BVWire Issue #151-3 | April 15, 2015


Damodaran questions the small-cap premium

“I have never used a small cap premium when valuing a company and I don’t plan to start now,” states Professor Aswath Damodaran (New York University Stern School of Business) in his latest blog post. He re-examines relevant data and discusses the long-standing arguments for adding a size premium to the discount rate for small firms.

Triple whammy: He cites three reasons why he doesn’t use a size premium: (1) the historical data are yielding more ambiguous results, which call into serious question whether a size premium exists; (2) forward-looking risk premiums are yielding no premiums for small-cap stocks; and (3) if based on intuition (that smaller firms are riskier than larger firms), much of the extra risk can either be diversified away, better treated as an adjustment to expected cash flows, or it’s double counted.

He also makes the point that “inertia” is another culprit. Some analysts add a size premium by rote because that’s the way it’s always been done. And he points out that the custom is reinforced by the legal system that looks to precedence as opposed to what may be a better practice. Damodaran made this same point in an interview in Business Valuation Update (September 2014) when he said: “For better or worse, you can have bad valuations that are legally defensible and good ones that are not.”

Comments: “I would highly recommend that all appraisers read Professor Damodaran’s take on the small stock premium,” Bob Dohmeyer (Dohmeyer Valuation Corp.) tells BVWire. “It contains very insightful commentary along with a beautifully nuanced analysis and coherent conclusion based on all of the available empirical data. Whether or not you personally agree with his findings, all appraisers should read this in order to be prepared for possible critiques. The thought of being open-minded is also important and we should keep that in mind.”

“I think Professor Damodaran asks some bluntly honest questions that few have the courage or knowledge to address,” says Michael A. Crain (The Financial Valuation Group). “Perhaps BV has reached a time to seriously assess some of its practices as Wall Street and regulators did on standard finance practice after the financial crisis of 2008 and 2009. This kind of discussion reminds me of a Harvard Business Review article that I read about 10 years ago by Emanuel Derman, a Ph.D. and former quant on Wall Street. He writes that modern economists tend to explain things with math even though, on average, the world is too complex for that. Contemporary finance (financial economics) research and practice tends to be part of this math phenomena.”

What do you think? Send us your comments.

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Delaware Chancery grapples with sale price versus post-merger DCF

What’s more plausible: the merger price or the value derived from the discounted cash flow? This was the overarching question the Delaware Court of Chancery recently explored in a statutory appraisal action.

Backstory. was a self-described “pioneer and the leader in the online family research market.” The company went public in 2009, when its shares traded at $13.50 each. After it became the sponsor of a popular NBC show, “Who Do You Think You Are?the price per share rose as high as $40. But its fortunes changed again, and its board decided to sell the company to a private equity investor for $32 per share. The merger price represented a 41% premium on the unaffected trading price of company stock. Ninety-nine percent of the voting shares approved of the transaction, but the dissenters asked the court for a fair value determination.

Both sides retained experts who agreed on the use of the DCF analysis but disagreed over key inputs. According to the Chancery, the petitioners’ expert “proved something of a moving target” in that he proposed at different points in the litigation that the company was worth as much as $47 per share and no less than $42.81. The company’s expert concluded the stock was only worth $30.63 per share. That price was actually below the value the buyer, a nonstrategic investor, was willing to pay, the court observed.

‘Riffs on market price’: Both experts were respected and well qualified, but their valuations were “less than fully persuasive,” the Chancery noted. The analyses were “result-oriented riffs on the market price.” By his own account, the petitioners’ expert “tortured the numbers until they confess[ed].” The company’s expert “candidly suggested” that if his valuation had been as far from the merger price as that of the petitioners’ expert, he “would have tried to find out a way to reconcile those two numbers.”

The Chancery said these statements showed the limited use of a post hoc DCF valuation. “If an analysis, relied upon to assess whether a sales price presents the fair value, in turn uses that very sales price as a check on its own plausibility, and if it must be revised if it fails that check, then the process itself approaches tautology.”

