cases in terms of numbers of squeeze out, with a lower quality of governance: independent directors often there because of links with the majority shareholder, management and majority shareholder often mixed up in a bid to make a good financial deal, financial advisers who do not always have the courage to warn their clients and guide them firmly.

By experience, these are the areas where problems regularly arise.

What can be done to strengthen the independence of independent experts?

They should no longer be pre-selected by the offeror's legal or financial advisers, and they should no longer be paid by the offeror or the target, which amounts to the same thing when the target is controlled by the offeror. In this way, their independence will be above suspicion.

Only the stock market regulator, one of whose roles is to protect savings and confidence in the integrity of the financial markets, can perform this impartial selection function. This is generally not the case. We could imagine that the regulator could appoint the expert on its own authority (and not from a list of 3 names proposed by the offeror...), ensuring a reasonable rotation of appointments, and temporarily or permanently disqualify an expert who has seriously failed in his or her duties. This would be a much more effective potential sanction than the current situation, where there is, de facto, no liability for the expert.

If the regulator is not directly involved, we could imagine it drawing lots among all the independent experts, or entrusting the choice to a committee within the regulator made up of 3-4 recognised valuation experts, such as a retired independent expert, a court-appointed valuation expert, a finance professor specialising in business valuation[2], and so on.  And if the first expert drawn was unavailable or conflicted, a second draw would be made.

Such a committee could also help independent experts who so wish in their dialogue with investors, the offeror and its advisers, because being alone in the midst of conflicts of interest is sometimes complicated. This committee could also carry out quality control of valuations, particularly in relation to the context of the offer and its outcome. To take the MAB case again, an offer declared fair to minority shareholders that attracts zero shares, with a closing price 22% above the offer price, is obviously problematic.

If it were decided to draw lots, the committee could add balls to the ballot box for the benefit of experts whose work has been judged to be of superior quality. The committee could also seek to attract new recruits to the field of independent expertise by identifying candidates who could be entrusted with projects that are not particularly difficult, such as a straightforward change of control, with no reinvestment by current shareholders and a substantial offer premium.

As for the compensation of the experts, this would be discussed with the committee on the basis of an hourly budget depending on the difficulty of the cases and the time required, and not on the size of the transactions. The minimum fee could be higher than the current €50,000 (€100,000), with a ceiling of €500,000, except for particularly complex cases (such as the EDF squeeze out). The regulator would then pay the fee to the chosen experts and rebill it to the offeror on a euro-by-euro basis.

Alternatively, following the example of Germany, we could also consider a decision by the Court.

This would put an end to a method of appointment and remuneration that, in most cases, needlessly arouses suspicion. The independent experts would thus be able to feel perfectly at ease in their work without the implicit pressure, or even explicit pressure in limited cases, of the offeror or its counsels. This would restore a balance between those providing the basic information (the offeror or the controlled company) and the minority shareholders for whom the fairness opinion is intended.

Pending such a development, it is up to shareholders to seize the rights to study the valuation reports of financial advisers and independent experts, to counter-argue if necessary, to be received by them to demonstrate by A + B that the expropriation price is inadequate, to make this known in order to convince the market. And in extreme cases, which are fortunately very rare, name and shame to prevent the recurrence of situations that should not exist.

In fact, it was not the regulator who was responsible for the failure of bids that infringed property rights, but the market. Being a shareholder is a job that, like any other, requires work.

Initially published by the Financial Times, and taken from an academic study, this graph has the advantage of showing the total direct and indirect exposure of households in the main continental European countries to equity markets.

The fact that two-thirds of Swedes invest in equities, compared with only 30% at best in the other major European countries, is no coincidence. It is the result of a consistent policy that began in the early 1980s, at a time when the stock market was at its lowest, which of course made it easier, with two strands: education to train people in basic financial tools; and taxation, with equity funds temporarily endowed with tax benefits to kick-start the movement and then abolish it later.

In this area too, it is striking to note the persistence of differences between northern and southern Europe, or between Europe with a Protestant culture and Europe with a Catholic culture.

