c/o Stolt-Nielsen M.S. Ltd
London WC2B 6TD
The Board of Directors
Enquiries to: Unni Persson Moseby
Dir. line. +47 22 93 97 22
Our reference: 13/8716
Finanstilsynet has reviewed certain aspects of the 2012 consolidated financial statements of Stolt-Nielsen Limited ("SNI"), see the Securities Trading Act section 15-1 subsection (3). Reference is made to previous correspondence in the matter, most recently Finanstilsynet's advance notification of decision of 13 February 2014 and SNI's response letter of 4 March 2014.
In 2012 SNI acquired a bulk-liquid storage terminal in the Netherlands (Moerdijk), a fuel and chemical storage terminal in the UK (Dagenham) and a turbot farm in Spain (Acuidoro). The cash consideration paid was USD 25.8 million for Moerdijk, USD 31.6 million for Dagenham and USD 27.5 million for Acuidoro. Post completion, SNI identified values in excess of purchase price for all three acquisitions, resulting in negative goodwill of USD 5.8, 4.8 and 6.5 million respectively. According to IFRS, the consideration paid in an orderly transaction will as a starting point represent the fair value of the businesses acquired.
In the 2012 financial statements, SNI recognised gains on the three bargain purchases, resulting in one-time income of USD 17.1 million. Finanstilsynet reviewed the three transactions and in the advance notification of decision, the company was requested to reassess the values of the fixed assets in the three business acquisitions. Following the advance notification, SNI reassessed the three acquisitions and reversed income of USD 12.3 million which are the entire gains for Moerdijk and Acuidoro. In Finanstilsynet's opinion the accounting treatment of these two transactions in the 2012 financial statements is not in accordance with IFRS 3 Business Combinations. With respect to Dagenham, the company concluded that reassessment of the transaction does not result in any material change to the gain and that the total gain on bargain purchase for this business acquisition is not material. Finanstilsynet notes the assessment of materiality and has no further comments.
In letter of 4 March 2014, SNI has stated that the effect of the reversed USD 12.3 million will be presented in the comparative 2012 financial statement in accordance with IAS 8, reducing the 2012 operating income by the said amount.
Other topics addressed in the review have been taken under advisement by Finanstilsynet.
A summary of the review relating to the three business acquisitions is presented in paragraph 2 below.
2. The three business acquisitions
In the 2012 financial statements, SNI recognised one-time acquisition-related gains of USD 17.1 million. The gains were meant to reflect the excess of fair value of net acquired assets over the consideration paid related to the three acquisitions. Note 34 to the financial statements provides information about the three acquisitions which are all described as bargain purchases. Information relating to the bargain purchases is also disclosed in a footnote to the consolidated income statement.
According to the company, even if each of the acquisitions had unique characteristics the reasons for bargain purchases were similar. The sellers wanted to dispose of non-core assets. Previous attempts to sell the businesses had not succeeded and the sellers were following a loss-avoidance strategy that reduced the transaction prices.
In Finanstilsynet's view, the accounting treatment of the acquisitions did not seem to be in accordance with IFRS 3 and the excess of fair value of net acquired assets over the consideration paid was mainly due to measurement errors. In the advance notice of decision, Finanstilsynet requested the company to reassess the values of fixed assets in the three business acquisitions, see IFRS 3.36, and take into account issues as described in paragraphs 2.2 to 2.5. The company has considered these issues when performing the reassessments of fixed assets.
2.2 Impact of expected expenditures on the fair value of net assets acquired
Knowledge of future investments required to sustain current operations and cash flows, was an element in all the negotiations which resulted in a price reduction. The purchase price allocations (PPAs) carried out subsequent to the transactions, valued the assets in existence at the acquisition date in their current state based on reproduction and/or replacement cost, not taking into account expected future capital expenditures mentioned above. The values of the assets as assessed in the PPAs are higher than the price paid in the transactions. According to SNI, any market participant would have considered these capital expenditures when pricing the businesses. The investments are required to sustain the current operations at the existing capacity. As no capital expenditure was committed at the acquisition date, SNI has argued that these should not be considered in the PPAs, resulting in bargain purchases.
In Finanstilsynet's opinion the excesses identified are not gains derived from bargain purchases. Fair value of the assets includes expectations of future cash flows and reflects assets' current status and level of performance. Another market participant would have to carry out similar investments to be able to sustain the current operations, and would consequently take these costs into account when calculating the assets' discounted net present value; see IFRS 13 BC39. Expectations of future expenses will depress the price an acquirer is willing to pay and consequently the net fair value of the assets.
SNI has argued that future capital expenditures are liabilities which cannot be recognised in the balance sheet as these investments do not satisfy the recognition criteria in IFRS 3. Considering a market participant's expected capital expenditure that is required to sustain the operations and capacity, is, however, not a matter of recognising liabilities. Rather, this represents assumptions that must be included when measuring the fair value of the assets in a business combination.
2.3 The appraised value of fixed assets should take into account economic obsolescence
SNI has received external valuations for fixed assets and land. These valuations are based on replacement costs and /or reproduction costs. Using cost approaches when valuing assets reflects the amount that would be required currently to replace the service capacity of an asset. Cost approaches are based on the cost for a market participant buyer to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence; see IFRS 13 B8 an B9.
