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29-05-2024 : Believe, an expert who outclasses the advisory banks

Here's the second thing that left us wondering when we read the offer notes, after the concept of a fair price, but not fair enough to allow expropriation as seen this Saturday.

While the consortium has made an offer of €15 to buy back the free float, the valuation of the 2 advisory banks is significantly lower, whereas there is usually little difference between this valuation and the offer price. Here, the opposite is true. The bank advisors arrive at a DCF of €10, where the independent expert is at €17; with the multiples it's a range of €5 to €10, where the independent expert is between €10 and €20... . With advisors valuing the target at €10 using a DCF and between €5 and €10 using multiples, one wonders how the consortium, which is not made up of financial choirboys, could put €15 on the table, and Warner Music articulate a price of €17 ... . 

When we look at the details of the banks' valuation, we are struck by the errors made: 

1/ The required rate of return estimated from the CAPM model is: risk-free rate + beta x (expected market rate of return - risk-free rate). The figure in brackets is the risk premium. But if we take one in bulk, we make sure that it has been calculated using the same risk-free rate that is also used in the formula, so that we don't have 2 different risk-free rates. In this case, the risk premium taken has no chance of having been calculated with the risk-free rate used (OAT 20 years), as required. 

2/ Use the 20-year OAT rate as the risk-free rate, whereas the usual practice is to use the 10-year OAT rate, in the absence of a short-term rate that is truly risk-free. This inflates the discount rate and reduces the value. 

3/ Adding consultancy costs not foreseen in the business plan prepared by management, which reduces the value. 

4/ Simply taking the multiples of two comparable companies, Warner Music and Universal Music (UMG), and lazily applying them to Believe, pretending to forget that the level of a multiple depends above all on the growth rate, and that by this yardstick, Believe is leaving these two groups behind: + 22% per year from 2019 compared with + 12% by UMG and 6% for Warner.  Just by comparing the multiple calculated by the banks for Warner (14) and UMG (22), the substantial difference between which is explained by the no less substantial difference between the growth rates of these two groups (6% and 12%), we can instantly see that these multiples cannot be applied to Believe, which is growing 2 or 4 times faster. This is exactly what the independent appraiser understood, having done some real thinking and managed to integrate, as she should, the impact of the growth rate into the multiple used to value Believe.


25-05-2024 : So, is the offer on Believe fair or not?

A reading of the draft takeover bid prospectus and reply prospectus leaves us wondering about two points.

Believe had been floated on the stock exchange in June 2021 at the bottom end of the announced price range, at €19.5. On the first day, the share price fell to €16.1 and continued to slide thereafter.

In February 2024, the management, together with one of the funds currently holding shares and a new investment fund, formed a consortium and proposed to delist Believe at €15 by buying back the 28% free float, even though the company was 2 years ahead of its business plan and the stock market index used by Believe (as part of its stock-based compensation policy, the Eurostoxx 600) had risen by 14% since the IPO. Of course, an index hides dispersion, and the rise in interest rates has hit harder those companies whose free cash flow is far in the future, like Believe whose free cash flow is still negative. The independent appraiser's task was going to be an arduous one, since it was not easy to attest to the fairness of an offer under these conditions, which could lead to the expropriation of shareholders, and which was causing quite a stir. 

But then a deus ex machina, in the form of Warner Music, appeared and announced for a while that it was considering making an offer at a price of at least €17; then, on reflection, it withdrew. The independent expert had then no problem telling the consortium: "Raise your price to €17 if you want me to certify the fairness of an offer that could lead to expropriation. Response from the consortium: We have already raised it from €14 to €15 at the request of the independent directors, and our price is final. Expert's reply: I cannot attest to its fairness, unless you drop the possibility of a delisting by squeezing out of the remaining minority shareholders if you win over 90% of the shares. Reply from the consortium: We modify our offer and abandon the delisting option. Expert's response: I can then attest to the fairness of an offer that will under no circumstances result in expropriation at €15.

It's not the first time we've seen this ballet (cf. SMTPC), and we've ended up with the concept of a price that's fair (€15), but not fair enough to allow expropriation (at €17 or €18?). It's up to each and every one of us to make up our own minds, because being an investor is an activity that, like any profession, requires hard work, and there's little room for dilettantism. The independent expert's report provides a lot of information and arguments for those who want to sell at €15, or who want to continue the adventure. That said, we're not going to complain about an independent expert who didn't let her feet be trodden, and who achieved the essential, avoiding compulsory expropriation at €15, even if she can say, like the minority shareholders: Thank you Warner Music.

See you next Saturday for the second element of this operation that leaves us wondering. 


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The Letter

Number 156 of May 2024

News : Managing a company under LBO

Statistics : Yield curves

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Q&A : What are the disadvantages of eliminating short selling?

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