Contents Table
- 1 Key Takeaway
- 2 Introduction
- 3 What are Contingent Value Rights?
- 4 How do CVRs work?
- 5 What are transferable and non-transferable CVRs?
- 6 What is Steinhoff’s case?
- 7 How will Steinhoff’s CVRs work?
- 8 Will Steinhoff’s CVRs be transferable or non-transferable?
- 9 What are the benefits of CVRs for Steinhoff?
- 10 What are the challenges of CVRs for Steinhoff?
- 11 Conclusion
Key Takeaway
- Contingent value rights (CVRs) are a type of derivative that pay out a certain amount of money or shares if a specific event happens by a certain date.
- CVRs are often used in mergers and acquisitions, when there is a disagreement between the buyer and the seller about the value of the target company.
- CVRs can be either transferable or non-transferable, meaning that they can be traded on a secondary market or not.
- Steinhoff, a South African company that has been struggling with a massive debt burden and an accounting scandal, plans to delist from the stock exchanges and convert its shares into CVRs.
- Steinhoff’s CVRs will represent the remaining value of its businesses, which include Pepkor, Conforama, Mattress Firm and others.
- Steinhoff’s CVRs will be distributed among its creditors (80%) and shareholders (20%), but their value is unclear and depends on many factors, such as the performance of its businesses, the outcome of legal claims against it, and the market demand for its CVRs.
Introduction
If you are a shareholder or a creditor of Steinhoff, you may have heard about its plan to delist from the stock exchanges and convert its shares into contingent value rights (CVRs). But what are CVRs and how do they work? How will they affect you as a stakeholder of Steinhoff?
In this article, we will explain what contingent value rights are, how they are used in mergers and acquisitions, and how they differ from other types of derivatives. We will also discuss the case of Steinhoff, a South African company that has been facing a lot of challenges due to its debt situation and accounting scandal. We will describe how Steinhoff plans to use CVRs to restructure its debt and give its creditors and shareholders some hope for future value. We will also analyze the benefits and challenges of CVRs for Steinhoff as a company and for you as a stakeholder.
By the end of this article, you will have a better understanding of what CVRs are, how they work, and how they affect you. You will also learn how to manage your risks and opportunities with CVRs. If you have any questions or need any guidance on cloud accounting solutions and virtual CFO services, please feel free to contact us at Thrive CFO.
What are Contingent Value Rights?
CVRs are a type of derivative that pay out a certain amount of money or shares if a specific event happens by a certain date. The event can be anything that is agreed upon by the parties involved, such as reaching a certain sales target, getting a regulatory approval, or achieving a certain milestone. The date can be either fixed or flexible, depending on the nature of the event. The payout can be either fixed or variable, depending on the formula that is agreed upon by the parties involved.
CVRs are often used in mergers and acquisitions, when there is a disagreement between the buyer and the seller about the value of the target company. The buyer may offer CVRs to the seller’s shareholders, promising them extra compensation if certain performance targets are met in the future. This way, the buyer can pay less upfront, and the seller can get more value for their assets.
Contingent value rights are similar to options, because they have an expiration date and a strike price. However, unlike options, CVRs do not require any upfront payment or premium. The holder of a CVR only receives a payout if the event occurs, otherwise they lose nothing. CVRs are also different from warrants, because they do not give the holder the right to buy or sell shares at a fixed price. CVRs only provide a contingent benefit that depends on the outcome of the event.
Here are some examples of CVRs in other mergers and acquisitions:
| Buyer | Seller | Event | Payout |
|---|---|---|---|
| Sanofi-Aventis | Genzyme | FDA approval of Lemtrada (a drug for multiple sclerosis) by March 31, 2014 | $14 per share |
| Bristol-Myers Squibb | Celgene | FDA approval of three drugs (liso-cel, ide-cel, and ozanimod) by December 31, 2020 | $9 per share |
| AbbVie | Allergan | FTC clearance of Humira biosimilar competition by May 15, 2023 | $20 per share |
How do CVRs work?
The process of creating and distributing CVRs in a merger or acquisition deal is as follows:
- The buyer and the seller negotiate the terms and conditions of the CVRs, such as the expiration date, the strike price, the payout formula, and the event trigger.
