PIPEs Conference Panel

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Information about PIPEs Conference Panel

Published on November 15, 2008

Author: erobak

Source: slideshare.net


Panel discussion at DealFlow Media PIPE Conference 2008. Participants: Espen Robak, Pluris Valuation Advisors (moderator); Ele Klein, Schulte Roth & Zabel; Chris Johnson, Crowe Horwath; Neil Pinchuk, Bernstein & Pinchuk.

Accounting and Valuation Issues i dli ‐ Examining new Fair Value Rules PIPES CONFERENCE 2008 ESPEN ROBAK CHRIS JOHNSON ELE KLEIN NEIL PINCHUK © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

FAS 157 Definitions 2 Fair value: the price that would be received in an orderly  transaction between market participants on the  measurement date.  Orderly transaction: market exposure  usual and customary marketing activities  usual and customary marketing activities not a forced transaction. Exit price: the price received upon sale in a hypothetical  Exit price: the price received upon sale in a hypothetical transaction. Based on assumptions of market participants.  p p p © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

Valuation Inputs (the “levels”) 3 Valuation techniques used to measure fair value shall  maximize the use of observable inputs and minimize the use  of unobservable inputs – FAS 157 Fair Value Hierarchy – focus on inputs, not techniques: Level I – Observable Inputs: unadjusted market prices for identical  assets. assets Level II – Observable Inputs: quoted prices for similar assets in active  markets, quoted prices for identical or similar securities in inactive  markets, other observable market inputs, and inputs derived from  markets other observable market inputs and inputs derived from or corroborated by the market.  Level III – Unobservable Inputs: everything else.  © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

Level II Measurements 4 Quoted prices for similar assets or liabilities in active  markets. Example: PIPE securities, other restricted securities. Quoted prices for identical or similar assets in inactive  markets. Markets with few transactions. Markets with few transactions Markets where prices are not current, or where quotes vary over  time or among market makers. Principal‐to‐principal markets or other markets where little  information is publicly available. © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

Level II Measurements (cont.) 5 Observable data other than quoted market prices. Interest rates and yield curves. Volatilities. Credit risks and default rates. di i k dd f l Inputs derived primarily from observable market data  through correlation or regression analysis.  through correlation or regression analysis The key distinguishing characteristic (relative to Level III  inputs) is that the fair value problem is solved by market  inputs) is that the fair value problem is solved by market participants.  © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

Recent Implementation  l i Guidance ‐ Center for Audit Quality ‐ Securities and Exchange Commission Securities and Exchange Commission ‐ Financial Accounting Standards Board ‐ Department Of Labor Department Of Labor © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

Center for Audit Quality 7 White paper on “Measurements of Fair Value in Illiquid  (Or Less Liquid) Markets.” “Questions have arisen about (…) whether current market  prices are more indicative of distressed sales”. In 2004 release, the SEC held that the registrant violated  GAAP by using a definition of fair value that assumed  GAAP b i d fi iti f f i l th t d supply and demand were in reasonable balance.  Specifically, the SEC objected to the practice of ignoring  Specifically the SEC objected to the practice of ignoring quoted prices and “taking the longer view”. © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

Center for Audit Quality (cont.) 8 If transactions are occurring in a usual and customary  manner, those deals are not “forced” sales. The fact that transaction volume is low does not indicate  the sales are forced or distressed sales. Decreased volumes in a market do not necessarily mean  the market has become inactive. th k th b i ti “Markets with a reduced transaction volume under  current conditions are still considered active if  current conditions are still considered active if transactions are occurring frequently enough on an  ongoing basis to obtain reliable pricing information.” gg p g © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

SEC Comment Letter 9 March 2008 letters  Specifies disclosures for MD&A, especially for any model‐ driven valuations Notes that FAS 157 does not require mark to market if  “market” consists of forced or distressed sales “Supporters of using fair value believe that investors and other users of  financial statements are better served by knowing, where possible, what  something is currently worth rather than relying on management  assumptions – which many experts deride as a rose‐tinted “yes, but it is going  assumptions which many experts deride as a rose tinted “yes but it is going to go up again” approach.  ‐ Financial Times, April 1, 2008 Lynne Turner: […] the notion that if you have a distressed asset, you can avoid  market prices, which is not the spirit or intention of this rule market prices which is not the spirit or intention of this rule”. – FT April 1 08 FT, April 1, 08. © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

