Hong Kong Issuers Must Substantiate Basis of Consideration and Valuations with Quantitative Details

The Hong Kong Stock Exchange (HKEX) has issued a new guidance letter (HKEX-GL116-23) urging issuers to disclose sufficient details (with quantitative inputs and in specific terms) to substantiate how consideration of a notifiable transaction is arrived; and where consideration is primarily based on an independent valuation, key assumptions and valuation inputs must be disclosed.

In a recent review of issuers’ transaction circulars, HKEX said it found that disclosure in some cases was overly general and simplistic.

HKEX emphasised that it would not be sufficient to include merely qualitative or narrative statements without specific quantitative disclosures of the relevant figures. For example, a mere statement in the valuation report that comparable companies were selected on the basis that they were “mostly” or “mainly” engaged in certain businesses, without providing any quantitative benchmark, was unacceptable.

Below is a summary of the key disclosure requirement on business valuation set out in HKEX-GL116-23:

Valuation Approach Disclosure Requirement
Apply to any adopted approach	an explanation of why and how the use of the adopted approach is appropriate for the transaction being considered where more than one valuation approach is used, an analysis of the different values derived and how they contribute to the final appraised value
Valuation Assumptions Disclosure Requirement
Market approach	key inputs such as the financial information of the target (Target) and the pricing multiples details of the selection criteria for the market comparables (including quantitative benchmarks) and the bases for excluding those (if any) that meet the selection criteria details of the selected market comparables (their business and financial information) details of any adjustments made for differences between the Target and the market comparables
Income approach	the key, specific assumptions underlying the financial projections, in particular quantitative assumptions and the supporting rationale the key inputs (e.g., the discount rate and terminal growth rate) to the valuation an explanation of the computation process showing how the key inputs are applied to the financial projections to arrive at the base value of the Target a reconciliation of any difference between the final appraised value and the base value a sensitivity analysis
Cost approach	the quantitative inputs used to determine the gross current replacement or reproduction cost (GCR Cost) the amount of depreciation adjustment made to GCR Cost to account for the physical and economic obsolescence and any technical deficiency the computation process for the final depreciated replacement or reproduction cost
Asset-based approach	key quantitative inputs and assumptions used in the calculations of the appraised values for each asset and liability of the Target and the computation process an explanation of the material difference, if any, between the book values and appraised values

This latest advisory also provides guidance on disclosure in notifiable transactions where no independent valuation is disclosed. In essence, issuers are reminded to provide adequate and relevant disclosure (both quantitative and qualitative) of the underlying performance that is key to determination of the consideration.

Key takeaways:

Although the focus of this guidance letter appears to be on the disclosure of valuation in notifiable transaction circulars, same principles would equally apply to notifiable transaction announcements with valuations. As set out in HKEX’ Listed Issuer Regulation Newsletter (Issue 8 of June 2023) on ‘disclosure of business valuations in transactions’: where the valuation of a target company is a primary factor in forming the basis for the consideration or other material terms of a notifiable transaction, disclosure of the valuation would need to be made in the relevant announcement and circular. In other words, going forward, clear explanation on the selection of valuation approaches, and detailed and specific disclosures on major valuation assumptions and inputs should also be disclosed in the relevant transaction announcement.
In addition, even though this new guidance letter refers to notifiable transactions only, we expect that HKEX would also require similar stringent disclosure on valuations for connected transactions.