Investment Banking Fairness Opinions: Profitable and Prestigious, or Glamorless Gruntwork?
“Morgan Stanley is acting as financial advisor to the buyer and Credit Suisse is acting as financial advisor to the seller, with the fairness opinion provided by Houlihan Lokey.”
So we’ve been over this “financial advisor to the buyer and seller” stuff before, but what about that fairness opinion bit?
You always see sentences like the one above at the bottom of deal announcement press releases – so what is this mysterious “fairness opinion,” why does it matter, and what should you do when your VP calls you at 2 AM and asks you to help out with one?
What are Fairness Opinions and Why Do Banks “Provide” Them?
A “Fairness Opinion” is just a detailed valuation of a company that’s being sold (if you’re representing the seller) or a valuation of the company that your client is buying.
Right before a deal is announced, the bank that prepares the Opinion presents it to the Board of Directors and concludes whether or not the deal is “fair” based on the purchase price and deal structure.
As you might guess, banks never say a deal is “unfair” – the Opinion is just a rubber stamp to justify the deal to investors.
While they’re not technically required by law, Fairness Opinions almost always get issued for deals that involve the sale of public companies due to lawsuits: no matter how much a company sells for, someone is bound to sue them.
Even if the company is worth $100 million and it gets sold for $1 billion, some random shareholder with too much time on his hands will argue that it should have been sold for $10 billion and will start a class-action lawsuit.
The bank’s Fairness Opinion is filed along with all the other documents related to the transaction (the definitive agreement that includes the terms of the acquisition, for example), and serves as evidence when lawsuits start arriving.
Why Should You Care About This Legal Nonsense?
Bankers have no love for lawyers, but you need to know what Fairness Opinions are and how they work because:
- The deals you work on determine your exit opportunities, your ranking and bonus, and how much you learn.
- You will be asked to work on or help out with Fairness Opinions from time to time, so you need to know whether to say “yes” or to claim you have other urgent deadlines.
- Some banks and groups do more Fairness Opinion work than others – you need to understand this upfront because it affects which bank and group you select.
When Do Companies Request Fairness Opinions?
99% of the time they get issued when there’s a public company being sold – you do not do Fairness Opinions for equity or debt deals, so if you’re in an ECM, DCM, or Leveraged Finance group you won’t deal with them.
If you work with mostly private companies, you also won’t see Fairness Opinions because private companies have far fewer shareholders (well, except for Facebook and its clever skirting around the rules) and are often closely held by the founders or VC/PE investors.
Fairness Opinions might also be issued when:
- There’s a management buyout or take-private (a PE firm acquires the company via a leveraged buyout and turns it private).
- A public company divests one of its divisions.
- There’s a bankruptcy, liquidation, restructuring scenario (less common).
- There’s a hostile takeover – in this case it would be called an “inadequacy opinion” instead and would be used to defend the target by claiming that the offer is not fair.
In short: whenever there’s a high chance of getting sued, companies request these Opinions and use them to defend themselves in lawsuits.
Outside the US, Fairness Opinions are common in some countries (Western Europe) and not common in other places (emerging markets). Whether or not they’re required depends on the legal system in the country, but you almost always see them for public company transactions in developed markets.
How to Issue a Fairness Opinion, Part 1: Before the Deal Comes Together
M&A deals come together in different ways: sometimes the company itself wants to sell, other times investors are getting impatient and force them to sell (Zappos), and sometimes a buyer jumps in with an attractive offer and starts a bidding war (YouTube).
If it’s the last case, where a buyer swoops in with an offer to buy the company, no one thinks about the Fairness Opinion until that point.
But if it’s one of the other scenarios, then the seller may hire an investment bank to find a buyer. If they do this, in the initial contract they might also give the bank the right to issue a Fairness Opinion in addition to advising on the deal process.
You see that sometimes, but many times the “financial advisor” bank and the “Fairness Opinion” bank are different.
The same bank advising a company on its sale and also saying whether or not the deal they get is “fair” is hardly objective – so executives and regulators believe that having a different bank issue the Opinion is more “impartial.”
If a different bank is providing the Fairness Opinion, they are not notified until the deal is about to be announced – doing so any sooner than that would create unnecessary work because M&A deals often fall apart in the early stages.