- The buyer and the seller sign a CVR agreement, which is a legal document that specifies the rights and obligations of both parties regarding the CVRs.
- The buyer issues the CVRs to the seller’s shareholders, either as a separate security or as a part of the merger consideration.
- The seller’s shareholders receive the CVRs, either in addition to or in exchange for their shares in the target company.
- The buyer and the seller monitor the progress of the event, and report any updates to the CVR holders.
- If the event occurs by the expiration date, the buyer pays out the CVRs to the CVR holders, either in cash or in additional shares.
- If the event does not occur by the expiration date, the CVRs expire worthless, and the CVR holders receive nothing.
The value and price of CVRs depend on several factors, such as:
- The probability of the event occurring by the expiration date
- The time to maturity of the CVRs
- The volatility of the underlying asset (the target company or its business)
- The market demand for the CVRs
The value and price of CVRs can change over time, depending on how these factors change. For example, if the event becomes more likely to occur, or if it occurs sooner than expected, then the value and price of CVRs will increase. Conversely, if the event becomes less likely to occur, or if it is delayed or cancelled, then the value and price of CVRs will decrease.
CVRs have advantages and disadvantages for both buyers and sellers. Some of them are:
| Advantages | Disadvantages |
|---|---|
| For buyers: | For buyers: |
| – Reduce upfront payment | – Increase complexity and uncertainty |
| – Share risk with sellers | – Face litigation risks from sellers |
| – Align interests with sellers | – Incur tax implications from payouts |
| For sellers: | For sellers: |
| – Increase potential value | – Receive delayed or uncertain payment |
| – Retain upside exposure | – Lose control over target company |
| – Diversify portfolio | – Bear valuation difficulties |
What are transferable and non-transferable CVRs?
CVRs can be either transferable or non-transferable, meaning that they can be traded on a secondary market or not. Transferable CVRs can be bought and sold by anyone who is interested in them, while non-transferable CVRs can only be held by the original shareholders who received them from the buyer.
Transferable and non-transferable CVRs have different implications for liquidity, transparency, enforceability, and taxation. Some of them are:
| Transferable CVRs | Non-transferable CVRs |
|---|---|
| Liquidity: | Liquidity: |
| – More liquid | – Less liquid |
| – Can be sold for cash or exchanged for other securities | – Cannot be sold or exchanged |
| Transparency: | Transparency: |
| – More transparent | – Less transparent |
| – Can be tracked by market prices and volumes | – Cannot be tracked by market prices and volumes |
| Enforceability: | Enforceability: |
| – Less enforceable | – More enforceable |
| – Can be subject to fraud or manipulation by third parties | – Can be protected by contractual clauses and legal remedies |
| Taxation: | Taxation: |
| – More taxable | – Less taxable |
| – Can trigger capital gains or losses when traded | – Can defer taxes until payout |
Here are some examples of transferable and non-transferable CVRs in previous deals:
| Buyer | Seller | Type of CVR | Details |
|---|---|---|---|
| Pfizer | Wyeth | Transferable | Pfizer issued $3.3 billion worth of transferable CVRs to Wyeth shareholders as part of its $68 billion acquisition in 2009. The CVRs were linked to FDA approval of bococizumab (a drug for cholesterol) by December 31, 2017. The CVRs were traded on NYSE under the symbol PFE-WT. However, Pfizer discontinued bococizumab development in 2016, rendering the CVRs worthless. |
| Gilead | Kite Pharma | Non-transferable | Gilead issued $2.8 billion worth of non-transferable CVRs to Kite Pharma shareholders as part of its $11.9 billion acquisition in 2017. The CVRs were linked to FDA approval of axicabtagene ciloleucel (a drug for lymphoma) by March 31, 2018. The CVRs were not traded on any exchange. Gilead paid out $50 per share to Kite Pharma shareholders after FDA approval of axicabtagene ciloleucel in October 2017. |
What is Steinhoff’s case?
Steinhoff is a South African company that operates in the retail sector, with businesses such as Pepkor, Conforama, Mattress Firm, and others. Steinhoff has been struggling with a massive debt burden and an accounting scandal that wiped out most of its share value.