Instead of relying on either expert’s analysis completely, the court performed its own DCF, arriving at a value of $31.79 per share. But, since the sales process was “reasonable, wide-ranging and produced a motivated buyer,” the court decided it would be “hubristic” to elevate its DCF estimate of value over the value an entity “for which investment represents a real—not merely an academic—risk” placed on the company. Therefore, the Chancery found the $32 merger price best represented the fair value of company stock. The DCF value was useful as a check on the market-derived valuation, the court said.

Find a discussion of In re Ancestry, 2015 Del. Ch. LEXIS 21 (Jan. 30, 2015) in the May edition of Business Valuation Update; the court’s opinion is available at BVLaw.

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Tweedie targets financial instrument valuation

In a video interview, Sir David Tweedie, chairman of the International Valuation Standards Council (IVSC), talks about the work of the IVSC and its efforts to develop unified global standards for valuation. One particular area of concern is the valuation of financial instruments.

“We are finding that financial institutions are getting quite different, wide variations in the value of these identical instruments,” he says. “That instantly worries you because if some of them are hugely different, and we know they are, you have a situation where you don't know how reliable the balance sheet is. And the balance sheet clearly affects the income statement, so how reliable is the profit number? And then if we talk about financial stability, which is based on the capital buffers, based on balance sheet numbers, are those rubbish, or do they mean something?”

Tweedie is pulling together regulators, auditors, banks, and standard-setters to work toward unifying standards for financial instruments—which can be extremely complex mechanisms. “Here's the guys with the pointy heads and the whirling eyes, astrophysicists and so on,” Tweedie remarks. “We have to say: ‘Wait a minute. What are you doing in your little black box?’ We have to bring this out and shine a light on it and see what is happening.”

Extra: To reflect the growing importance of business valuation in an international setting, BVR has launched its new Global Business Valuation Resource Centre. It’s designed to deliver best-in-class news, training, research, and data tools to business valuation professionals around the world. If you have ideas on topics, products, and/or news items, we would welcome the chance to speak with you! Contact Lexie Gross at 617 861 770.

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Free download of select 2015 Mergerstat data now available

Did the total value of announced M&A deals in 2014 exceed those in 2013? What were the top five seller industries in 2014, in number and dollar value of announcements? Which U.S. states announced the greatest number of corporate sales/divestitures in 2012?

The answers to these questions—and more—are all in this new free download of selected data from the newly released 2015 Mergerstat Review, which gives you quick access to selling price multiples by industry and premiums paid by industry. Not only does the book provide a review of the 2014 M&A activity in a statistical analysis section, but it also includes:

  • Industry analysis for 2014;
  • Geographical analysis for 2014;
  • Details from completed and pending 2014 transactions in a transaction roster; and
  • Historical review going back 25 years.

You also receive a free monthly bonus: the Factset Mergerstat Monthly Review, in PDF form, that will make sure you’re always up-to-date with the latest M&A news and trends, industry activity and value comparisons, private equity updates, top advisor activity, and top U.S. deals.

The 2015 Mergerstat Review is available now in PDF form. The hardcover version will be available to ship in late April. To order the PDF or preorder the hardcover version, click here.

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Healthcare services multiples and trading performance

The S&P Healthcare Services Index has increased by 16% over the past three months, thus outperforming the S&P 500 (a 1.8% increase over the same period), according to the March 2015 Healthcare Sector Update from Duff & Phelps. The best performing sectors were emergency services (up 32.5%) and managed care—government (up 24.5%). The worst performing sectors were specialty managed care (down 13.9%) and physician practice management (down 0.5%).

Latest multiples: The current median LTM revenue and LTM EBITDA multiples for the healthcare services industry overall are 1.75x and 12.1x, respectively. The sectors with the highest valuation multiples include: healthcare REITs (12.96x LTM revenue, 20.1x LTM EBITDA) and HCIT (3.49x LTM revenue, 21.39x LTM EBITDA).

