Valuing a Public Company’s Exotic Option and Preferred Stock
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July 21, 2022
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A US energy company (the “Company”) issued an option (the “Option”) and convertible preferred stock (the “Preferred Stock”). FTI Consulting was engaged by the Company to determine the fair value of the Option and Preferred Stock for financial reporting purposes.
Situation
The Company issued a new class of preferred shares—which included a mandatory conversion to common stock, a liquidation preference, and zero coupon—and an option to acquire additional common stock. The option’s payout had complex features such as a variable strike and early exercise.
The experts at FTI Consulting were retained by the Company to provide an independent fair value assessment of the Option and the Preferred Stock for financial reporting purposes. The Company required valuations at the time of the transaction, the issuance, and for each of their quarterly statements until exercise of the Option.
Our Role
FTI Consulting experts reviewed the sales and purchase agreement of the Option and Preferred Stock to analyze the terms underlying each position.
Using our analytics and risk management system, FTI Quantum, we priced the Option payout with a stochastic volatility model calibrated to market implied volatilities and valued the early exercise feature of the Option through advanced numerical techniques.
To account for the Option selling restriction, our experts quantified the discount for lack of marketability (“DLOM”) using a derivatives-based methodology.
We calculated the fair value of the Preferred Stock with the backsolve method and assessed the Company’s liquidation preference prior to the mandatory conversion.
FTI Consulting experts used machine learning techniques to model and assess the likelihood of a liquidation event and calculated the probability of the Company defaulting or being acquired.
Our Impact
- We provided a fair value of the Option and Preferred Stock as of the transaction, issuance, and financial statement dates using industry best practices and, in a manner, consistent with Generally Accepted Accounting Standards (“US GAAP”).
- Our experts provided support to the Company’s auditor to understand the Option’s terms and its complex valuation challenges. The auditor agreed with our approach and valuation.
- The Company was impressed by the quick turn-around and quality of our analysis. We continue to support the Company with ongoing valuation requirements.
Published
July 21, 2022
Key Contacts
Senior Managing Director, Leader of Securities, Commodities and Derivatives
Managing Director