Companies - valuation

[2024]JRC117

Royal Court

(Samedi)

17 May 2024

Before     :

A. R. Binnington, Esq., Commissioner, and Jurats Ronge and Christensen

 

Advocate R. S. Christie for the Plaintiff.

Advocate M. O’Connell for the Second Defendant.

judgment

the COMMISSIONER:

Background

1.        On 19 July 2023, we gave judgment in favour of the Plaintiff, following a five week hearing, in respect of his claim brought pursuant to Article 141(1) of the Companies (Jersey) Law 1991 (“the Law”) that the affairs of the First Defendant had been conducted in a manner which was unfairly prejudicial to his interests in it (Pender v GGH (Jersey) Limited and Ors [2023] JRC 124).

2.        During the course of that hearing we heard evidence from, inter alios, two expert witnesses, namely Mr Amit Arora for the Plaintiff and Mr Paul Cliff for the Second Defendant (together “the Experts”).

3.        We ordered that:

(i)        The Plaintiff’s 100,000 A Preference shares shall be transferred to the Second Defendant in return for the withdrawal of the counterclaim.

(ii)       The Plaintiff’s 1 Waterfall Protection Payment Share shall be purchased from him by PSG and that PSG pay to him the sum equal to the fair value of his former holding of 1,800,000 Ordinary Shares in the capital of the First Defendant which is to be valued on the basis that it represents 18% of the issued Ordinary Shares, at a price to be determined following further advice from Mr Arora and Mr Cliff, making allowance for the reversal of the effects of the acts of unfair prejudice committed by the Defendants in accordance with the guidelines set out in the judgment.

(iii)      Mr Arora and Mr Cliff should seek to agree the valuation of the Plaintiff’s shares using the valuation methodology set out in the judgment and that they should provide their agreed valuation to the Court within 12 weeks failing which they should submit to the Court their respective conclusions identifying those points upon which they agree and disagree.

(iv)      Upon the Court ruling as to the appropriate purchase price the purchase of the Plaintiff’s shares shall be completed within four weeks of the Court's order.

The law

4.        It is to be noted that in a case such as the present the Court may take a flexible attitude to valuation and has to an extent already done so in identifying counter-factuals in its earlier judgment.  As Arden LJ said in Re Tobian Properties [2013] 2 BCLC 567:

“An order for the purchase of the non-controlling shareholder’s shares by the respondents to the petition is commonly called a ‘buyout order’. It effects a divorce of the parties’ interests in the company. For the purpose of establishing the price payable under a buyout order, the courts have adopted a flexible attitude to share valuation. Notably, actual share values can be adjusted to reflect the effect on the company of all or any wrongs which the wrongdoer respondents have committed against it.”

5.        Some of the guiding principles were identified in Financial Technology Ventures II (Q) LP and Ors v ETFS Capital Limited and Tuckwell [2021] JCA 176, at paragraph 26, where the Jersey Court of Appeal summarised the Royal Court's approach to valuation (ultimately with approval) as follows:

"(i) the object of any valuation under Article 143 is to achieve a fair outcome which is proportionate to the unfair prejudice which a plaintiff has suffered;

…

(iv) the valuation exercise did not involve a hypothetical sale in the open market, nor did it involve a sale by an unwilling vendor: it involves valuing a minority holding which was held by a shareholder who was keen to sell (albeit only at what he regarded as the right price);

(v) the purchaser was neither unwilling nor was he a speculative, incoming investor, but rather was the existing majority shareholder whose purchase of the shares would enhance his control over the Company;

…

(xii) the prejudice suffered by the Plaintiffs in this case was "ultimately, that the value of their shares has been suppressed, one way or another…".”

The valuation approach to be applied

6.        The valuation approach adopted by Mr Arora and which we directed the experts to follow in our earlier judgment, was what he described as a ‘venture capital’ approach, being a hybrid Income and Market approach.  He said that it was broadly based on a modified Discounted Cash Flow, the methodology being described in the following terms:

(i)        estimated expected earnings or revenues over a short (maybe 2 or 3 years) to mid-term period (approximately 5 years), often matching the point at which a venture capitalist might be assumed to exit the investment;

(ii)       the terminal value is calculated by using an exit multiple applied to earnings, the multiple being assessed using the Market Approach;

(iii)      discount the cash flows using a “venture capital” rate of return that is sufficiently high to capture the risk in the business, the possibility that the business will not survive and the illiquidity in these types of business; and

(iv)     the resultant valuation is a “post-money” valuation in that it is based on forecasts that may assume an investment is made. The “pre-money” valuation is calculated by deducting the assumed investment.

The valuation hearing

7.        Pursuant to the order that we made in August 2023 we heard further evidence, at a four-day hearing which commenced on 4 December 2023, which included evidence from the Experts. The Experts had filed further reports, pursuant to our Order, being Mr Arora’s Third Report and Mr Cliff’s Second Supplemental Report. In addition, the Experts had filed a joint statement, being their Second Joint Statement, which identified those areas upon which they agreed and disagreed. It had not proved possible for the Experts to agree on a valuation of the Plaintiff’s interest in the First Defendant (“the Company”), Mr Arora valuing it at between £44.6 million and £59.6 million and Mr Cliff valuing it at between £0 and £4.1 million. As we noted in our judgment of 19 July 2023 the Company is a holding company in respect of entities conducting a business variously referred to as the Guardian Business or the Gryphon Business.

8.        Although both Experts had prepared their valuations according to the methodology that we had ordered, the substantial difference between them in terms of their valuations arose as a result of different inputs that they had made in key areas of their calculations.

9.        These were identified by Advocate Christie in his closing submissions as the following:

(i)        Choice of model

(ii)       Sales APE profile

(iii)      Expenses profile

(iv)     Adjustment to IFRS/BE ratio

(v)      Exit multiple

(vi)     Exit year

(vii)     Discount rate

(viii)    SFA advance commission

(ix)      Debt

(x)      Yield curve

10.     We shall deal with each of these in turn. In doing so, we are reminded of a passage in Chapter 1 of a book by Henrik Liesen entitled “Starting a business in the Life Sciences – from Idea to Market” to which we were referred during the hearing, in which the author says:

“Valuing early-stage, high-growth companies has always been an exercise fraught with immense difficulties due to the high uncertainty levels inherent in those situations.”

And continues some paragraphs below:

“The value of a company lies mainly in its ability to generate economic profits in the future.  As such, all valuation exercise is based on ‘visioning’ the future, rather than simply measuring the present situation.  Value is grounded in the future, which means assumptions have to be made as to what that future may look like and what important strategic decisions will need to be made and when. … An Intrinsic part of the visioning process is thus the ability to question the fundamental hypotheses and the company’s ability to deliver on the promises.”

Choice of model

11.     For the purposes of its financial modelling the Company used an Excel spreadsheet known as FM Lite.  We were told by the CEO of the Company, Ms MacLean, and by the former CFO, Mr Gibson, that the version of the model that had been used for the 2023 budget and approved by the board in March 2023 was a version known as FM Lite v2.3. That version had been used by Mr Cliff for the purposes of his Second Supplemental Report and had initially been used also by Mr Arora. However, Mr Arora subsequently discovered that there was what appeared to him to be a more up to date model, known as FM Lite v2.5. In her Fourth Affirmation, Ms McLean explained that FM Lite v2.5 was “a partially updated model created for the narrow purpose of checking whether or not a new product (income protection) would impact the short-term cash position such that we would need to accelerate the usual review/approval cycle”. She said that the model was never finished or approved for any formal use, adding:

“As such, it remains my view that FM Lite v2.5 is an incomplete and unapproved model. FM Lite v2.4, v2.6 and v2.7 are similarly partially updated and unapproved models. FM Lite v2.8 is the current version of the model that is being updated comprehensively and will form the basis of the numbers submitted to the Board for approval on 5 December as part of our usual review/approval cycle. The version number changes every time the functionality of the modelling changes (for example, a new product, or a change to the spreadsheet layout). Changes to input data, for example, new yield curves each month or a change to sales assumptions do not change the version number but are made within the model.”

12.     Mr Arora explained in his Third Report that prior to identifying FM Lite v2.5 through his own review and it being provided subsequently on 28 September 2023, he had understood that FM Lite v2.3 was the latest model. He had noted that FM Lite v2.3 was described as supporting the Board Plan Forecast, but FM Lite v2.3 actually had different EBITDA to the Board Plan Forecast as the Board Plan Forecast had a lower expense profile (and therefore generated higher EBITDA). He noted that Ms MacLean had described the Board Approved Plan model, in her Third Affirmation dated 27 July 2023, as continuing to be the most appropriate forecast and that she had stated that:

“The 5-year plan contained in the March Board pack, plus the supporting spreadsheets behind it, therefore continues to be the most appropriate forecast.”

13.     However, in Mr Arora’s view, the existence of a later-dated (FM Lite v2.5) model raised the issue as to whether FM Lite v2.3 had become outdated and therefore might no longer represent a reasonable estimate of future performance as at the Valuation Date.

14.     Mr Arora noted that the FM Lite v2.5 model included some limited detail describing changes made compared to prior iterations of the FM Lite model. However, he had not been provided with any other commentary to describe the changes or rationale behind preparing the updated model.

