Disclosure of the Basis of Consideration and Business Valuations in Notifiable Transactions

In October 2023, The Stock Exchange of Hong Kong Limited (HKEx) published a guidance letter HKEX-GL116-23 (the “Guidance Letter”) outlining the disclosure gaps identified in transaction circulars from their previous vetting. The Guidance Letter underscores the need for listed companies to provide adequate explanation of the basis of determining the consideration of the transaction by disclosing in the transaction announcement sufficient and objective information with quantitative inputs and analysis to substantiate how the consideration was arrived at. In a recent review of issuers’ transaction circulars, HKEx found that the disclosure in some transactions was overly general and simplistic. As a result, in the Guidance Letter, HKEx provides guidance on the recommended disclosures of business valuation reports, as well as the recommended disclosures for transactions where no independent valuation is conducted. This article will explore the key aspects of the Guidance Letter and its potential implications for the disclosure of circulars or announcements related to acquisition or disposal transactions.

What’s the Guidance Letter about?

The Guidance Letter states that, regardless of which valuation approach is adopted, the issuer shall provide an explanation of why and how the adopted approach is appropriate for the transaction. It also provides an overview of the necessary information that should be included in the circular or announcements of the transaction to substantiate how the consideration was arrived at. Under the current requirements of Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (the “Listing Rules”), when an issuer conducts an acquisition or disposal that constitutes a notifiable transaction, it must disclose the basis for determining the consideration and the terms of the transaction. Where the consideration of the transaction is determined primarily with reference to an independent valuation report of the target company (the “Target”), the transaction circular should contain a valuation report of the Target or a summary of the valuer’s views and analysis, as well as all material factors contained in the valuation report. These include, but not limited to, the effective valuation date, scope and limitation of work, valuation approach(es) or method(s) adopted, key inputs and assumptions adopted, conclusion of value and the identity, qualification and independence of the valuer.

It’s important to note that this summary provides a condensed overview of the Guidance Letter’s content. For a more detailed understanding, you can refer to the official HKEx announcement at this link: https://en-rules.hkex.com.hk/sites/default/files/net_file_store/GL116-23_e.pdf

Business valuation is even more difficult in some specialized industries

Companies in the biotechnology industry primarily use living organisms, molecular, and cellular techniques to provide chemicals and services that meet human needs, especially in drug or disease treatment. Target companies in this industry may be in the pre-clinical phase or different phases of clinical trials with a probability of success or failure. Valuation of biotechnology companies involves intensive research on fundraising transactions at various stages, public companies, and possibly the application of the rNPV method.

Mining companies often operate in environments where the quantity and quality of mineral reserves are critical to their value. Geology and exploration results should be carefully considered through a reasonable review of the feasibility study and technical report. The requirement for experience is high, and experience should be properly accumulated from truly experienced experts. Each mining project is unique, and its valuation depends on specific factors such as deposit size, ore grade, location, and extraction methods. These factors can vary significantly from one project to another, leading to a high technical requirement for constructing discounted cash flow models.

How Valtech could assist listed companies in any notifiable transaction that involves valuation?

Valtech Valuation has a team of experienced professional valuer to provide independent business valuation services for transaction purpose to assist issuers assists directors to determine the reasonableness of the consideration to be paid for a potential transaction. Valtech’s professional team, when conducting a valuation engagement, would go through a rigorous process in every relevant aspect pertinent to the valuation including but not limited to selection of valuation approaches, key inputs and assumptions, selection of appropriate market comparables. The valuation process and the conclusion would be documented in the valuation report in a transparent and systematic manner. This enables issuers to understand the logics behind in order to formulate a solid basis for determining the consideration of the transaction. This is essential to cases where directors of the issuer do not possess the knowledge or expertise in the industry which the subject asset or business is operating in. Including a comprehensive and transparent valuation report in issuer’s circular or announcement would also facilitate the review process conducted by HKEx, as all material and relevant information in relation to the valuation of the Target and the basis of how the consideration is determined have already been disclosed properly with regards to the requirements of HKEx.

CPA + CFA – Guaranteed at Minimal

We are committed to have qualified CPA and CFA to involve in an valuation engagement at minimal. It is more often we have CPA, CFA, FRM, MRICS, ABV (by AICPA) with master level of education background in finance or statistics involved in the valuation for disclosure purpose. PhD level will also be involved for mining companies seeking for compliance with Ch. 18 of listing rule.

Our Recommendation Regarding HKEX-GL116-23

  • Appropriate selection and application of valuation approaches
  • Well documented valuation process
  • Financial analysis in line with generally accepted theory in finance
  • Adhereance to Internationally Recognised Valuation Standards

One-Page Summary of Valtech Tips for Compliance with HKEX-GL116-23: Download

Guidance of Valuation Approaches and Recommended Disclosures 

To access the valuation of Transaction Targets, issuers may adopt various valuation approaches. The income approach, market approach, cost approach, and asset-based approach are examples of common approaches to valuation. There are various ways to apply each of these approaches. Whichever approach is used, the issuers should clearly explained the key assumptions and valuation inputs with detail and specific terms in order to assist shareholders to comprehend the valuation.

The followings are considered that disclosures should (not) include:

Valuation vs No Valuation

While it may be possible in some cases to proceed without a valuation, generally it is strongly advisable to obtain an independent valuation. As the Guidance Letter suggested, issuers should thoroughly explain and back up any pricing multiples or financial forecasts used without solid supporting rationale. Therefore, proceeding without independent valuer to conduct the business valuation is still requires reliable alternative analyses or evidence to replace the support provided by the valuation.  Unless truly comparable transactions exist or the business is very mature with straightforward valuation, we would still recommend that a valuation carried out by a qualified third party analyst would add credibility and mitigates risks.

About Valtech Valuation

Valtech Valuation is a professional valuation firm accredited with ISO-9001 in valuation advisory services. The firm is renowned for its expertise in advanced valuation techniques, customized valuation models, data-driven insights, and adherence to compliance and reporting standards. With a solid track record in valuation advisory for listed companies, private equity, fund managers, and financial institutions, Valtech Valuation has a qualified team of PhD, CPA (HKICPA), CFA, Chartered Valuation Surveyor of Royal Institution of Chartered Surveyors, and valuer having Accredited in Business Valuation (ABV) by AICPA and CVA qualification in Singapore.