With the collaboration of Simon Gueguen, teacher-researcher at CY Cergy Paris Université

When a company suffers an operational shock, the goods or services it provides to its customers are often affected. For example, their quality or availability may be degraded. The company's place in the value chain is threatened, particularly if its customers can easily change supplier. The article we are presenting this month[1] is an empirical study which shows that companies affected in this way increase the payment terms they grant in order to retain their customers. And companies up the value chain facilitate the operation by granting payment terms themselves, so that a flow of customer receivables is organised to the affected company. This mechanism is explained by a common interest in not losing downstream customers due to a transitory shock.

The sample studied covers the period 2003-2019. It was created by merging two databases on companies based in the United States, one containing accounting data and the other customer-supplier relationships in value chains. This is one of the strong points of this study: the upstream effects are measured not only on direct suppliers, but also on suppliers of suppliers, and so on. As is often the case in this type of study, natural disasters are used as an operational shock. These disasters have the merit (for the researcher, of course!) of being exogenous and a priori uncorrelated with other events affecting companies.

The empirical study shows that the ratio of trade receivables relative to sales of affected companies increases by 2 percentage points after the shock. Out of around 100,000 observations, this increase is highly significant. The most plausible explanation is that this increase is voluntary and is intended to retain customers. What is more interesting is the effect observed on supplier debts: they also increased, by 8 percentage points relative to the cost of sales. When this is translated into dollars, we see that the lead times obtained almost exactly cover the lead times granted, so that these two effects have a statistically zero cumulative impact on the cash position of the company affected.

In the sample as a whole, less than 6% of suppliers are located in the same geographical area affected by the disaster as the affected company. The increase in receivables granted cannot therefore be explained by the fact that suppliers are subject to the same shock. More likely, they are trying to help their customers cope with the shock by means of a delay flow that is passed down the value chain.

To confirm this idea, the authors look at the substitutability of the goods and services provided by the affected company. To this end, they use substitutability indicators developed in a study published in 2014. When substitutability is high, the risk of losing customers is high. In this case, the affected company grants more lead times and obtains more from its suppliers, which corroborates the idea of voluntary trade receivables.

Finally, the authors look at cases in which the affected company's suppliers have difficulty obtaining financing. The flow of trade receivables cannot be established. Obtaining lead times up the value chain appears to be a necessary condition for using trade receivables as a shock absorber.

There are two main lessons to be learned from this study. The first is that companies subject to an operational shock increase the lead times granted to their customers in order to compensate for the deterioration in the goods and services rendered. This is not a trivial result: in the event of a liquidity shock, companies reduce their lead times. In the case of natural disasters, the desire to retain customers outweighs the need to absorb the liquidity shock. The second idea concerns the value chain. The affected company's suppliers are aware of the need to increase the time allowed to avoid a break in the chain and a drop in sales. Trade receivables flows are therefore an effective tool for stabilising value chains in the event of an operational shock.

It only seems like an oxymoron because over time ETF has become synonymous with index funds, and therefore passive management, as the vast majority of ETFs are index funds.

But the forest should not hide the tree, especially when the tree is multiplying rapidly! In reality, an ETF is first and foremost an exchange-traded fund.

So there is nothing to stop it developing an investment strategy other than simply duplicating an index within ETFs.

First introduced in the United States in 2008, active ETFs really started to take off in 2019, even though they still only account for 2% of ETF volumes in Europe.

They have retained two key characteristics: they are listed on the stock exchange, so you can buy or sell them during the day without having to wait until the next day for their net asset value to be calculated, as is the case with unlisted mutual funds ; and they publish their assets daily, rather than just the top 10 lines once a month, as is the case with unlisted funds. On the other hand, the management fees of active ETF are higher to remunerate the introduction of a greater or lesser amount of active management.

Regularly on the Vernimmen.com Facebook page^[1] we publish comments on financial news that we deem to be of interest, publish a question and its answer or quote of financial interest. Here are some of our recent comments.

KKR - Capital Group: engagement before marriage? (May 10)

Capital Group is one of the world's leading asset managers. Based in Los Angeles, it manages $2,800 billion, mainly through active management on behalf of tens of millions of individual investors. As examples, it owns 16.6% of Publicis, 10.3% of ASML Holding and 13.8% of BAT.