15.     He also noted that in a response to a query raised by his instructing advocate the Second Defendant’s lawyers had stated:

“Our understanding from Guardian’s management is that there are multiple copies of what is essentially the same FM Lite v2.3 30 YR forecast used by Guardian’s management in their day to day running of the business but the forecast has not changed from that disclosed to you on 14 July.”

16.     Mr Arora said that he was not clear as to what was meant by this response since it appeared to him that the FM Lite v2.5 was prepared after the last iteration of the FM Lite v2.3 and that FM Lite v2.5 was last modified on 18 July 2023. He suggested that it would not be uncommon for a specific model to underpin a budget and then for management to continue to track against the budget that was set at the start of the year. In that sense an older model may continue to be referred to in the day to day running of the business. However, that model may not be the appropriate one on which to base a valuation at a subsequent date.

17.     He therefore proposed to use the data available to him to consider whether the FM Lite v2.5 represented a superseded version of FM Lite v2.3, or not, for the purposes of his analysis.

18.     Mr Arora noted that the main similarities and differences between FM Lite v2.3 and FM Lite v2.5 were:

(i)        the APE was the same;

(ii)       the expenses were the same;

(iii)      the yield curve in FM Lite v2.5 was updated to reflect a more recently published yield curve of 31 December 2022;

(iv)     the unit economics were different between the models. The associated modelling was also more sophisticated to accommodate the greater complexity in the FM Lite v2.5 unit economics;

(v)      the IFRS/BE ratio input had changed in FM Lite v2.5 to revert to an assumption that was more consistent with inputs in previous FM Lite models; and

(vi)     the SFA debt repayment period had been shortened to 1.53 years, as opposed to the 10-year repayment period in the FM Lite v2.3 model.

19.     Mr Arora concluded that assumptions other than unit economics were either the same between FM Lite v2.3 and FM Lite v2.5, or inputs that were more easily adjusted by the user; whilst FM Lite v2.3 appeared to have unit economics that were superseded by v2.5. Therefore, he considered it more appropriate to focus on FM Lite v2.5 rather than FM Lite v2.3.

20.     It appeared from the evidence given by Ms MacLean that the Company recognised that the FM Lite model in general had deficiencies in relation to long-term forecasting, but as they used it primarily for short-term forecasting this was of little concern to them. In the FM Lite model the current business mix unit economics were modelled for each and every future year in the same way, showing no improvement. Thus, in an email from the Actuarial Director of the Company, Nischal Singh, dated 17 August 2023, in answer to a comment that “FM Lite model appears to assume constant unit economics despite a changing business mix", Mr Singh responded "Any modelling will include limitations, and this is one of them for FM Lite. For ease of modelling, FM Lite was developed with replicating unit economics”.

21.     Concerns were expressed by the Plaintiff as to what appeared to be a persistent model error in the way that the FM Lite models operated. The EBITDA which they report in relation to current year, based on actual inputs or near to actual inputs, does not reflect (by a very considerable margin) the actual EBITDA which is being reported by the Company. The FM Lite models appear to report EBITDA at a significant negative variance to the figures reported by the Company, this being demonstrated by Mr Arora in his Third Report at section 8.2 and Table 8.1.

22.     Mr Arora had highlighted this in his First Report when considering the Company’s EVA metric (which is a measure of the future value of all business written to-date). He said (at paragraph- 7.2.34):

“I understand from the mechanics of the models that EVA will generally increase as new profitable business is written and becomes in-force and as the actuaries’ view on the profitability of business already written. In the Sep 2020 Model, the forecast for March 2021 was negative at approximately -£4 million and it was estimated to turn positive in December 2021. Actual results show a much-improved position with the recent March results showing that EVA turned positive in November 2020 and was positive +£4.4 million as at March 2021.”

23.     The Plaintiff argued that there were two main valuation consequences resulting from this persistent model error. First, it had a negative impact on the EBITDA in the terminal year, compared to actual experience, which in this valuation methodology when multiplied through by the EBITDA multiple, would result in what appeared to be a very significant undervalue as against the EBITDA which is likely to be achieved in the exit year and therefore as against the Enterprise Value at exit. Second, because the value of the In-Force book is underestimated in the intervening years prior to the terminal year, the cash position in the model appeared to be lower than would actually be achieved based on the Advance Commission that would be paid by SFA. This underestimates the cashflows of the Company in the years before exit and therefore impacts the valuation of those cashflows prior to the 2027 terminal value.

24.     When this was put to Mr Gibson, he suggested that it might be down to the margins in 2023, and the fact that the margins had been significantly more positive than were expected.

25.     When this was put to Ms MacLean, she also suggested that it was down to the difference in margins but when the margins in FM Lite were demonstrated to her, she was unable to give any explanation on the point. She did however accept that what was alleged to be a lack of concern on her part, was because the Company did not produce the model for the purpose of valuing the shares, but rather to assist in calculating the financial impact on the Company of changes to the pricing of its products, to the Company’s sales and expenses and to economic inputs, such as inflation and interest rates.

26.     Mr Cliff selected FM Lite v2.3 for the simple reason that he was instructed that this was the latest complete model, approved and in use by the business as at the Valuation Date. Ms MacLean described FM Lite v2.5 as “very much an interim working version". Ms MacLean further noted that v2.5 and v2.6 represented Guardian's "early thinking around what is now our end of year plan… [which] will be adopted this afternoon, unless the board rejects it”.

27.     The 2024 business plan (based on FM Lite v2.8) was approved by the Board on 5 December 2023 as described in Ms MacLean's Fifth Affirmation, which was filed after the hearing. As such, FM Lite v2.8 would appear to be the latest complete and approved model by the Company.

28.     FM Lite v2.8 has not been disclosed to or reviewed by the experts. However, at paragraphs 44 and 45 of their Closing Submissions, the Second Defendant suggests that ordering the use of v2.8 would allow both experts to set aside the debate about the issues inherent in both v2.3 and v2.5 (namely that they are both out of date and do not take into account, for example, Guardian's outperformance in H1 2023, and the delay to launching the "Life Essentials" product, and additionally, that v2.5 is incomplete) and work from the latest, fully worked-through and completed model, which has been approved by the Company for use and reliance in the ordinary running of the business. The Second Defendant suggests that doing so would allow the Court to have confidence that the base model in use by the experts contains the most up-to-date view of the Company as to its actual performance in 2023, and likely performance in subsequent years, and most particularly 2027 and 2028.

29.     In relation to the importance of using the most up to date information Mr Arora said, at item 38 of the 2nd Joint Statement: “Mr Arora considers that whilst the FM Lite v2.3 was the model which supported the Board Plan Forecast, (albeit with different assumptions regarding expenses), FM Lite v2.5 appears to be the more up to date model. He considers it appropriate to adopt the most up to date forecast as at the 2023 Valuation Date, rather than the model that was used to set the forecasts for the year in progress at the start of the year.”

30.     In Paragraphs 20 and 22 of the Plaintiff’s Closing Submissions, in which Advocate Christie was urging the use of v2.5 rather than v2.3, he said:

“(at paragraph 20) It is submitted that the Court should prefer FM Lite 2.5. It was a clear update from FM Lite 2.3 to include the unit economics for Income Protection. FM Lite 2.3 had unit economics from June 2022; this was a 2023 update. Given that Income Protection is a highly profitable product, it is not surprising that this appears to have improved the unit economics slightly. Both Mr Gibson and Ms MacLean were cross-examined on this at some length. It was difficult to discern any reasonable basis on which they opposed the use of FM Lite 2.5. Their attitude appears to have been that it was not the official model adopted by the Company, so it should not be used. That is not consistent; the September Reforecast version of FM Lite 2.2 was also not the official model adopted by the Company last year at the time of trial, yet Mr Gibson and Ms MacLean both defended the use of it….…(at paragraph 22) Any expert doing the best he can ( despite the limitations) should therefore want the latest unit economics.”

31.     In his Closing Submissions, Advocate Christie referred to a number of possible ways in which the Court could deal with the modelling errors in FM Lite, in particular in relation to the valuing of the in-force book. These were:

(i)        The Court could order the Company to produce a new model with unit economics which accurately reflect the actuals which the Company is reporting. However, he suggested that this would run the risk of delay in achieving a final result and potentially lead to further hearings to resolve any difficulty which arises. He submitted that this was therefore not the preferable option.

(ii)       The Court could apply a £4 million uplift to the EBITDA in each year, on the assumption that the error is absolute in size and not relative to the size of the sales in each year. He accepted that this adjustment could potentially underestimate the effect of the model error in the exit year by a considerable margin but may be the best that the Court can do on a “rough and ready basis”.

(iii)      Alternatively, based on a table set out in his Closing submissions, the Court could apply a 120% uplift to the FM Lite 2.5 change in EVA (change in value of the in-force book) for the exit year. He suggested that to be precise, the uplift to EBITDA for inclusion in the terminal value would be the difference between 120% of the end year 2027 EVA and 120% of the end year 2026 EVA, compared to the difference between the unadjusted end year 2027 EVA and the unadjusted end year 2026 EVA. The advantage of this approach was, he suggested, that it directly targets the known model error driven in the EVA exactly and the adjustment can be made easily.