The report also provides data on the pharmaceutical/medical devices/life sciences sectors.

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Trademark valuation data for CRM software

The average trademark royalty rate for CRM software is 2% of revenue, according to a new analysis from Markables. This information is gleaned from the Markables database of over 5,000 trademark valuations published in financial reporting documents of listed companies from all over the world. The database reports value solely for the use of trademarks (not bundled with other rights).

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Preview of the May issue of Business Valuation Update

Here’s what you’ll see:

  • Indefinite Is Not Infinite—Solving a Dichotomy in Trademark Valuation (Christof Binder, Ph.D., MBA, and Robert B. Morrison, MBA, ASA BVIA). New research reveals that trademark valuations appear to be not fully in line with ASC 350 and IAS 38. Once a trademark is given an indefinite life, it appears to be treated that way permanently, which has serious effects on valuation and accounting. The authors also discuss how to estimate a finite remaining useful life of a trademark.
  • Misapplication of the Gordon Growth Model Can Lead to Undervaluing (Drew E. Voth, CVA, CPA/CFF, CIRA/CDBV, CFE). Every valuation analyst is taught the Gordon growth model, and it’s not particularly complex. But the author sees common mistakes being made in applying this model and looks behind the model to demonstrate its proper application.
  • Avoiding Complications and Disparate Opinions of Value in Buy-Sell Agreements (Brian Burns, CPA/ABV/CFF, ASA, and Chris Mitchell, CPA/ABV/CFF). Common ambiguities and valuation pitfalls can lead to complications surrounding buy-sell agreements. Also, relevant case law concerning disputes with buy-sell agreements is discussed.
  • BVU Profile: Business Valuation From the Perspective of an Appraiser in Italy (BVR Editor). An interview with Ascanio Salvidio (Salvidio & Partners), who talks about the valuation profession in Italy and the importance of a convergence of valuation standards. He also discusses the data sources he uses for valuation purposes.
  • Ongoing Research Related to the S Corp Valuation Puzzle (BVR Editor). Nancy Fannon (Meyers, Harrison and Pia LLC) and Keith Sellers (University of Denver) present several areas where additional research would be helpful to further the analysis concerning the effect of shareholder-level taxes on a firm’s value. Their new book is a major advance in the area of valuations of pass-through entities.

To read these articles—as well as digests of the latest court cases—see the May issue of Business Valuation Update (subscription required).

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BV movers . . .

People: John Bautista joins CohnReznick as a principal in the firm’s Valuation Advisory Services Practice and will be based out of the New York City office … Brian Kerwin was named chair of corporate practice group of Duane Morris and will continue to work out of the Chicago office, which he helped establish in 1999 … Mark Meinberg was named partner-in-charge of EisnerAmper’s Long Island office in Syosset, N.Y., and succeeds Eric Altstadter, who for the past five years has led this office’s growth from half a dozen staffers to nearly 40 … The Central Penn Business Journal named Bethany Novis, a managing partner at Reinsel Kuntz Lesher, a2015 Woman of Influence.”

Firms: Pittsburgh-based The Meridan Group, an investment banking and management consulting firm specializing in business advisory services and M&A consulting, has merged with the national firm Schneider Downs … Porte Brown was chosen as one of the “2015 Best Places to Work” in Illinois … Stockman Kast Ryan + Co was named the exclusive Colorado Springs, Colo., member of the nationwide association of Auto Dealer CPAs, where membership is based on a demonstrated proficiency and commitment to the auto dealer industry.

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CPE events

Put the tax season behind you and check out this exciting slate of CPE events:

Important note to webinar attendees: To ensure that you receive your dial-in instructions to BVR’s training events, please make sure to whitelist

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We welcome your feedback and comments. Contact the editor, Andy Dzamba at: or (503) 291-7963 ext. 133
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In this issue:

Size premium under fire

Post-merger DCF

Global BV News

2014 M&A data

Healthcare multiples

Trademark values

May BVU preview

BV movers

CPE events









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