Steinhoff’s debt situation started in 2016, when it acquired Mattress Firm, a US-based mattress retailer, for $3.8 billion, which was considered to be an overpriced deal. Steinhoff also acquired other businesses in Europe and Africa, increasing its debt to more than $12 billion by 2017.
Steinhoff’s accounting scandal erupted in December 2017, when it announced that it had discovered “accounting irregularities” in its financial statements, and that its CEO Markus Jooste had resigned. Steinhoff’s shares plunged by more than 90% in a few days, and its creditors and investors demanded an investigation and repayment.
Steinhoff’s legal troubles followed in 2018, when it faced several lawsuits from its shareholders, creditors, regulators, and former business partners. Some of the most notable cases are:
- Tekkie Town: A South African shoe retailer that was acquired by Steinhoff in 2016 for $300 million. The founders of Tekkie Town claimed that they were misled by Steinhoff’s financial statements, and that they wanted their business back or compensation.
- VEB: A Dutch investor association that represents thousands of Steinhoff shareholders. VEB sued Steinhoff for damages caused by its accounting fraud, and demanded access to its financial records and audit reports.
- PwC: A global accounting firm that was hired by Steinhoff to conduct a forensic investigation into its accounting irregularities. PwC delivered a 3,000-page report in March 2019, which revealed that Steinhoff had inflated its profits and assets by more than $7 billion over several years.
To avoid bankruptcy, Steinhoff made a deal with its creditors to restructure its debt and give them control over most of its assets. As part of this deal, Steinhoff will delist from the Johannesburg and Frankfurt stock exchanges and convert its shares into CVRs.
How will Steinhoff’s CVRs work?
Steinhoff’s CVRs will represent the remaining value of its businesses, which include Pepkor, Conforama, Mattress Firm and others. The CVRs will be distributed among its creditors (80%) and shareholders (20%), but their value is unclear and depends on many factors.
The terms and conditions of Steinhoff’s CVRs are as follows:
- Expiration date: The CVRs will expire on December 31, 2029.
- Strike price: The CVRs will have a strike price of zero.
- Payout formula: The CVRs will pay out a percentage of the net proceeds from the sale or refinancing of Steinhoff’s businesses, after deducting certain costs and liabilities.
- Event trigger: The event trigger for the CVRs will be the sale or refinancing of any of Steinhoff’s businesses.
The value and price of Steinhoff’s CVRs will depend on several factors, such as:
- The performance of Steinhoff’s businesses: The higher the profits and growth of Steinhoff’s businesses, the higher the value and price of the CVRs.
- The outcome of legal claims against Steinhoff: The lower the damages and settlements that Steinhoff has to pay to its claimants, the higher the value and price of the CVRs.
- The market demand for Steinhoff’s CVRs: The higher the interest and activity from investors and traders who want to buy or sell Steinhoff’s CVRs, the higher the value and price of the CVRs.
The value and price of Steinhoff’s CVRs can change over time, depending on how these factors change. For example, if Steinhoff sells or refinances one of its businesses at a high price, or if it wins or settles one of its lawsuits at a low cost, then the value and price of the CVRs will increase. Conversely, if Steinhoff fails to sell or refinance one of its businesses at a good price, or if it loses or pays a high amount for one of its lawsuits, then the value and price of the CVRs will decrease.
Will Steinhoff’s CVRs be transferable or non-transferable?
Steinhoff’s CVRs will be either transferable or non-transferable, depending on the decision of a new holding company that will take over Steinhoff’s books, records and data. The new holding company will be established by Steinhoff’s creditors, who will have the majority voting rights and control over the CVRs.