(iv)     Finally, he submitted that if the Court did not feel that it could apply any mechanical adjustment, then any concern it should have on this point should lead to it leaning in favour of the Plaintiff's submissions in any other areas where there is a marginal decision to be made. One directly comparable issue, he suggested, was the IFRS/BE ratio. The Company is currently modelling the EVA (in-force book) in a way which due to a model error depresses the value of any change in it by 20%, and then applying a further margin which depresses it by a further 26% (on an 80% ratio which becomes 74% effective by 2027). He suggested that the Court might take the view that if the model is already undercalculating the value of the in-force book, then no further IFRS/BE ratio/margin should be applied.

32.     Unfortunately, none of the Plaintiff’s suggestions actually address the fact that the figures derived from the models (all versions) appear to differ significantly (and always negatively) from the actual performance of the Company. The problem appears to lie more with the way in which the model works rather than with the individual inputs. The same may be said of Mr Cliff’s continued reliance on FM Lite v2.3. In the circumstances we believe that it would be appropriate for the Experts to use the latest approved model, being FM Lite v2.8.  As stated in our judgment of 3 August 2023, in relation to events taking place between 19 July 2023 and 29 September 2023, the Experts may take into account any information made available between those dates but only to the extent that it relates to the Company’s performance up to 19 July 2023.  However, we would expect the modelling error in relation to the EBITDA and value of the in-force book identified by Mr Arora to be addressed, if it has not already been, before any reliance is placed upon it. Given that it was highlighted to both Mr Gibson and Ms MacLean at the hearing, and noting Ms MacLean’s response that “If we were to find an error in the model, then we would of course track through to see whether everywhere that had an impact in the model”, we would expect the Company, as a neutral party, to take urgent steps to identify and rectify the issue, if it has not already done so. We appreciate that this will involve some further delay, but we believe that if we are addressing changes in the inputs then if there are errors in the model they should also be addressed.

Sales APE profile

33.     In section 6.1 of his Third Report, Mr Arora considered adjustments to sales that he regarded as necessary to be made to the valuation model in order to make the modelled output of forecasts reflect more up to date parameters as at the Valuation Date.

34.     Mr Arora had noted that APE (Annual Premium Equivalent) sales in YTD 2023 had been ahead of budget in all months, despite delays in the launch of a new product. In other words, had that product been released on time, then, in his view, the Company would have been further ahead of budget. Additionally, he pointed out that Ms MacLean’s expectations were that 2023 sales targets would be met despite another delay to the launch of a new product, the Life Essentials product, in spite of the potential for a market slow down. The level of sales APE outperformance by year end, on an underlying basis, could be estimated by reference to the level of budget sales once adjusted for the delays. The historical underlying outperformance might be expected to continue in future periods. To reflect this, Mr Arora suggested that an uplift to APE sales in the forecast could be applied. However, he acknowledged that the delays to the product releases in the current year would result in no outperformance in 2023 and so did not make an adjustment to 2023 APE sales. He considered that an uplift could be made to the subsequent period through to 2026. He did not adjust 2027, because the APE sales forecast was consistent with a longer-term expectation that had been unchanged for an extended period. He accepted that there was a risk that projects could be delayed further which would lower the APE outperformance. This type of risk was, he suggested, typical for businesses at the Venture Capital stage and was therefore already incorporated within the discount rate assessment. Further, he noted that the latest forecast was based on a release timeline of new products that has been extended compared to the expectations in Q2 2022.

35.     Mr Arora therefore introduced two scenarios to reflect these options for adjusting sales:

(i)        Scenario 1: FM Lite v2.5 APE sales with no adjustment; and

(ii)       Scenario 2: FM Lite v2.5 APE sales with a 12.7% increase between 2024 and 2026.

36.     In the Second Joint Statement, Mr Cliff said that he considered that Scenario 2 represented a reasonable alternative scenario. However, in his evidence in chief he suggested that perhaps the increase “could be tempered somewhat”. He based this on the impact of new product launches, the Company having delayed the Life Essentials product twice already and also on the delay in the income protection product. He suggested that a reasonable investor would look at that as a risk and “build in a little bit of extra caution”.  Nevertheless, he accepted that an upward adjustment to sales was still appropriate but that he might want to build in some additional risk from a slower than expected ramp-up, and possibly some delay.

37.     It was put to Ms MacLean in cross-examination that despite the Company still beating its budget considerably, setting aside delays in launching new products, she was supporting a downgrade in sales forecasts for 2027.

38.     Ms MacLean said that there were three major changes:

(i)        At the hearing in December 2023, one could predict with greater accuracy where the 2023 numbers were likely to finish. She was predicting them to finish at £19.2 million, slightly below the £20 million that was being forecast before.

(ii)       There had been a delay in launching the Life Essentials product.

(iii)      They had now built a bottom-up sales plan and arrived at a number of £33 million, which was a little lower than the £35 million that was in the previous forecast.

39.     She said that the 2025 and 2026 numbers were relatively similar to where they were before, but she had taken out the assumption of market growth in 2027 and was now assuming 5% growth per annum through the period of the plan whereas they had previously been suggesting 26% growth for 2027. She said that what had happened in 2027 was a change in assumptions of market growth.

40.     Mr Gibson was asked about a reforecast that he had been asked by PSG to carry out in September 2022.  This had been requested on a call with Jonathan Punter, who had asked for a reforecast which reflected “the current economic conditions”. It was put to him that that piece of work was now more or less the sales plan in FM Lite 2.3, to which he replied “The sales figures have come out the same, yes”.

41.     It was put to Mr Gibson that it had been suggested to him at the first trial that the sales underperformance at that time was being blamed on the market, but that in fact it appeared quite likely to be heavily influenced by a large shortfall in the sales team, which was more or less up to strength by the time of trial. When it was put to him that what had been seen in 2023 was significant outperformance on sales, he accepted that the sales figure had outperformed but suggested that this was at a significantly low margin. It was put to him that his forecasts had simply not been accurate and that the market had clearly been growing at a greater rate than he had been prepared to recognise. Mr Gibson accepted that it had been “on the margins” but maintained that the sales plan for 2023 had still been a reasonable one.

42.     In a detailed review, in cross-examination, of Mr Gibson's forecasts, it became clear that a document produced by Mr Gibson which was intended to justify sales APE forecasts involving different "accessible markets" and market shares had the same sales APE as the September Reforecast and had numbers (such as market share percentages) which appeared to have been reverse engineered to produce those same sales APE forecasts. These percentages were revealed, when clicking on the cells in the spreadsheet, not to be the whole numbers as first appeared, but to have numerous decimal places and patterns from year to year which were often inconsistent and had a hidden column labelled "STILL DOES NOT WORK".

43.     The Court was left with the distinct impression that both Ms MacLean and Mr Gibson were seeking to minimise the likely growth of the Company’s Sales APE.  It appeared that Mr Gibson had in effect ‘reverse engineered’ the spreadsheet to justify a pre-determined forecast for Sales APE; whilst Ms MacLean’s evidence seeking to justify the revised forecasts for 2027, was far from convincing, using a 5% year-on-year market growth figure that led to a 27%+ reduction to their previous forecast of 2027 Sales APE, from £110 million to £80 million.

44.     In the light of our concerns, we take the view that the valuation should be concluded on the basis of Mr Arora’s Scenario 2 (which was indirectly based on the Company’s forecasts from September 2022, adjusted by a 12.7% increase to reflect the outperformance in sales in 2023); in other words, with Sales APE in 2027 of £111 million. Whilst we note that Mr Cliff suggested a greater degree of caution we nevertheless regard Mr Arora’s approach as an appropriate one.

Expenses profile

45.     There are three key elements to this issue:

(i)        The steps that have already been taken by the Company, along with steps that it might take in future, to cut expenditure. For example:

(ii)       The level of charges levied by PSG against the Company for providing services from PSG’s Central Business Unit (the ‘CBU charges’); and

(iii)      The extent to which the Company has factored possible expense savings into its FM Lite models.

46.     The parties agreed that the starting point was the Board Plan and that the Board Plan Expenses should be used in preference to those in FM Lite v2.3.

47.     The Plaintiff submitted that there should be a reduction in the base expenses, but this was a difficult issue because of the lack of reliable information from the Company.

48.     Shortly before the hearing the Plaintiff learnt that in June 2023 Craven Street Capital (“CSC”) had been commissioned to review the Company’s expenses. When cross-examined Ms MacLean explained that this was “an exercise to see whether we could get Guardian into the position where it no longer needed to draw down additional investment.  So, to get ourselves into a cash neutral position, effectively, on the basis that that would make the company appear more valuable to certain types of potential investors”.

49.     This CSC analysis in relation to expenses had not previously been mentioned to the Plaintiff and the relevant documents were not disclosed until 17 November 2023.

50.     The Plaintiff submitted that the CSC process clearly demonstrated that the Company was considering cutting a number of costs in June 2023, despite Ms MacLean having stated in her Third Affirmation of 27 July 2023 that the expenses budget was the right figure, and that there was a positive personnel variance but that was unlikely to last.

51.     In her Fourth Affirmation of 28 November 2023, Ms MacLean suggested that expenses for 2024 would be "broadly similar but slightly lower than previously forecasted" but only "because sales are expected to be lower so the direct costs associated with sales are expected to be reduced. Otherwise, the costs are in line with previous expectations". She also said that "Looking beyond 2024… expenses are expected to be broadly similar to previously forecast". There was no comment on or mention of the CSC documents.

