Valuation of Anglo Irish Golden Circle Deal
This post was written by Gregory Connor
There has been some discussion on this blog site about the value of the secret deal provided by Anglo Irish management to a circle of ten wealthy Anglo clients. The deal was done last summer, in order to prop up the Anglo Irish share price. Each of the clients was lent Euro 45,100,000 by Anglo Irish with the requirement that all the loaned funds be spent on Anglo shares. Clients were only responsible for repaying one-quarter of the loaned amount (Euro 11,275,000) in cash; they were permitted to repay the remainder of the loan by returning the shares.
At the time of the deal, the Anglo share price was approximately Euro 6.01 per share. The share price has since collapsed to zero. Each of the wealthy clients in the secret circle has lost Euro 11,275,000 (unless they now avoid repaying through bankruptcy or restructuring). Meanwhile, the “shareholders” of Anglo have lost the remainder of the loaned cash (Euro 33,825,000 for each of the ten circle members). Everyone has lost on this deal ex post. It is particularly vexing since the Irish taxpayer now serves as the Anglo Irish “shareholder” and suffers a loss of Euro 338,250,00 on this secret deal.
It is worthwhile to analyse, under reasonable assumptions, the ex ante value of the deal, both to the clients and to the Anglo management acting on behalf of shareholders (as if). An accurate valuation is not possible with the information available to me, but a reasonable approximation can be made, and also a reasonable analytical framework provided for anyone who wishes to substitute other parameter values.
Last July Anglo had total shares outstanding of 749,585,405 and a share price in the range 4 – 7 Euros (quite volatile during the month), see the data here. If we use a share price of Euro 6.01 then this gives a total cost of Euro 451,000,000 to purchase 10% of shares outstanding, which corresponds to the stated amount in later government reports. Hence I assume that this is the share price at the time of the deal. The one-year LIBOR interest rate last July was 3.2796% so I use a slighly higher interest rate of 3.75% as the two-year borrowing/lending rate.
Suppose that the clients have no insider information telling them that Anglo Irish shares are over-valued. Also suppose that they are not liquidity-constrained. In this simple case, the loan-plus-share-purchase is window-dressing designed to hide the real value of the deal. The client takes a loan of Euro 45,100,000 from the bank, and puts the proceeds in an interest-bearing account which exactly pays off the loan. The client also purchases Euro 45,100,00 worth of Anglo Irish shares with true value of Euro 45,100,000. Neither of these transactions adds or subtracts any value for the client. The real value of the deal comes in the free put option which Anglo management has provided to the client. If the client’s Anglo shares fall in value, the client can pay Anglo only ¼ of initial loan value, plus hand over the shares, in full restitution of the loan. This put option constitutes the only source of value in the deal (admittedly under these strict assumptions).
The put option can be valued reasonably well using the Black-Scholes option pricing model; see here for details. These estimates of value are conservative since empirically the Black-Scholes model tends to undervalue out-of-the-money put options. I assume that the loan is for a two-year period and that the Anglo Irish shares have annualised volatility of 60% per annum. The put option has an exercise price of (1-.25)(Euro 6.01) = Euro 4.512. Using normdist and exp in excel it is easy to compute that the value of the put option for each client was Euro 6,757,469. The put option is given to the client for free, in exchange for acting as a go-between to allow Anglo Irish management to secretly use bank-deposited funds to purchase their own shares.
The client is earning excess return of Euro 6757469 on risk capital of Euro 11,275,000 which is 59.93% or 29.97% abnormal return per year. So even allowing for some liquidity-constraints or client nervousness about Anglo Irish share values, it seems a good deal. Admittedly, it turned out disastrously for the clients, but this was due to a worldwide bank share meltdown plus the emerging scandals (notably this one) at Anglo Irish.
Perhaps Anglo Irish management raised the borrowing rate on the loans to account for the free put option. This seems unlikely. Again using the case of 2 years and 60% volatility, in order to recoup an option value of Euro 6757469.675 on a loan with principle value of Euro 45,100,000 they would need to add roughly (1/2)( 6757469.675/45,100,000) = 7.49% to their base interest rate. So if the base rate is 3.75% they would need to use a loan rate of 11.24%.
Bob Dylan has a song “The Lonesome Death of Hattie Carrol” about a shameful incident in the early twentieth century when a wealthy, well-connected young man bludgeoned to death a poor, African-American female servant, and escaped with virtually no punishment. In his lyrics, Dylan makes the point that the truly horrifying aspect of this event was not the murder (there will always be violent individuals) but the reaction of the judicial establishment in ignoring it. Analogously, in the Anglo Irish scandal, it is not the presence of greedy, underhanded individuals in Irish financial services (such people exist around the world in all countries and all industries) but the horrifying approach of the Financial Regulator, condoning and even encouraging such behaviour. To quote from Dylan’s song:
In the courtroom of honor, the judge pounded his gavel
To show that all’s equal and that the courts are on the level
And that the strings in the books ain’t pulled and persuaded
And that even the nobles get properly handled
Once the cops have chased after and caught ‘em
And that the ladder of justice has no top and no bottom,
Stared at the person who killed for no reason
Who just happened to be feelin’ that way without warnin’
And he spoke through his cloak, most deep and distinguished
And handed out strongly, for penalty and repentance
William Zanzinger, with a six-month sentence.
Oh, but you who philosophize disgrace and criticize all fears,
Bury the rag deep in your face
For now’s the time for your tears.