How Duff & Phelps used data to elevate a long-running debate

In at least one respect, fairness opinions — a third-party’s assessment of a prospective merger or acquisition to determine whether its terms are reasonable — are like the C.I.A.: They only make news when something’s gone wrong. Such was the case last September, when Lazard made headlines for its $400 million arithmetic error in a fairness opinion for SolarCity, which was being targeted for purchase by Tesla Motors. The error — and the fact that it made no difference in Lazard’s valuation range (fairness opinions are always expressed in a range) — elicited sharp critique in several prominent media outlets, including The Wall Street Journal. The critical gist was that fairness opinions don’t provide value to companies’ boards. Why? Primarily because the valuation ranges, they say, are so overly broad as to be useless, and because providers are too reliant on “mechanical” discounted cash flow (DCF) analyses that don’t provide accurate information. As this perspective played out in the media, Duff & Phelps, grew frustrated. As the leading provider of fairness opinions, Duff & Phelps knew that this wasn’t the whole story. Sure, in this one instance, something had gone awry. But those casting dispersion on the entire practice for one mistake had constructed their arguments on conjecture rather than evidence, anecdotes rather than facts. As an industry leader, Duff & Phelps sought to elevate the debate around a topic that was crucial to its business. Greentarget believes that true thought leaders have an obligation to contribute to a smarter conversation. So together, and with the help of IBM’s Watson, we collected, reviewed and analyzed more than 3,000 fairness opinions in order to address the critiques — with empirical evidence. The resulting report, which was released last week, demonstrates that, contrary to popularized criticisms, the average range of valuations is sufficiently narrow to support the view that fairness opinions serve as a valuable tool in evaluating purchase offers. Duff & Phelps also learned that the “massive valuation ranges” railed against by critics were not massive at all, and more often than not occurred in assessments of smaller companies. That’s understandable, seeing as there’s less historical data and fluctuating growth expectations that can cause dramatic variances in expected cash flow. Oh, and that reliance on DCF analyses? Not really the case. Duff & Phelps found that fairness opinion advisors have relied on multiple methodologies for some time. For instance, 91 percent of the fairness opinions we reviewed used more than one methodology to arrive at valuations. In 75 percent of the deals, advisors used three or more methodologies. Not only will the report inject some sorely needed empirical data into this conversation, but the findings can be used by boards as a tool in evaluating the fairness opinions they receive when assessing an offer. The data set on average valuation ranges, for example, can be employed as a benchmark, while the information regarding various methodologies will help boards ask the right questions of their advisors. At the end of the day, this won’t end the debate around the efficacy of fairness opinions. The next time one goes haywire, its critics will discuss its possible shortcomings, and rightly so. But with data in hand, Duff & Phelps has given itself a stronger voice to drive a smarter conversation.