52.     When cross-examined, Ms MacLean was referred to part of the CSC report which referred to charges made to the Company by PSG in relation to the provision of central services, and she explained that “As is quite normal in any business that I have worked for, there are recharges which are made from central functions within a group of companies, and what is shown on this page here are the recharges that we are given by Punter Southall Group for the functions that they provide from central teams. What Craven Street were suggesting here is that there could be savings to those functions, either by using external services rather than Punter Southall services, or by, I assume, reducing costs within the central functions themselves”.

53.     What became clear in further cross-examination was that in fact, significant expenses savings had been adopted, and having been £898,000 below budget on personnel and £148,688 below budget on expenses generally as at the end of June 2023, and then £1 million below budget on personnel and £403,300 below budget on expenses generally at the end of July 2023, the Company was £1,566,941 below budget on personnel and £875,105 below budget on expenses generally at the end of October 2023.  Ms MacLean addressed the CSC exercise for the first time in her oral evidence. In her examination in chief, she summarised the expenses cuts to be made to the 2024 budget. She commented on the following potential savings by reference to the CSC document, stating that the Company "have done a bottom-up review of our staffing requirements for 2024, and we will have made some savings there, unlikely to be the extent that's in there". There was no explanation of why this was unlikely, when the Company was already £1.57 million below budget in relation to personnel in October 2023. In relation to technology, where CSC had suggested a £882,000 saving, Ms MacLean said that "Technology, we are in renegotiation with our technology suppliers and very close to achieving some of those gains”.  In relation to facilities management where CSC suggested £120,000 savings, she said "I couldn't answer for the details of that one, I'm afraid. That's a relatively small number".

54.     One area on which Mr Cliff placed considerable importance was the CBU (Central Business Unit) recharge by PSG.

55.     The CBU recharge is a recharge whereby PSG charges the Company for services provided, which amounted to £535,000 in 2022. Mr Cliff asked questions about this on 21 July 2023. The answers were provided to him on 26 July 2023, but this information was not passed on to Mr Arora. A document was created on 4 October 2023 to record these questions and answers, which appeared to have been sent by email, but this document was not provided to the Plaintiff's legal team. It was only when Mr Arora noticed that Mr Cliff had referred to a document that he had not seen that this issue came to light, some time after the expert reports had been finalised. Mr Cliff adopted his own estimate of the CBU re-charge, which Mr Arora suggested was slightly higher than the Company’s own estimate.

56.     Ms MacLean was asked in cross-examination whether the Company had acted on any of the suggestions in the CSC review in terms of cost-cutting and she said that they had, but “not on this CBU charges that are shown here, because these are - these come centrally from Punter Southall, and I don't believe that I have yet seen the charges they are going to give us for next year.  So they may have taken some action I don't know about”.

57.     The findings in the CSC review were that there was a significant level of overcharging by PSG in relation to CBU charges which Advocate Christie characterised as PSG using the CBU charges to ‘treat the Company as their personal fiefdom’.  The CSC review suggested that through a variety of cost-cutting strategies, the Company could reduce PSG’s CBU charges by £750,000, from just under £1 million to £246,000 in 2024.  We were somewhat surprised that Ms MacLean, the Company’s CEO, appeared to be relaxed at the level of PSG’s CBU charges, despite the fact that the Company was not, and is not, currently making positive EBITDA and that these charges will act as a drag on the Company’s future profitability.

58.     This CBU expense is not included in the Board Plan models or the FM Lite models as it is a non-cash internal recharge.

59.     Neither of the parties’ experts challenge the proposition that the Board Plan overstates likely expenses; the argument is about how much the expenses are overstated.  Mr Cliff’s position at the time of the Second Joint Statement was that overall the Board Plan did not overstate expenses but at the time of trial and with reference to documents detailing the Company’s performance post-19 July 2023 he could now see that there was some scope to reduce certain expenses in the Board Plan.

60.     Mr Arora’s conclusion in relation to the CBU re-charge, as set out in his letter to Advocate Christie of 2 December 2023 was that, given the additional detail that had been provided by the Company, he considered it appropriate to include an element of the CBU recharge in his analysis and that he considered a reasonable level of CBU expense to include would be circa £246,000 in each of 2023 and 2024 consistent with CSC’s analysis. He would then assume that the CBU would continue thereafter increasing with inflation.

61.     In relation to the overall level of expenses Mr Arora noted that CSC had prepared a separate spreadsheet analysis, which divided costs into “no material impact”, “efficiency impact (non-sales)” and “sales impact”. If only the “no material impact” values are filtered, the total cost savings (excluding the CBU cost savings) that were shown were £1.7 million for 2023 and £2.9 million for 2024. This level of cost reduction represented a circa 5% and circa 8% reduction to 2023 and 2024 Board Plan expenses, respectively. He concluded that his own adjustment of a 2.2% reduction appeared to be too low in light of this information, resulting in too high a level of costs.

62.     In response to a suggestion made to Mr Arora in cross-examination that he had been selective because he had been willing to cut the expenses in the business without having regard to the corresponding suggestion that there were going to be decreases in sales, he pointed out that that was exactly why he went to the Craven Street document and did not select all of the expense reduction, only selecting the column that suggested there would be no material impact on sales.

63.     In the light of the evidence given by the Experts we believe that a saving in relation to the Board Plan expenses of 4% should be applied to 2023 and all future years.

64.     In relation to Mr Arora’s suggested reduction to £246,000 in respect of the CBU recharge we regard that as too low. In this connection we note that one of the principal savings suggested by CSC was a reduction in the charge for HR services from £420,000 to £30,000 which we regard as somewhat optimistic. Furthermore CSC state in their report that “It’s worth noting that Jeremy and Katya have only discussed these cost-reducing measures with the senior leadership of Guardian on a high level and further analysis will be required to ensure that i) all cost savings are genuinely achievable and ii) they don’t have a disproportionate impact on growth”.

65.     We do not have sufficient information before us to suggest an alternative figure. We would therefore wish the Experts to seek to agree an appropriate figure and, failing agreement, they should each suggest a figure upon which we shall make a decision.

Adjustment to IFRS/BE ratio

66.     When calculating the value of its in-force book the Company made certain adjustments, in line with their auditors’ requirements. A valuation was made on a “best estimate” basis which was described by Mr Singh at the first hearing as being “neither optimistic nor pessimistic”. A further adjustment, known as the IFRS adjustment was then made, Mr Singh explaining that “the application of the IFRS valuation was the result of guidance from the Company’s auditors and, whilst best estimate was neither optimistic nor pessimistic, IFRS was a pessimistic basis of valuation”.

67.     The process was described by Ms MacLean in her evidence in chief in the following terms:

“So the best estimate that we've been talking about over the course of yesterday is the best estimate of our -- the value of our in-force policies.  It might help to think about that by explaining how we would calculate -- very quickly, how we would calculate the best estimate of a single policy, because then what we do is we just add up all the policies we have.

So, we are working with long-term insurance policies. So, for example, we sell a policy where we expect to earn £500 of premium a year, maybe for the next 20 years.  But the policyholder has the opportunity of claiming during that time.  And what the best estimate calculation is trying to do is to look at a value today of all those future cash flows.  So, cash flows into us, like premiums, cash flows out, like expenses of administering the policy or claims.

And to do that, what we have to do is assign a probability to everything that might happen in the future.

So, we expect that we're going to earn that £500 of claim every year.  We know that there is a probability each year that the customer might claim.  We also know that there's a probability each year that the customer might cancel.  And we also know that there are expenses that we will have to pay while the policy is still in force, and that those expenses will grow potentially with inflation.

And when we are working out the best estimate, what we're saying is, using all the statistical evidence that we have available, both from our internal company experience and sometimes external data, what is the best estimate that we have of the probabilities of each of those things happening over, say, the 20 years, calculating a probability weighted cash flow in each of those years, and then a slight complication because a pound in 10 years' time is not the same as a pound today.  We then do this thing called "discounting", which is where the yield curves come in that have been mentioned quite a lot.

So when we're doing best estimate, we do it saying let's not be too careful, not too prudent, not too optimistic, genuinely best estimate, for all of those probabilities and all of those cash flows. That's very useful to me in running the business because it really helps me to understand what's happening with everything that might happen in future.

When you then come to preparing the accounts, the IFRS is a set of accounting rules.  What IFRS says is there are some things that you know because they've already happened.  So, when I'm preparing the accounts I know how much we spent on office supplies two months ago.  That's a known fact.  But all of those things that I have just described are uncertain and in the future. So the accounting standards say you need to apply some caution to those, because they're uncertain.  It wouldn't be reasonable from an accounting point of view to apply the same value to something you know has happened as to something that you believe will happen in the future.  So, some caution is applied.

The way that caution is applied is that a number of scenarios are worked out of things that might reasonably happen to be a bit worse than your best estimate.  So, a policyholder might be slightly more likely to cancel in future, for example, meaning that we lose that income stream.  Or they might be slightly more likely to claim, meaning that we have more claims outgoing.

So, the scenarios are not fixed by the accounting standards.  They are internal judgments which then go through audit by an external audit partner.