How to Issue a Fairness Opinion, Part 2: Just Before the Deal is Announced
Now comes the fun part. A couple factors make the actual construction of the Fairness Opinion especially painful:
- You are under extreme time pressure – you get a few days, and sometimes up to a week or a bit longer. This happens because the process is last-minute and occurs only when everyone is 99% sure the deal is going through.
- You must be excruciatingly precise – this is where bankers’ reputation for “attention to detail” comes from. This valuation could be used as evidence in lawsuits, so if you’ve added back the incorrect amortization amount when calculating EBITDA, you might be thrown into a snake pit.
Normally when you value a company you don’t have to be super-precise: bankers ask for quick valuations all the time, and if you spent hours going through a company’s SEC filings (or equivalent government organization abroad) you would never get anything done.
So you pull a lot of information automatically using tools like Capital IQ and Factset and rely on their numbers.
But when you’re working on a Fairness Opinion you can’t do that – rather than just pulling the LTM (Last Twelve Months) EBITDA from Capital IQ, for example, you have to look at a company’s income statements and cash flow statements (for the correct non-cash charge numbers) to calculate it.
And then you would have to look through the Notes to the Financial Statements and the MD&A to find all the non-recurring charges and other accounting shenanigans that you need to remove.
Another analyst will also check your numbers, your associate will check them, and even the VP may get involved depending on the deal.
To make things even more fun, this entire process will be a last-minute effort that requires all-nighters over the few days you get to complete it.
Oh yeah, and then the deal announcement itself is often delayed – so you need to monitor the seller and all the other companies you’ve used in your analysis and update the numbers when someone announces earnings, issues debt or equity, or does anything else that affects its numbers.
When you finish the Opinion and everyone has checked it over 52 times, you then present it to the Fairness Opinion Committee at your bank and explain all the numbers to them – if they see something they don’t like, you get to re-do that part.
And then when you finally get their approval, the senior bankers working on the deal will present it to the Board of Directors of the company and sign off on the decision.
Sometimes they actually present it to the company’s Special Committee – if one was formed for the deal – but usually it’s to the Board.
Internationally the entire process may be a little less painful, but it depends on your group and the country you’re in – in London, for example, there’s no difference and you will still spend hours poring over filings and adjusting for capitalized leases, pensions, and other trickery.
Why Do Banks Provide This Service?
Simple: it’s easy money and easy prestige for banks, especially for the senior bankers that don’t have to suffer through ultra-precision.
Fees paid to banks in a sell-side M&A deal are a percentage of the sale price (the equity value of the deal, not the enterprise value), and that percentage scales down as the size of the deal increases.
For a $500 million deal, the bank might negotiate a 1% fee and therefore earn $5 million if the deal closes. For a $5 billion deal, it might be 0.2% or 0.3%, for $10-$15 million. For deals in the $50 billion range – very rare – the fee might be around $50 million (0.1%).
With a Fairness Opinion a bank earns a much lower fee – it might be in the hundreds of thousands for smaller deals up to the low millions for larger deals – but it earns that fee with far less time and effort.
Let’s say that a bank is advising a company on a $50 billion deal – something that large would take years to put together (unless we’re in the late 90’s and it’s happening all the time), and they might earn a $50 million fee on the actual advisory work if the deal closes.
The bank that issues the Fairness Opinion might earn a few million – let’s call it $5 million – but it earns that fee with 1/100th the amount of time and effort that the financial advisor put in.
The other, really important point is that the bank earns that fee even if the deal gets announced but does not close – it’s not like M&A advisory fees where they only get paid out when the deal closes.
So a bank could make tens of millions of dollars by issuing Fairness Opinions for deals that never close.
The thinking here is that paying banks upon completion of the Opinion rather than when the deal closes makes them “less biased,” but it had the unintended consequence of making FOs extremely lucrative for risk-averse bankers as well.
In addition, the bank receives league table credit for issuing a Fairness Opinion – so a bank that issues 50 Fairness Opinions but doesn’t advise on any deals would look as good as a bank that has advised on 50 real deals, at least according to a table that ranks banks by # of deals.