In only one of the business acquisitions the appraised value of fixed assets has been reduced by an economic obsolescence factor. In Finanstilsynet's view economic obsolescence should be taken into account for all three acquisitions. The acquired businesses face environmental and other regulation that requires investments to be made with little or no return. One of the businesses was acquired based on high growth expectation. However, the recession has reduced the market and the expected growth has not materialized. Reduced demand for a company's product is an attribute for economic obsolescence in an industry or for an entity. Generally, a buyer would not be willing to pay more than the present value of the cash flows that the fixed assets can generate and the appraised replacement costs shall be adjusted to reflect this.
2.4 Fair value; observable transaction price versus appraised value
Even if they are carried out as business combinations, the three acquisitions are mainly investments in fixed tangible assets. In two of the acquisitions no positive value has been identified related to customer contracts, customer relationships, brand name or workforce. In the acquisition of Dagenham values regarding customer relationships were identified, in addition to the fixed assets.
According to IFRS 3.18 an acquirer shall measure identifiable assets acquired and liabilities assumed at their acquisition date fair values. The wording of the definition of fair value has changed with the introduction of IFRS 13. The definition in Appendix A to IFRS 3 now reads: "Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." An orderly transaction is defined in IFRS 13 Appendix A, as: "A transaction that assumes exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction (eg a forced liquidation or distress sale)". 1
Based on the information Finanstilsynet has reviewed, there are no indications that the acquisitions were not orderly. There were no forced transactions and the transactions were all exposed to the market for a period of time. The transaction price for the fixed assets is, in Finanstilsynet's view, the best evidence of fair value.
When establishing fair value it is a presumption that observable transaction prices have priority over appraisals performed in connection to the transactions. This understanding is confirmed in IFRS 13 through the introduction of the fair value hierarchy.
According to SNI, the businesses were acquired on favourable terms for amounts less than expected. However, the fact that the acquisitions were favourable does not necessarily mean that the transaction price is not fair value. A seller will generally not knowingly and willingly sell an asset below its fair value.
In support of the bargain purchases, SNI has argued that there were no other market participants and hence, almost no competition for the target companies. The IASB has concluded that market inactivity is not an indicator that the transaction price may not represent fair value, but an indicator that the entity should do further work to determine whether the transaction price represents fair value; see IFRS 13 BC134. A company should consider both strategic and financial buyers when determining potential market participants for purposes of measuring the fair value of assets and liabilities.
According to the annual report, one reason for the acquisition- related gains was that SNI would be able to realise higher benefits than the sellers due to SNI's large customer base and its operational knowledge. An acquirer shall measure an asset at fair value determined in accordance with the asset's use by market participants; see IFRS 3 B43. Due to the fact that the fair value is set from a market participant's perspective, a company's assessment of future positive effects and own use cannot explain a bargain purchase. The company has during the review clarified to Finanstilsynet that no entity-specific synergies were taken into account.
2.5 Reassessment including a test of reasonableness of the valuation methods applied
The company performed a reassessment of the PPAs and the identification of assets and liabilities. This was an iterative process involving advisors, auditors and management from the operating businesses before the final report was prepared. The appraised fixed assets as such were not reassessed.
The use of independent valuation experts is viewed by the IASB as mitigating the risk of measurement errors resulting in recognition of a gain; see IFRS 3 BC375. However, applying traditional valuation approaches without considering the actual ability of the asset to generate the requisite cash flows can result in recognition of an unwarranted gain. The use of independent valuations experts does not relieve management of its responsibility to ensure the appropriateness of the valuation techniques applied and the underlying inputs and assumptions used to estimate fair value. The reassessment should include a test of reasonableness of the entire transaction, including the appraisals of fixed assets.
Finanstilsynet has requested SNI to reassess the values of fixed assets in the three business acquisitions, see IFRS 3.36, and take into account specific issues.
Finanstilsynet has pointed out that expected capital expenditure that any market participants would take into consideration and that is required to sustain current operations and capacity must be included when measuring the fair value of the fixed assets. Furthermore, it is Finanstilsynet's opinion that a buyer would not be willing to pay more than the present value of the cash flows that the fixed assets can generate and that the appraised replacement cost shall be adjusted to reflect economic obsolescence. The transaction price for fixed assets obtained in an orderly transaction is the best evidence of fair value.
SNI has performed reassessments for the three acquisitions and has reversed the entire gain on bargain purchase for two of them. With respect to the third one, the company has concluded that the reassessment of the transaction has not resulted in any material change to the gain. In SNI's opinion the total gain on bargain purchase for this business acquisition is not material and Finanstilsynet notes this for the record.
Finanstilsynet has not considered whether the above matters are subject to the securities legislation's rules governing the requirement to disclose inside information according to the Securities Trading Act section 5-2 subsection (1), cf. section 3-2, and requests the issuer to consider if this is the case.
Finanstilsynet has forwarded a copy of this letter to the issuer's appointed auditor and to Oslo Børs.
On behalf of Finanstilsynet
Head of Section
Unni Persson Moseby
1 In Finanstilsynet's view there is no significant difference between the definition of fair value in IFRS 3 prior and after the introduction of IFRS 13.