What the auditors have said to us is that if the difference between best estimate and IFRS ends up being -- if IFRS ends up being more than 85% of best estimate, they don't think we've been prudent enough. So, they assess our scenarios and test whether they believe them, but they also have a rule of thumb that says: if those scenarios lead to something that's more than 85%, then you need to go back and you definitely need to go and look at the scenarios again.

Similarly, as I think Mr Gibson mentioned yesterday, if you ended up with a number that was less than 55%, then you'd be likely to have been too cautious, and they would ask us again to look at the scenarios.

Because the scenarios behave differently depending on the particular conditions and the business mix that we have, and a whole load of other things, because they are looking at all of these future years of cash flows, they can move around, then we reassess the scenarios and are then audited on them each year-end, as we're doing the accounts.”

68.     Continuing her evidence in chief, Ms MacLean said that she would not describe the best estimate as an “adjustment”, but as “a calculation of the value today of that future income”. Having arrived at the best estimate, they would “redo the calculations, but with assumptions that have that margin for prudence in them. So, we don't directly apply a margin to the best estimate number as a whole, we apply the prudent assumptions into a calculation that almost replicates the best estimate calculation, but with more prudent inputs”.

69.     It was difficult to ascertain, from Ms MacLean’s description of the process that was followed, precisely how the adjusted figure was calculated. Her suggestion that having arrived at a best estimate figure the calculations would be “redone” suggests that the exercise was more than simply applying a percentage reduction to the best estimate figure. This is relevant in relation to how we approach the issue as to whether IFRS-adjusted or best-estimate figures should be used.

70.     Ms MacLean was asked what the auditors would say if they did not apply any IFRS assumptions, to which she responded “So firstly we wouldn't, because we would know that was an inappropriate thing to do.  We have in the past shown them assumptions which led to an answer slightly above 85% and were invited by the auditors to go and think again before resubmitting the numbers. So, they have been very clear with us on that – on where their comfort limits are”.

71.     When cross-examined by Advocate Christie, Ms MacLean accepted that when she referred to the IFRS rules requiring the Company to apply “an element of caution” she was talking about being “on the pessimistic side of best estimate”. She said that whilst they did not apply a percentage reduction, they regarded 85% of best estimate as a figure which would be acceptable to the auditors, who would be looking for a figure between 55% and 85% of best estimate.

72.     She went on to say:

“You have to work out your assumptions, your cautious assumptions you need to calculate individually as a set of assumptions, and then when you put them all together and run them, you will then find out what ratio that leads to. So yes, in that we know once they are all put together, if it comes out higher than 85%, the auditors are likely to have a concern about it.”

73.     Mr Arora has explained in the Second Joint Statement that the way in which the IFRS ratio is modelled by the Company has different effects in future years. According to Mr Arora, “if it is set at 80% in FM Lite 2.3, in particular, by the time you reach 2027 and 2028 it is depressing the value of the in-force to 74%”. Accordingly, to overcome this issue, he adjusted the input assumption such that the BE Ratio calculated in a forecast year matched the intended target level.

74.     Mr Gibson and Ms MacLean readily admitted that the model had this effect in relation to later years: Ms MacLean expressed the view that it did not matter to her because it did not affect what she needs the model for.

75.     Mr Arora, having observed this effect, therefore adjusted the model using a separate line, effectively to make an adjustment so that the effect of any IFRS/BE ratio remained constant. Mr Cliff would not adjust the model. Mr Cliff said in the Joint Statement that he had not ‘fixed’ the ratios for each year as he considered that changes to the modelling of actuarial inputs fell outside his area of expertise. When cross-examined on this point he said that this was the job of an actuary.  He explained that if the ratio was 74% in 2027, that ratio was within the range that was acceptable to Guardian's auditors, being 55 to 85%. He therefore saw no reason to change that ratio, because he was not an actuary, and it was within that range. He pointed out that he had provided two different ratios: one of his ratios went down to 74%, and the other one rose to 93% but he was unable to say which was appropriate.

76.     There was a difference of opinion between the Experts in relation to the application of the IFRS/BE ratio.

77.     We note that the references to an “IFRS adjustment” are references to IFRS 4 (now superseded by IFRS 17).

78.     We were referred by Advocate Christie to the website of the IFRS (the IFRS Foundation being a not-for-profit organisation that sets international financial reporting standards), which explains the application of IFRS 4, in the following terms:

“IFRS 4 specifies some aspects of the financial reporting for insurance contracts by an entity that issues such contracts and has not yet applied IFRS 17.”

79.     It goes on to define an “insurance contract” as “a contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder”.

80.     In relation to the application of IFRS 4 it states that “IFRS 4 applies to all insurance contracts (including reinsurance contracts) that an entity issues and to reinsurance contracts that it holds, except for specified contracts covered by other Standards”.

81.     Advocate Christie argued that the Company was not required to apply the IFRS adjustment as it is not a “full-stack insurer” issuing its own insurance contracts but is an Appointed Representative (a type of distributor) paying 2.25% of its insurance premiums received to SFA, which protects Guardian from insurance risk, and which then manages its own risk by outwardly reinsuring 90% of the risk to GenRe (in the example that he gave). He pointed out that SFA therefore carries the insurance risk and is subject to mandatory regulatory rules through Solvency II, and the Company pays for this through the 2.25% fee.

82.     By way of example of a business which operated in a similar manner to the Company, and which did not make the IFRS 4 adjustment, Advocate Christie referred us to Note 2.5 of the Notes to the 2021 Financial Statements of the company Reviti Limited which described Reviti as “a distributor of insurance products that are provided by its insurance partner, Scottish Friendly Assurance Society Limited”. The note went on to state that “as an agent arranging insurance on behalf of the insurer, the company’s one performance obligation is satisfied when customers purchase a Reviti insurance product from its insurance partner….. Revenue is stated net of provisions for estimated lapses of policies, based on the company's best estimates which are regularly reviewed and reassessed”.  He pointed out that there was no further adjustment.

83.     A further industry example of a protection distributor put forward by Advocate Christie was SunLife Limited, which, like the Company, was an insurance distributor. SunLife relied on its parent company, Phoenix Life Limited, to be its full stack insurer. Note 3 of SunLife’s 2021 accounts explained that it estimated the variable consideration amount for certain contracts using “the expected value method, using lapse, funeral redemption and mortality assumptions based on historic experience”. Advocate Christie again submitted that there were no probability-weighted additional margins.

84.     On the first day of his cross-examination, it was put to Mr Arora that “anyone with any experience of preparing accounts for insurance businesses” would always build in the additional margins. Mr Arora suggested that Ageas Protect, a company in which he had considered a comparable transaction was one that did not. However, on the second day of his cross-examination he was taken to Note 17 of its 2018 accounts which stated that:

"The assumptions used to determine insurance contract liabilities are set by the Board of Directors based on advice given by the Chief Actuary.  These assumptions are updated at least at each reporting date to reflect latest estimates.  Technical provisions are calculated using best estimate assumptions with an explicit risk adjustment to allow for prudence in the value of the liabilities."

85.     Mr Arora agreed that this showed that risk margins were in fact applied in Ageas' accounts. However, this was in our view hardly surprising given that, as Mr Arora had indicated in his First Report, whilst the market of Aegeas was comparable to that of the Company “there were some differences in that Ageas Protect was a regulated insurance company. Ageas Protect would have had a higher risk profile as a result”.

86.     It appears to us that whilst the IFRS 4 adjustment may be obligatory for a company that sells its own insurance contracts, it is not obligatory for insurance distributors to do so although they may, on the advice of their auditors, as was the case with the Company, choose what level of prudence margins to apply.

87.     The aspect of the valuation that is impacted by this issue is the estimate of EBITDA to which an exit multiple is applied. In his Third Report Mr Arora explained the impact in the following terms:

“The issue that arises from any valuation that is based on forecasts that include an IFRS adjustment of less than 100% to the best estimate, i.e. the current Gryphon forecasts, would therefore depress the value of the business. In other words, any valuation based on the IFRS to Best Estimate ratio of less than 100% may result in an undervaluation.”

88.     Further, we note that if a multiple is derived from a transaction concerning another insurance business it is important to establish whether that business has applied best estimate with or without a further IFRS deduction, in order to ensure that, to use a phrase used by Mr Cliff, one is comparing “apples to apples”. This was echoed by an assertion by Mr Arora to which we referred in our earlier judgment that “there should be a level of consistency in that if he was to derive his multiple from a company that did use best estimate then he would need to make sure that he was going to apply it to a business that itself used best estimate. If, on the other hand, his comparable used a discount he would have to bear that in mind when applying it to the Company, otherwise he would be creating a mismatch”.