FSP 157‐3 10 FASB Staff Position: Fair Value in Inactive Markets Warns against broker quotes, in particular. Provides amendment to FAS 157 – new Example. p Invested in AA tranche of CDO Market increasingly inactive, widening bid‐ask spreads, volume  down Few observable transactions, no current quotes, widely varying  quotes Approach chosen: increase discount rate from when markets were  active, supplement with data from indicative quotes.  Supported by SEC September 30 release.  Supported by SEC September 30 release © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

DOL Letter (June 2008) 11 To pension plan investors in hedge funds. “A process which merely uses the general partner’s  established value for all funds without additional analysis  may not insure … fair market value” Plan administrators “must have a thorough knowledge of  the general partner’s valuation methodology” th l t ’ l ti th d l ” © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

LP Interest Discounts? 12 Funds‐of‐funds, pension funds and other investors invest at  NAV: entry price. Should the exit price be adjusted for lock‐ups? If an LP investor wants to sell its interest, would buyers  If an LP investor wants to sell its interest would buyers demand a haircut from NAV for a two‐year lockup?  In most situations, “issue went away” Question: what happens when gates go up?  Often valuation uncertainty/volatility associated with gates. Not a point where investors typically put new money in.  p yp yp y Acceptable to value “liquidating” portfolio at different level  than ongoing portfolio?  © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

Questions for Panel 13 Recent guidance – did any of that help? g y p Going from Level I to Level II – what rules or  standards can we rely on?  y When, if ever, can we ignore market evidence? Determining fair value when every sale is a  fire  Determining fair value when every sale is a “fire sale” Broker quotes vs  mark to model Broker quotes vs “mark‐to‐model” The LP valuation discount issue is back – and this  time for good?  time for good? © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

Specific Valuation Evidence ifi li id ‐ Restricted Stock Discounts ‐ Warrant Discounts ‐ Convertible Securities Valuation © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

Restricted Stock Discounts 15 70.0% 60.0% 50.0% Discount 40.0% 30.0% 30 0% D 20.0% 10.0% 10 0% 0.0% 0 0 0 0 0 0 0 0 0 0 0 0 0 10 30 50 70 90 11 13 15 17 19 21 23 25 27 29 31 33 35 Days of Illiquidity Remaining © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

Restricted Stock Discounts (ct) 16 Market Block Size Revenues Holding Market Volatility Discount Cap ($ ) C ($m) ($m) ($ ) Period P id Price Pi (Days) 293 450% 124 203 $7.89 86% 28.3% Average 203 76 38 210 4.03 77 22.9 Median 407 35 48 227 13.11 81 12.8 1st Quintile 100 59 54 251 3.63 74 19.4 2nd Quintile 90 40 54 105 3.85 76 22.9 3rd Quintile 232 256 13 229 5.24 5 24 68 35.0 35 0 4th Q i til Quintile 99 274 7 197 2.70 104 47.5 5th Quintile © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

Warrant Discounts 17 Market Stock Intrinsic Delta Money- Volatility Discount Cap ($m) Price Value ness 231 $6.81 $2.31 0.817 0.202 86.3% 42.7% Average 153 4.12 0.38 0.831 0.153 69 44.2 Median 229 7.66 2.16 0.903 0.471 52 15.3 1st Quintile 160 4.96 1.42 0.841 0.317 66 30.2 2nd Quintile 127 4.40 0.43 0.794 0.139 60 44.5 3rd Quintile 123 2.45 0.00 0.830 -0.058 83 56.8 4th Quintile 106 2.44 0.00 0.803 -0.184 90 66.9 5th Quintile © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

Basics of Convertible Valuations 18 Convertible valuations can be at a premium to “intrinsic”  or as‐if‐converted value. Reflects the value of the “floor” downside protection to the equity  value of the instrument. value of the instrument Implies little or no illiquidity discount for the underlying shares – effective registration statements and no “implied” blockage. Valuations can be at a discount from face value.  Risky, highly illiquid positions in nano‐cap issuers. Significant deterioration in the stock price. Significant deterioration in the stock price Usually “fallen angels” with or without floating conversion prices. Severe illiquidity for the underlying convertible. Most convertibles: value somewhere in‐between. © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

Questions for Panel 19 Convertible debt bifurcation analysis – models  y or market data?  Valuation impact of shortening Rule 144 period. p g p How do agreement terms affect fair value? Registration rights Warrant call caps Cashless exercise Effect of going through the reverse merger  Effect of going through the reverse merger process.  © Pluris Valuation Advisors LLC  ● www.PlurisValuation.com  ● 212.248.4500

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