As with all active managers, the rise of passive management is a very real threat. While Capital Group has multiplied its assets under management by 2 since 2016, Vanguard, the pioneer of passive management, has multiplied them by 3 over the same period to $10,500bn. With management fees of 0.07% of assets under management, Vanguard has commercial arguments that Capital Group does not have.

Private debt - i.e. unlisted debt, which is often more profitable because it is riskier than listed bonds - is a way of combating passive management by increasing the rates of return available to clients. But just because you manage $555bn in listed bonds doesn't mean you're comfortable with private debt.

KKR was born in LBOs, but has long diversified into all types of investments: infrastructure, real estate, . . . and private debt ($100bn out of $600bn of assets under management). Joining forces with Capital Group means finding new resources: the countless individuals that Capital Groupe serves via 200,000 independent financial advisors. It is true that in 40 years institutional investors have had time to convert to the charms of private equity, while only 5% of private individuals have access to it.

Last year, the two companies announced an alliance to create two new funds, launched a fortnight ago, 60% of which are invested in listed bonds and 40% in direct loans to companies or asset-based financing. The minimum investment is $1,000. On a quarterly basis, and if necessary, up to 10% of the fund can be redeemed at net asset value, and we can imagine that KKR will make the corresponding liquidity on the private debt held by these 2 funds. The management fee announced for these 2 funds is 0.84% or 0.89%.

Other funds mixing listed and unlisted assets should be launched in 2026 by the duettists, in the field of equities, and in that of target date funds. From there, we can imagine that one day, KKR and Capital Group might consider merging, having learned to work together to better find new assets to manage and offer mass affluent individuals access to private equity.

But until then, they will have to prove that their ad hoc alliance is effective despite their different corporate cultures, especially as their competitors are not standing still: Apollo has done the same with State Street and Vanguard with Blackstone. The distinction between listed and unlisted assets is weakening, and this is not a trend that is going to disappear any time soon.
 

Delaying the inevitable always has a cost (May 4)

Mediobanca owns 13% of Generali, Italy's largest insurer and number 3 in Europe. This stake represents a large third of its assets and results, and gives it de facto control of Generali, which obviously contributes to its power and influence.

Mediobanca's managers have been very successful in preventing this major asset from being reflected in its share price at a discount to the sum of the parts, attracting criticism and predators. 

But there is more to life than finance; there is also power. And whoever controls Mediobanca controls Generali. Mediobanca's directors were well aware of this. But rather than resolving this dilemma, cutting off this strong point which is also their weak point, they chose, as is all too often human nature, to wait and see rather than to take pre-emptive action, thinking that the good performance of their share price on the stock market would protect them.

And the risk took the form on 24 January of a takeover bid by Monte dei Paschi di Siena (MPS), for more than a decade the sick man of European banking. When we learned that MPS was launching a non-friendly takeover bid for Mediobanca, many of us thought that the April Fool’s day was 70 days in advance this year. 

The retail bank MPS, finally back on its feet and with a market capitalisation of €9bn, wanted to become a universal bank by acquiring Mediobanca (then with a market capitalisation of €12.5bn) with its investment banking and asset management assets, . . and its 13% stake in Generali. Rather than saying MPS, better to mention its two leading private shareholders, the Caltagirone and Del Vecchio families, who are contesting Mediobanca's control of Generali, of which they are also shareholders.

To escape MPS and its two voracious shareholders, Mediobanca has just announced a takeover bid for Generali's listed private banking subsidiary. The takeover bid will be paid for in Generali shares, almost all of which will be sold. This could logically reduce the attractiveness of Mediobanca for the Caltagirone and Del Vecchio families, to whom the withdrawal of Mediobanca from Generali opens a wide door to control of the insurer. All the more so as their position in the latter's capital will be automatically boosted if Generali cancels its own shares received in return for selling its private banking subsidiary to Mediobanca.

By confessing that he had been thinking about this operation for 5 years, the CEO of Mediobanca is simply acknowledging that postponing the inevitable always has a cost, which could be the loss of Mediobanca independence if this clever manoeuvre fails.

If it succeeds, it will be the symbolic end of capitalism without capital in Italy, in the same way as the independence given to PAI Partners by Paribas in France, or the sale by Deutsche Bank of its stakes in German industrial groups, many years ago.