89.     At paragraph 309 of our earlier judgment, we described the comparable transaction that was used by Mr Arora to derive his exit multiple as follows:

“The transaction identified by Mr Arora in relation to PruHealth and PruProtect was the sale by the Prudential Assurance Company Limited of its remaining 25% stake in Prudential Health Holdings Limited (trading as “PruHealth” and “PruProtect” for each of the main component health and protection businesses) to Discovery Group Europe Limited on 14 November 2014, for a total consideration of £155 million. Mr Arora had noted that the two businesses had initially been established for private medical insurance and subsequently expanded to offer long term protection products. It was therefore a more diverse business than Guardian, although it was a relatively young company and focused on the UK. However, it also focused on the premium competitor end of the market that Guardian was also targeting. Financial information from the ultimate parent entity of the acquirer separately identified the financial performance of the UK Life and UK Health businesses (which he understood to be the PruProtect and PruHealth businesses) which showed that over the period 2013 to 2017, up to the 2018 valuation date, the PruProtect business generated slightly more EBITDA than the PruHealth business. On a combined basis, the business grew its EBITDA at approximately 20% per annum between 2014 and 2017, after a small decline of 7% between 2013 and 2014. The sale of PruHealth and PruProtect implied an equity value of £620 million for the entire 100% stake, based on £155 million for a 25% stake and assuming that no minority discount was reflected in the purchase. From this he was able to calculate multiples showing an EV/EBITDA of 20.4x for the historical year, which ended in the June prior to the acquisition in November 2014, 17.0x for the current year and 14.3x for the forecast year.”

90.     In relation to the question as to whether PruProtect applied IFRS 4 neither expert could be certain.

91.     Mr Cliff was taken, in cross-examination, to the description of Accounting Policies in the accounts of Discovery Life for the year ended 30 June 2014, which, in relation to “Insurance Contracts” stated:

"Insurance contracts are those contracts that transfer significant insurance risk. Such contracts may also transfer financial risk. Discovery defines as significant insurance risk the possibility of having to pay benefits, on the occurrence of an insured event, that are significantly more than the benefits payable if the insured event did not occur. Discovery developed its accounting policies for insurance contracts before the adoption of IFRS 4.  As provided for in IFRS 4, Discovery continues to apply the same accounting policies for the recognition and measurement of obligations arising from insurance contracts that it issues and reinsurance contracts that it holds."

92.     The note went on to say that:

"Discretionary and compulsory margins are therefore added to the best estimate assumptions within the following framework: All margins are at least equal to the compulsory margins prescribed by regulations."

93.     It was put to Mr Cliff that as a full-stack insurer Discovery Life would have to apply additional margins which were compulsory under IFRS 4, but Mr Cliff pointed out that PruProtect did not have an insurance licence as it used Prudential’s balance sheet. When it was put to him that those accounting policies, which are appropriate for Discovery Life because it is a full stack insurer and is carrying insurance risk, would not be appropriate to a distributor such as PruProtect, which is not carrying insurance risk as it pays a fee to somebody else to carry that risk for it, Mr Cliff said that he simply did not know what margin, if any, PruProtect applied. He said: “my understanding is that different insurance companies and distributors had different ways of accounting for risk, be it applying a margin to a discount rate or a scenario analysis where you've reduced the cash flows directly.  But whatever that methodology is, essentially it results in a discount to best estimate”.  We note that in 2014, PruProtect was not a separate entity but was a business which was in essence an unincorporated joint venture between Discovery Group Europe Limited and The Prudential Assurance Company Limited, conducted pursuant to agreements between those two companies and supported by Prudential’s balance sheet, giving Discovery the ability to sell life insurance in the UK market.  As Discovery Life was a joint venture partner, it had to account for its share of the business within its own accounts.

94.     In Mr Cliff’s view, the principal concern was to ensure that the comparable being used for the purposes of the valuation was being used on a like for like basis, in his words that “the issue on IFRS 4 is simply -- it has nothing to do with regulatory requirements.  It's simply an apples-with-apples comparison for valuation purposes”.

95.     This was consistent with the view that Mr Cliff expressed in the Second Joint Statement where he  stated: “Mr Cliff considers that the task at hand is not an IFRS compliance exercise but a valuation exercise in which the aim is to ensure the EBITDA of Guardian and the comparable companies have been calculated using the same accounting policies, and that those same policies have been applied in a consistent manner. Mr Cliff considers that the exclusion of the IFRS 4 adjustments is consistent with one the fundamental principles of valuation that different accounting policies between companies should not result in different valuations”.

96.     The Plaintiff accepts that it was extremely difficult to establish precisely what PruProtect was doing. Given that it did not have an insurance licence and was using Prudential’s balance sheet it would not be required to apply IFRS 4.

97.     In the Second Joint Statement both Experts stated that they had adopted the EBITDA reported for PruHealth and PruProtect as presented in the accounts of Discovery Limited, its parent.

98.     In his Second Supplemental Report Mr Cliff notes that:

“The segmental financial information in the annual reports of Discovery Limited discloses the financial performance of UK Life with separate IFRS 4 reporting adjustments.  In excluding the IFRS 4 adjustments, I have considered whether such adjustments in PruProtect/PruHealth’s EBITDA makes the methodology to calculate EBITDA more comparable to the methodology in Guardian’s December 2022 Forecast or less comparable. I make the following observations regarding these IFRS 4 adjustments:

“The Discovery Limited annual reports state that the segmental information “is presented on the same basis as reported to the Chief Executive Officers of the reportable segments. The segment total is then adjusted for accounting reclassifications and entries required to produce IFRS compliant results.” I consider that the segmental information as reported to the Chief Executive Officers of the reportable segments would be more comparable to Guardian’s forecasts which are prepared for Guardian’s management.”

99.     It would therefore appear that the segmental figures were likely to have been produced on a best estimate basis rather than being further adjusted to comply with IFRS. In order to compare like with like we therefore regard it appropriate to have regard to non-IFRS adjusted figures in respect of both PruProtect/PruHealth and the Company.

Exit multiple

100.   In the Second Joint Statement, it was noted that Mr Arora had set out the calculation of multiples arising from the acquisition of PruHealth/PruProtect (the Pru Multiples) in his First Report. This calculation was based on an Enterprise Value of £620 million, an assumption that there was no additional net debt in the transaction; and that the EBITDA was calculated using values that were stated in S&P Capital IQ database. The EBITDA values were translated from ZAR to GBP by S&P Capital IQ database using an S&P Capital IQ stated FX rate. Mr Cliff, in his Second Supplemental Report, suggested certain amendments to the calculation, including:

(i)        Adjusting the Enterprise Value to be £645.7 million, being an original Enterprise Value of £620m then updated for net debt of £25.7 million; and

(ii)       amending the EBITDA to be calculated using the average FX rate for the period as presented in the accounts of Discovery Limited.

101.   The Experts agreed that these amendments were appropriate. The amendment for net debt increased the current year multiple, the amendment for FX rates decreased the current year multiple and, the net impact of both amendments slightly decreased the current year multiple from 17.0x to 16.7x, before considering other factors and other disagreements relating to the calculation of earnings, which were the subject of further discussion in the Second Joint Statement.

102.   Discovery's 75% ownership of PruProtect was represented in its annual report in two different ways; first, as segmental information and then with an adjustment to comply with the accounting requirements of IFRS 4, which required that insurance contracts were disclosed.

103.   The principal area of disagreement between the experts on this issue was whether the IFRS 4 adjustments should be taken into account when calculating the EBITDA in the Pru Multiple(s).

104.   In calculating his multiple, Mr Arora adopted the EBITDA reported for PruHealth and PruProtect that was presented as being IFRS 4-compliant in the accounts of Discovery Limited, its parent.

105.   Mr Cliff also based the EBITDA in his calculation of the Pru multiples on the EBITDA of PruProtect and PruHealth as presented in the accounts of Discovery Limited. However, he noted that the Discovery Limited accounts included specific IFRS 4 reporting adjustments for PruProtect which he considered were not relevant to the Company because, he said, the Company did not apply IFRS 4. Mr Cliff therefore excluded the IFRS 4 adjustments in his calculation of EBITDA.

106.   Mr Cliff’s rationale was that he considered that the task at hand was not an IFRS compliance exercise but a valuation exercise in which the aim was to ensure the EBITDA of the Company and any comparable companies had been calculated using the same accounting policies, and that those same policies had been applied in a consistent manner. Mr Cliff considered that the exclusion of the IFRS 4 adjustments was consistent with one of the fundamental principles of valuation that different accounting policies between companies should not result in different valuations.

107.   If the IFRS 4 figure is preferred, it does not appear to be disputed that the appropriate multiple when rounded up is 17x (Mr Cliff’s view being that it is 16.7x and Mr Arora’s view being that it is 17.2x). If the non-IFRS 4 figure is preferred, Mr Cliff says that the appropriate multiple is 13.4x.

108.   In a letter to Advocate Christie dated 2 December 2023 in which Mr Arora set out certain updated conclusions, he said that if the non-IFRS data is preferred, then the “current” multiple (i.e. for the period ending 30 June 2015) would be 13.4x based on the value implied by the acquisition of the remaining 25% holding of PruHealth/PruProtect by Discovery in November 2014. The period adjusted current multiple, to match the period to the specific use in the DCF, would be 13.8x.

109.   For reasons related to the passage of time, to which we refer below, and other indications including the 2019-2020 transactions in the shares of PruProtect, Mr Arora’s view (if the Court prefers the non-IFRS figures for the 2014 transaction) is that the multiple would be above 14.8x. In his oral evidence he identified a conservative range of 15 to 16x by applying a portion of a 17% premium to 14.8x.

