Business combinations (as defined by IFRS 3), the resulting goodwill and its subsequent potential impairment (impairment as defined by IAS 36) have repeatedly been the subject of public discussion on accounting in accordance with IFRS principles. With regard to financial instruments, we have outlined some of the core aspects in past articles in our newsletters (see for instance the article “Special considerations for financial instruments in business combinations”).

While a great deal has been written about business combinations and their accounting treatment in IFRS financial statements, the knowledge of what precedes these mergers is usually limited to a few experts. Quite interestingly, this is also the case for a frequently used vehicle to facilitate a business combination in the first place: the cash tender offer. As to such tender offers, the question to be addressed is whether they constitute derivatives or not. If the offer indeed represents a derivative, there may be relevant effects on earnings in the income statement (statement of profit and loss) and in relevant key figures (such as net debt ratio).

These values can be so substantial because a unilateral offer, which a tender offer often represents, may refer to a high subscription amount ( shares not yet acquired); and tender offers generally represent the substance of a conditional written option from an economic point of view. When valuing options, in addition to the intrinsic value (offer price less the unit value), the fair value is also relevant (here: the risk that the unit value will fall well below the offer price at the time the option is exercised). In line with classical theory, the fair value depends on the time remaining until the expiration date, the difference between the offer price and the unit's value as well as the volatility of the units.

Given that existing shareholders generally only accept a tender offer towards the end of an offer period and that the issue attracts speculators, this can lead to material fluctuations in the valuation parameters during a preceding cut-off date. As a consequence, the tender offer may take on relevant values which, should they be subject to subsequent valuation as a derivative, may also lead to relevant effects on earnings.

Since the design of tender offers is very varied, no decision tree can be provided at this point. It does, however, make sense to briefly outline the issues and arguments that are potentially relevant. The following considerations primarily relate only to tender offers for shares in companies that are not already fully consolidated in the company's own consolidated financial statements in accordance with IFRS 10 (in such event, there would be tender rights of non-controlling minorities; we have outlines this situation in a separate article: “Tender rights of non-controlling interests under IFRS – the hidden risk”).

Initially, it is questionable whether a derivative formally exists that must be valued as per the scope of IFRS 9. To this end, the tender offer must first involve a financial instrument. For this purpose, a financial liability is a contractual obligation (IAS 32.11) and, although contracts are defined fairly broadly under IAS 32.13, such a contract must be an agreement between two or more parties that entails an unavoidable obligation. This means that mandatory statutory offers, which the German Securities Acquisition and Takeover Act (WpÜG) provides for when for instance the 30% shareholding threshold is exceeded, can be excluded from the scope for derivatives, as the obligation is based on a statutory and not a contractual basis. In some tender offers, such as the takeover of a limited liability company (GmbH), a legal opinion should first be obtained to clarify whether the WpÜG and thus any statutory provisions apply. In the case of voluntary tender offers, the question arises as to what extent the existing shareholders were involved in the agreement. While bilateral agreements tend to give rise to contractual obligations, in the case of a voluntary tender offer to all existing shareholders the question is not so easy to answer and depends on the individual case. In this context it should be taken into account that any third party could also acquire shares and would then be entitled to such a tender offer. Bilateral agreements entailing a specific obligation are in any case contractual obligations in this regard and are thus also financial instruments.

The often raised objection that this is a conditional tender right (which would only apply if at least 50% of the shareholders agreed) and as such does not have to be accounted for as a pending contract is without merit. As a rule, contingent contracts can also be derivatives (e.g. options with a knock-in feature) and are also recognized at fair value through profit or loss even before the condition is met. However, for the exercised options, the fact that the minimum acceptance threshold will also result in control (within the meaning of IFRS 10) is existential if the acceptance period was reached before the reporting date but control has not yet been gained (i.e., the business combination has not yet taken place). At this date, a conditional forward on the acquisition of a business exists (within the meaning of IFRS 3) and, according to IFRS 9.2.1 (f), this is not to be recognized in the balance sheet using this standard and therefore not as a derivative.

Where a tender offer must be recognized as a derivative, it is worth taking a closer look at the initial measurement rules in IFRS 13.57 et seq. While in the initial valuation it is generally assumed that the transaction price corresponds to the fair value, this is not necessarily the case for a unilaterally issued right to third parties possibly at no cost. Simply put, although the tender offer is made free of charge, it always represents a value for the beneficiary and an obligation for the obligor. In addition, the acquirer will generally pay a premium (for example the control premium); the strike price is therefore higher than the purchase price of the acquired shares. These two factors result in a discrepancy between the transaction price and the financial value of the tender offer.

If the shares are not traded on active markets, the imputed fair value of the tender offer is deferred in the statement of financial position when the shares are initially recognized (in accordance with IFRS 9 B5.1.2A(b)). In such cases, the tender offer represents a financial liability (credit), which is subsequently compensated for in the first-time valuation by means of an accrual (debit). In the German profession's commentary on IFRS 13, these values can be reported in the same line item (IDW RS HFA 47.54). The deferral must be dissolved using a logically justifiable procedure, although it cannot be attributed. Depending on the duration of the offer period and the value trend of the tender offer, the derivative's accrual and fair value will not yet have changed significantly for this reason, which limits the problem in reporting the results. And in the balance sheet-oriented key figures, there is no or only a minor impact from the combined reporting. Here, however, it is worth briefly pointing out that the deferral is not part of the derivative's fair value (IFRS 13.30, IFRS 13. BC138) and the deferral may therefore not be included in the IFRS 7.25 disclosure. Moreover, the transaction must be presented in accordance with IFRS 7.28. So, at the very least, the value will become apparent in the notes disclosures.

Occasionally, a debate also arises as to whether these instruments have any value at all when exercised. Following such reasoning, the price of the shares will have adjusted to the offer price by the end of the tender offer period, although not by a preceding cut-off date (the intrinsic value is therefore zero, the fair value no longer exists at the end of the period), or no more than 50% of the shares would be tendered (the intrinsic value might be high, but the option expires on account of the minimum acceptance threshold). In the case of contracts whose offer price always corresponds to the unit value, it would also formally apply that they are not considered to be derivatives, as they do not have an underlying (IFRS 9.A, KPMG Insights into IFRS 17th Regrettably, such proof is theoretically obvious but has yet to be made in the literature. It is also conceivable that the market for the underlying asset will remain at a low level and the offer is still accepted, since all shareholders would like to accept the offer anyway. Given the current literature, such an argument currently remains too uncertain, if it can be made compelling at all.

Do not hesitate to contact us if you have any questions about transactions in this context. Should you be planning a significant tender offer in the near future, your reasoning should be on a firm footing and the accounting implications should be known in advance of a closing date. Please be especially aware that even slight variations in the circumstances of such transactions can have a completely different impact on the balance sheet.

Source: KPMG Corporate Treasury News, Edition 114, September 2021
Authors: Ralph Schilling, Partner, Finanz- und Treasury-Mangement, KPMG AG; Felix Wacker-Kijewski, Senior Manager, Finanz- und Treasury-Mangement, KPMG AG