What is Contingent Value Right (CVR)?
It’s the duty of every public company to return value to shareholders. This includes during times of tumultuous change, such as a buyout, restructure or acquisition. In these extraordinary circumstances, the trajectory of a company isn’t always clear. To do right by shareholders, companies issue contingent value rights (CVRs).
Contingent value rights are agreements to ensure a level of confidence among shareholders. They stipulate certain conditions that, if not met, result in some form of reward to shareholders, as a way to return value. These conditions usually tie to stock price or performance. They have an expiration date and work to protect investors in times of uncertainty.
In many ways, CVRs are a lot like stock options: they can either pay out or expire worthless, depending on the conditions. Here’s a closer look at these agreements and how they work.
Where do Contingent Value Right Come Into Play?
CVRs are most-often used to bridge the gap in company valuation that stems from merger and acquisition (M&A) activity. When one company acquires another, there’s usually some disagreement about the value of the deal. Acquirers tend to value their target low, while the target company will do everything it can to drive up its acquisition premium. To bridge the gap, acquiring companies will issue contingent value rights. For example:
ABC Company wants to acquire XYZ Company for $10 per share; however, XYZ believes its value is closer to $15 per share. ABC might purchase XYZ for $10 per share, with a CVR stipulating a stock price of $15 within the next 12 months. If the stock price reaches $15 in the 12-month period, the CVR expires worthless. If it doesn’t reach this threshold, ABC agrees to pay a special dividend of $0.10 per share every month beyond 12 months until the stock price reaches $15.
Contingent value rights can stipulate a host of conditions and shareholder rewards, specific to the situation. For instance, some CVRs entitle shareholders to a portion of the proceeds from a divestiture or asset liquidation. Others entitle shareholders to additional shares of common stock.
The important thing to remember is that these shareholder rewards are only realized if all conditions stipulated in the CVR are met.
CVRs Can Expire Worthless
Often, contingent value rights expire worthless when the issuer meets the criteria outlined in the agreement. In these situations, shareholders aren’t entitled to any additional reward. Depending on how you look at it, this could be good or bad.
- A worthless CVR is good in the sense that, while shareholders forgo any reward, the company’s performance has met expectations. Theoretically, it means shareholders have benefitted from price appreciation and currently hold an investment that’s on the rise.
- On the flip side, a worthless CVR is bad for investors who anticipated poor performance or who have a bearish outlook on the M&A activity. These traders may have short positions in the stock, while also owning it for the potential CVR payout.
It’s important to think about CVRs as safeguards: not opportunities to profit. They’re in place to protect shareholders, not necessarily benefit them.
The Benefits of CVRs for Shareholders and Companies
When used appropriately, CVRs offer benefits for both companies and shareholders. Again, it comes down to the stipulations that trigger the agreement.
For shareholders, the primary benefit of a CVR is the guarantee of compensation if the company underperforms expectations during a transitionary period. These agreements create shareholder confidence by ensuring there’s some level of accountability to the shareholders themselves. If a company wants to avoid paying out the reward mandated in a CVR, it needs to outperform the stipulations that trigger it.
For companies, CVRs are a great tool in bridging gaps between expectations. Using the example from above, ABC Company will pay less money upfront to acquire XYZ Company thanks to its CVR. And, if its forward-looking estimates are correct, it’ll outperform the stipulations in the CVR agreement, meaning the company won’t need to pay an additional reward. The best-case scenario is less upfront and nothing paid later.
Ultimately, the purpose of a CVR is to get companies and shareholders on the same page, in agreement on terms that ensure a desired level of stock performance within a specified time frame.
Types of Contingent Value Rights
Contingent value rights come in two forms: exchange-traded and non-transferrable. Companies stipulate the type of CVR upon writing the agreement.
- Exchange-Traded Contingent Value Rights. These rights trade actively on stock exchanges and aren’t tied to the common stock of the company. That means the bearer is entitled to the reward specified by the CVR upon the exercise date, should the company fail to meet criteria. Investors can buy and trade CVRs up until the expiratory period.
- Non-Transferable Contingent Value Rights. Companies distribute these types of CVRs to common stock shareholders on the date of M&A activity. Recipients can’t sell or trade them, and the bearers hold them until expiration. Most contingent value rights are non-transferrable, since it’s easier to regulate them.
No matter the capacity, CVRs are a type of unsecure debt that functions similar to an option. Not only are they based on the performance of an underlying asset (the stock price), recipients aren’t guaranteed rights to the reward.
Protect Against the Unknown
Every good investor looks for ways to safeguard against risk. As companies seek to retain investor confidence during turbulent times, contingent value rights serve as an olive branch. They incentivize shareholders to ride out the uncertainty and pay out if things don’t go according to plan. If all goes smoothly, they expire worthless and both the company and its shareholders benefit.