If you look at a table that ranks banks by fees earned instead, the Fairness Opinion-centric bank won’t look as good – but you can bet they won’t be showing that version of the table in their pitch books.
Often Fairness Opinions are given to banks as “favors” for work done in the past.
A company might go with a bulge bracket bank for the M&A advisory work for political reasons, but the CEO might know a senior banker at a boutique and might have worked with them in the past – in this scenario the company might give the Fairness Opinion assignment to that boutique as a favor for their past relationship.
The boutique will still feel as if its toes have been stepped on, but the pain won’t be quite as acute if they can make at least some money off the deal anyway.
What Banks and Groups are Known for Fairness Opinions?
No, I’m still never going to rank the banks, so please go away right now if you’re expecting that.
But some banks and groups – for better or worse – are known for Fairness Opinions.
Houlihan Lokey is consistently ranked #1 in Fairness Opinion market share, beating even the bulge bracket banks and elite boutiques.
At HLHZ, the Financial Advisory Services (FAS) group does all the Fairness Opinion work and the other groups don’t touch them. And yes, the FAS group provides other services like solvency opinions, purchase price allocations, and more technical accounting-esque work as well.
Other banks – from bulge bracket to elite boutique (Perella Weinberg is also well-known for FOs) to middle-market – also do Fairness Opinions but no one else dominates the space as HLHZ does.
Groups such as ECM, DCM, and Leveraged Finance do not work on Fairness Opinions because they’re not required for debt or equity deals – so you only have to worry about them if you’re in an M&A, Restructuring, or industry group.
Of those, industry groups are the most likely to work on Fairness Opinions, although you may get asked to help out even if you’re in another group.
Outside of investment banks, some Big 4 firms also do Fairness Opinion work and dedicated valuation boutiques also issue Opinions from time to time.
Take Me to the Examples
Finding actual Fairness Opinions is not the easiest thing in the world, so here are links to good examples. Some of these are quite old, but corporate valuation barely changes over time so they are equally valid today:
- Credit Suisse – Fairness Opinion for LBO of SunGard Data Systems
- JP Morgan – Fairness Opinion for Merck / Schering-Plough Merger (Note the P/E, EBIT, and EBITDA multiples – see, nothing special for healthcare…)
- Perella Weinberg – Fairness Opinion for TPG’s $3B Buyout of J.Crew
You’ll see the usual valuation analyses there: public company comparables, precedent transactions, premiums, DCF, future share price, and so on.
Even if you have no interest in Fairness Opinions, I strongly recommend looking at those examples because they show you exactly how banks value companies in the real world, common multiples, and other questions you’ll get in interviews.
Sometimes Fairness Opinions also include mergers models and LBO models – merger models are more common on deals where it’s more of a merger as opposed to a behemoth acquiring a much smaller company, while LBO models are more common for LBO deals.
You do not include a detailed 3-statement model for the seller, nor do you show all the supporting work that went into the numbers – only the output matters.
If you want to find more examples yourself, you can search for S-4 or DEF 14A (proxy) forms on the SEC EDGAR site; for countries outside the US you will have to go to the company’s website directly and hope they have it there, or go through whatever online database has securities filings in your country.
So, Should You Work On Fairness Opinions?
I am not a huge fan of Fairness Opinions because they represent the worst parts of banking – last-minute all-nighters and combing through filings to make small tweaks to numbers that don’t make a difference in the final analysis.
It’s good to get exposed to a Fairness Opinion at least once, but similar to climbing Mt. Fuji or going ice swimming, you don’t want to get exposed repeatedly – especially at the expense of real deals.
Yes, it’s good to learn how to find all the hidden charges and shady tactics a company is using but 99% of the time they don’t make a difference in your final analysis – and on the buy-side you rarely go into such detail unless you’re about to close an investment and you’re in the final stages of due diligence.
So if your VP or staffer waltzes in and asks if you have any “bandwidth” to help out with a Fairness Opinion, cite an urgent deadline and say that you might be able to check some of it, but can’t do it all yourself because of [Important Client-Related Item] that’s due in 2 days.
And if you’re out of excuses, suck it up and do it – but make sure that you hand it off to the 1st years or interns next time around.
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