Passage of time

110.   In relation to the passage of time since the multiple was first calculated Mr Arora noted in his Third Report that his calculation of the Pru Multiple (of 17x EBITDA as applied to earnings in the year of exit) included a starting, potentially conservative, assumption, for the purposes of applying that multiple in his 2018 Valuation. He explained that this was because he did not increase the multiple despite an increase in the Comparable Listed Companies’ multiples, which are usually used as a broad indicator of changes to relevant multiples in the market, between the acquisition of the PruHealth/PruProtect and the 2018 Valuation. The Comparable Listed Companies were companies identified by Mr Arora in his First Report which were principally broker-type companies and thus, whilst not conducting precisely the same business as that of the Company, were in the same sector and therefore “broadly” comparable.

111.   Mr Arora noted that the Comparable Listed Companies’ multiples had increased further since his 2018 Valuation and were significantly higher than the original time of acquisition in November 2014. However, he also considered the general market perspective in relation to InsurTech did not currently warrant applying an upward adjustment to the Pru Multiple for the change in Comparable Listed Companies’ multiples. Taking these factors into account, he considered that the Pru Multiple of 17x continued to be appropriate to apply in the 2023 Valuation. The Plaintiff submitted that if the Court chose the non-IFRS approach to the Pru Multiple, the Court should choose a multiple in the range of 15x to 16x.

112.   Mr Cliff did not address the passage of time issue in his Second Report. However, in cross-examination he explained that he did not regard the Comparable Listed Companies as comparable to the Company for valuation purposes. He pointed out that other “market factors” were also relevant, noting that “There is a very important market factor earlier this year, and that is the exit of Aegon from the UK Life insurance market.  And I would ask the court to look at the reasons Aegon provided for leaving the market.  And you will see that they mention the reasons are because the market was so competitive, it was difficult to make any money, and the environment was such that smaller players were unlikely to succeed”.

113.   The principal reason why Mr Cliff did not regard the Comparable Listed Companies as comparable to the Company was because they were multinational listed brokerage companies. However it was put to him that they were merely indicative of the movement of multiples in the insurance sector over the last ten years rather than being comparable companies from which a particular multiple could be ascertained. Nevertheless, Mr Cliff maintained his view, preferring to rely on what he regarded as an important market factor in the past year, namely the exit of Aegon from the UK life insurance market, citing its reasons being that “the market was so competitive, it was difficult to make any money, and the environment was such that smaller players were unlikely to succeed”. However this ignored the fact that, as Ms MacLean had agreed in cross-examination, the Company had gained market share as a result of Aegon’s exit.

114.   In light of the above we regard a 15x multiple as appropriate for the non-IFRS approach to the Pru Multiple.

Exit year

115.   Mr Arora’s approach was based on selecting an exit year that reflected a similar stage of development for the business as the PruHealth/PruProtect business at the time of the acquisition. Mr Arora considered that the rates of growth in EBITDA were an appropriate proxy for this and used this to select 2027 as the better approximation for the exit year.

116.   Mr Cliff’s approach, which relied on an assumption that the number of years the business had been in profit was an indicator for the stage of development, led him to select 2028 as the exit year. Mr Cliff said in the Second Joint Statement that he had been unable to find a sensible matching of growth rates of Guardian to PruProtect/PruHealth or Ageas as their EBITDA growth profiles were very different, and he had therefore relied on a simpler analysis which involved matching the transition of EBITDA from negative to positive. He considered an exit year of 2028 by comparing Guardian to PruProtect/PruHealth based on the time at which the businesses’ earnings turned from negative to positive.

117.   Mr Arora was critical of Mr Cliff’s approach, noting in the Second Joint Statement that Mr Cliff had made no adjustment for the following issues:

(i)        by selecting the 2028 exit year, Mr Cliff had used a year in which the forecast growth had sharply decreased which may result in an undervaluation. This arose because the forecasts become "less-detailed" in later years that affected 2027 onwards, whilst especially impacting 2028 onwards; and

(ii)       notwithstanding the significant issue in 1) above, if it was believed that only market growth in sales would be achieved beyond 2027, there was an inconsistency in that the 2028 forecasts included significant change costs of £3.3 million included in the EBITDA in Mr Cliff’s exit year.

118.   Mr Arora considered it appropriate to normalise the expense line and this (and potentially other expenses) would be reduced if the Company was assumed to have matured such that growth was restricted to only market-wide levels. This would significantly increase the EBITDA that was capitalised in the exit year in Mr Cliff’s calculations.

119.   In the letter to Advocate Christie to which we have referred above Mr Arora considered the relevant year of application if a non-IFRS multiple were to be chosen. In order to consider when would be an appropriate point of application, he noted that the average 3-year growth rate for PruHealth/PruProtect was 14% on an average and 9% using compound annual growth rate over the period from 2015 to 2017 using the non-IFRS EBITDA, compared with 17% on an average and 15% using compound annual growth rate for the IFRS EBITDA. This rate of growth was lower than the comparable 2027-2029 average EBITDA growth rates for the Company in scenarios 1 to 4 set out in his Third Report and trended to the 2028- 2030 growth rate. He said that this would suggest that the relevant year for the application of the exit multiple would be closer to 2028.

120.   He did however note concerns over the forecasts for later years and consider that to apply the exit multiple in 2028 would require further adjustments to key assumptions. These adjustments were likely to include consideration of sales growth opportunities, or at least the removal of certain expenses and lowering the discount rate. These considerations had been identified by Mr Arora under item 22 in the Second Joint Statement and we accept from the evidence that we have heard that the forecasts become less accurate after 2027. In particular, despite flattening out to very little growth they still contain considerable costs consistent with the development and marketing of new products.

121.   We find that 2028 is the appropriate exit year for the Experts to adopt but note that we would expect that the further adjustments to the key assumptions identified by Mr Arora should be made.

Discount rate – Cost of Equity

122.   There was a measure of agreement between the experts as to the approach, both having adopted a discount rate which was built up of:

(i)        A point cost of equity that is maintained at a constant level for the period of the cash flows to the year in which the exit multiple is applied;

(ii)       A cost of debt with a 25% corporate tax rate applied to derive a post-tax debt; and

(iii)      A leverage ratio based on market debt to enterprise value ratios derived from publicly listed insurance brokers count rate.

123.   In relation to leverage they agreed that a ratio of debt to enterprise value of between 18.7% and 19% was reasonable.

124.   In relation to cost of debt both experts had agreed that their respective pre-tax cost of debt estimates were within a reasonable range of between 11.4% and 12.6%.

125.   In relation to cost of equity, Mr Cliff considered that a venture capital rate of 30% was appropriate which was based on the Company being in the second/expansion stage of development. He stated that he considered 8 different sources used by valuation practitioners and took his venture capital rate directly from those sources.

126.   Mr Arora had assessed the cost of equity to be unchanged from his previous report, which was a range of 20% to 22%. This was on the basis that although the Company had advanced further in its lifecycle, which lowered risk exposure, this reduction was offset by an increase in the risk-free rate. Mr Arora set out in his Second Report that the low end of venture capital target rates was relevant to Gryphon through the period through to exit year.

127.   When Mr McKelvey gave evidence at the second hearing, he pointed out that within the Company, they would put a high discount rate on the business, “regardless of all the discussion for the court about discount rates and so on”.  He explained that in PSG's thinking about how to use their capital they saw the business as still relatively higher risk than other opportunities that they had. He acknowledged that the Evercore valuation used 20% or 15% discount rates according to which of the scenarios one looked at. However, PSG regarded it as a 30% discount rate business, because of the uncertainty about the medium-term future. The Evercore valuation in fact used 20% or 15% cost of equity rates, and it is clear Mr McKelvey was here using "discount rate" as a proxy term for cost of equity.

128.   We conclude that the appropriate cost of equity to apply is 21% (subject to any further adjustment for a 2028 exit year as set out in paragraphs 120-121).

SFA advance commission

129.   The SFA Facility is a loan facility provided by SFA and secured against the “in force book”.

130.   There is a difference of opinion between the Experts as to whether the facility should be treated as pure debt or be dealt with in some other way.

131.   Mr Arora, at paragraph 8.4.1 of his Second Report, described how “as Gryphon sells new policies, it records a growing asset on its balance sheet, which is in effect the value of its in-force policies that will pay out in the future. This is a balance that has substantial value. For example, by 2027, the total value of this asset is approximately £137 million to £165 million. This can be thought of as the value of the in-force book at that time, and value that Gryphon could generate thereafter (less some costs to administer policies over time) without selling any additional policies. There are also companies that purchase such books to run them off on existing cost platform and so there is substantial real value associated with such assets…..”

132.   Mr Gibson, in his First Affidavit, described how the SFA Facility “enables Gryphon to extract cash from the in-force policies earlier and repay them gradually which will have a beneficial present cash flow value impact on the business”. He explained that the treatment of the value of the in-force policies in the financial accounts was not entirely straightforward and suggested that one way would be to incorporate the value of in-force policies on a cash flow basis, “to take the value of the cash released from the business including that realised by the borrowing from Scottish Friendly”.

133.   He went on to describe how “The debt facility with Scottish Friendly was put in place at the end of 2020. During 2021, we reduced the amount we borrowed under this facility because we were able to negotiate the FinRe to be more favourable, as I set out above. We have just agreed a slightly enhanced facility where Scottish Friendly have agreed to expand the time horizon against which the cash flows are discounted, which is more favourable to us. What this debt facility allows us to do is to realise some of the non-cash profit that we record from the change in the value of the `in force book' by borrowing it from Scottish Friendly, to bridge the gap between our profit from an accounting perspective and our actual cash profit”.