The new holding company will have to choose between transferable or non-transferable CVRs, based on the trade-offs between liquidity, transparency, enforceability, and taxation. Some of the implications of transferable or non-transferable CVRs for Steinhoff’s creditors and shareholders are:
| Transferable CVRs | Non-transferable CVRs |
|---|---|
| For creditors: | For creditors: |
| – Can sell or exchange their CVRs for cash or other securities | – Have to hold their CVRs until payout or expiration |
| – Can diversify their portfolio and reduce their exposure to Steinhoff | – Have to rely on Steinhoff’s performance and legal outcome |
| – Can benefit from market prices and volumes of the CVRs | – Have to estimate the value of the CVRs based on internal information |
| – Have to pay taxes on capital gains or losses from trading the CVRs | – Can defer taxes until payout of the CVRs |
| For shareholders: | For shareholders: |
| – Can buy or sell their CVRs on the secondary market | – Cannot buy or sell their CVRs on any market |
| – Can increase their stake in Steinhoff’s businesses or exit completely | – Have to keep their stake in Steinhoff’s businesses until payout or expiration |
| – Can monitor the market prices and volumes of the CVRs | – Have to rely on the new holding company’s reports and updates |
| – Have to pay taxes on capital gains or losses from trading the CVRs | – Can defer taxes until payout of the CVRs |
Some recommendations for holders of Steinhoff’s CVRs on how to manage their risks and opportunities are:
- If the CVRs are transferable, then holders should track the market prices and volumes of the CVRs, and decide whether to buy, sell, or hold them based on their expectations and preferences.
- If the CVRs are non-transferable, then holders should monitor the progress and performance of Steinhoff’s businesses, and evaluate the probability and value of the event trigger based on their information and analysis.
- In either case, holders should also keep an eye on the legal claims against Steinhoff, and assess the potential impact of any settlements or judgments on the value and price of the CVRs.
What are the benefits of CVRs for Steinhoff?
CVRs have some positive aspects for Steinhoff as a company that is trying to avoid bankruptcy and regain trust from its stakeholders. Some of them are:
- Reduce upfront payment: By issuing CVRs to its creditors and shareholders, Steinhoff can reduce its upfront payment and preserve its cash flow. This can help Steinhoff to meet its short-term obligations and avoid default.
- Share risk with creditors and shareholders: By linking the payout of the CVRs to the future performance of its businesses, Steinhoff can share some of its risk with its creditors and shareholders. This can reduce Steinhoff’s liability and exposure to adverse outcomes.
- Align interests with creditors and shareholders: By offering a contingent benefit to its creditors and shareholders, Steinhoff can align their interests with its own. This can motivate Steinhoff to improve its operations and profitability, and incentivize its creditors and shareholders to support its recovery.
What are the challenges of CVRs for Steinhoff?
CVRs also have some negative aspects for Steinhoff as a company that is facing a lot of uncertainty and complexity in its operations and legal environment. Some of them are:
- Increase complexity and uncertainty: By creating and distributing CVRs to its creditors and shareholders, Steinhoff can increase the complexity and uncertainty of its financial structure. This can make it harder for Steinhoff to manage its debt, assets, and cash flow.
- Face litigation risks from creditors and shareholders: By promising a contingent payout to its creditors and shareholders, Steinhoff can face litigation risks from them. This can happen if there is any dispute or disagreement over the terms and conditions of the CVRs, or if there is any fraud or manipulation by any party involved.
- Incur tax implications from payouts: By paying out cash or shares to its creditors and shareholders through the CVRs, Steinhoff can incur tax implications from various jurisdictions. This can affect Steinhoff’s net income and cash flow.
Conclusion
In this article, we have explained what contingent value rights (CVRs) are, how they are used in mergers and acquisitions, and how they differ from other types of derivatives. We have also discussed the case of Steinhoff, a South African company that has been struggling with a massive debt burden and an accounting scandal. We have described how Steinhoff plans to use CVRs to restructure its debt and give its creditors and shareholders some hope for future value. We have also analyzed the benefits and challenges of CVRs for Steinhoff as a company and for you as a stakeholder.
We hope this article has helped you understand what CVRs are, how they work, and how they affect you. You should also be able to manage your risks and opportunities with CVRs, depending on whether they are transferable or non-transferable, and how they are valued and priced.
If you have any questions or need any guidance on cloud accounting solutions and virtual CFO services, please feel free to contact us at ThriveCFO. We are a virtual CFO consultancy for small and medium sized companies in South Africa. We offer monthly accounting services, virtual CFO, secretarial services, and cloud accounting solutions. We utilize cloud-based software to provide real-time financial data and make it easy for you to access your financial information at any time. We are here to help you thrive in your business.