134.   The details of the arrangement are set out in Clause 14 of a Deed of Amendment and Restatement between Scottish Friendly Assurance Society Limited and the Company, restated on 31 March 2023.

135.   Mr Christie suggested, in his Closing Submissions, that the SFA Advance Commission is not in fact a loan but is instead advance commission which is advanced on the profitability/pricing strength of policies SFA has itself issued through the Company as its distributor, in effect a form of debt factoring. He said that SFA then repays those advance commissions plus interest from the cashflows referable to those policies; however, under the contractual arrangements if the outstanding balances are not repaid, in relation to each policy, within ten (or as the case may be, fourteen) years from when the advance commission was advanced, the debt is extinguished. The Company is not personally liable for it. In no circumstances can it be called in, on any event of default.

136.   Mr Arora considered that the SFA drawdown should be treated as operational funding. Mr Cliff, referring to the fact that it is referred to as a loan/lending in the Company's accounts, argued that it should therefore be treated as debt funding.

137.   At the end of his evidence the Court asked Mr Arora: “… if the SFA funding arrangements result in future cash flows being reduced by the amount needed to refund the SFA, or perhaps looking at it another way, to take into account the advances made by the SFA towards future cash flows, doesn't it logically follow that the current value of the amount advanced by the SFA, but discounted for the fact it won't be paid to them immediately, ought to be deducted from the terminal value?”

138.   Mr Arora’s response was:

“Yes.  So, this is similar to FinRe in a way.  Just because it would keep going and it would – essentially it’s just an ongoing part of the business.  You never just deduct a point in time working capital position when you're doing this analysis.  It's just assumed to continue. And that's also why I said the alternative, if you really did want to adopt that type of position, would be just to explicitly model out all the cash flows - and the board plan has this modelled out to 2060.  You would model out those cash flows.  And they are net - it's a net draw for about another ten years - I think maybe more than that - to 2034.  There are positive cash flows coming into the company and then there are some negative cash flows. Now, when you put that into a discount rate back to today, because those positive cash flows are much sooner, it significantly outweighs the fact that overall, a greater amount needs to be repaid. It will depend on your opinion of a discount rate. For example, if you - actually, conversely, the higher discount rate you use, the lower the value is.  So…..when I tried doing it using Mr Cliff's starting discount rate, it ended up being overall positive value. So actually, the net benefit of this stream and the fact that you get cash flows for the first ten years, quite large cash flows, because your company hits scale, significantly outweighs the fact that you've got to pay back some large sums later. At my levels of discount rate, it was switched the other way round.  But either way, they're single digit million adjustments. There's a nuance to that, which is you do need to model the discount rate going forward, which is a challenge.  And so in this I made a very simplistic adjustment.  I would like to go back to it and do it in more detail, if it's helpful.  But I just lowered the discount rate from 2027 to a rate of around 12%, which is of the order that I said would be reasonable for this company going forward.  Again, that could be 10, 11, 12, 13.  It could be any one of those.  I could produce a matrix that would show the value at different rates. But ultimately, it's a small positive or a small negative.  So even if you chose to do that, it's not actually going to impact the overall value by a significant amount just because of that discounting effect, and actually because it is a net benefit cash flow into the company for quite a period of time yet to come.”

139.   Mr Cliff explained in his Second Supplemental Report that he added the SFA debt to his calculation of net debt as at the valuation date and excluded the associated cash flows in his DCF model. He said that this was different to Mr Arora’s approach where he did not include the SFA debt in his calculation of net debt as at the valuation date, but instead included the cash flows in his discrete period to 2027 (being his assumed exit year). Mr Cliff explained that Mr Arora’s approach resulted in GBP 122.2 million of net cash inflows between 2022 and 2027 without recognising any liability for that debt having to be repaid. He said that in keeping with Mr Arora’s Scenario 2 valuation approach, he had also included the SFA cash flows in his discrete period. However, he had recognised the resulting liability in his exit year in 2028 whilst Mr Arora did not. Mr Cliff pointed out that the SFA funding was referred to as a loan or lending in the Company’s accounts and should therefore be treated as debt. The Plaintiff suggests that unusually he deducts this as debt from his exit value in 2028, before discounting back the exit value, rather than adding it to his debt and deducting it from the Enterprise Value as at 19 July 2023, which is what he does with the properly-so-called debt items.

140.   We regard Mr Cliff’s approach, of treating the SFA funding as if it were a straightforward commercial loan, as too simplistic, failing to recognise that it has different characteristics, in particular the extinguishment of liability if indebtedness is not repaid after a specified period. In our view a purchaser of the Company would treat it as operational funding and would in all probability simply ensure that the existing arrangements were continued. However, we also regard Mr Arora’s approach as somewhat simplistic, as he appeared to acknowledge in his response to the question that we put to him as referred to above. We therefore conclude that the relevant cash flows should be modelled out in the manner that Mr Arora suggested, rather than simply deducted from the exit value as suggested by Mr Cliff.  We order the First Defendant to procure the provision of any data requested by the experts in order for them to be able to model this cashflow.

Debt

141.   This was not in dispute, having been agreed at £187,009,433 net of the mezzanine counterfactual, plus £13.4 million for the counterfactual relating to the money PSG put into the Company in January 2018.

Yield curve

142.   Both experts have used the 30 June 2023 yield curve which is up to date as at the Valuation Date.

Other matters

Evercore

143.   The Plaintiff drew our attention to further discovery that was produced by the Second Defendant not long before the valuation hearing. Included within the documentation were documents that related to an exercise that the Second Defendant had embarked upon whereby they had instructed a firm known as Evercore Partners International LLP to advise them on the valuation and marketing of the Company. We did not regard those documents as relevant to the exercise that we have to carry out: Evercore were not instructed as experts, their work post-dates the dates which the Experts were to consider and without a detailed examination of the documents and other evidence it would be difficult to reach any conclusions as to the basis upon which they were instructed and the basis for any valuations, tentative or otherwise, that they may have produced.

Summary of our decision

Choice of model

144.   The Experts are to use the latest approved model, being FM Lite v2.8, subject to the modelling error in relation to the EBITDA and value of the in-force book identified by Mr Arora being addressed, if it has not already been, before any reliance is placed upon it.  We order the First Defendant to provide all information and assistance required by the experts to determine (1) the extent to which, if at all, the current model FM Lite v 2.8 contains a modelling error, as suggested by Mr. Arora; and (2) the SFA Commission cash flow issue to which we refer below.

Sales APE profile

145.   The valuation should be concluded on the basis of Mr Arora’s Scenario 2 (which was indirectly based on the Company’s forecasts from September 2022, adjusted by a 12.7% increase to reflect the outperformance in sales in 2023); in other words, with Sales APE in 2027 of £111 million.

Expenses profile

146.   A saving in relation to the Board Plan expenses of 4% should be applied to 2023 and all future years.  In relation to the CBU re-charge, we order that the two experts review this and seek to agree what level of adjustment should be made to it.  Failing agreement, they should state their respective positions and refer the matter to us for a decision.

Adjustment to IFRS/BE ratio

147.   The exit multiple is to be applied to the non-IFRS-adjusted EBITDA of the Company.

Exit multiple

148.   The exit multiple to be applied is that calculated by reference to the non-IFRS-adjusted EBITDA of PruProtect/PruHealth, namely 15x (after adjustment for the passage of time).

Exit year

149.   The exit year is to be taken as 2028 but this will require further adjustments to the key assumptions identified by Mr Arora under item 22 in the Second Joint Statement.

Discount rate – Cost of Equity

150.   We conclude that the appropriate cost of equity to apply is 21% (subject to any further adjustment for a 2028 exit year as set out in paragraphs 120-121).

SFA advance commission

151.   The relevant cash flows are to be modelled out in the manner that Mr Arora suggested, rather than simply deducted from the exit value as suggested by Mr Cliff.

Debt

152.   We take the agreed figure of £187,009,433 net of the mezzanine counterfactual, plus £13.4 million for the counterfactual relating to the money PSG put into the Company in January 2018.

Yield curve

153.   Both experts have used the 30 June 2023 yield curve which is up to date as at the Valuation Date.

Further steps

154.   It is a matter of some regret that we find ourselves unable to make a final decision due to the significant differences between the experts and a number of unresolved issues which are likely to impact the valuation. We therefore direct the First Defendant to provide the required information and assistance in respect of the identification and resolution of the FM Lite modelling issue to which we have referred within a period of 3 weeks from the handing down of this judgment, using the FM Lite 2.8 version, and for the Experts to complete and file their respective valuations within 4 weeks thereafter.  The parties are then to file closing submissions within 1 week thereafter.  Should it not prove possible to resolve the modelling issue we would ask the Experts to prepare their valuations based on the existing FM Lite v2.8 but making such adjustments as they think fit to take into account the issue.

Authorities

Companies (Jersey) Law 1991.

Pender v GGH (Jersey) Limited and Ors [2023] JRC 124. 

Re Tobian Properties [2013] 2 BCLC 567. 

Financial Technology Ventures II (Q) LP and Ors v ETFS Capital Limited and Tuckwell [2021] JCA 176