| August 21, 2013 | Issue #131-3 |
Damodaran’s new thinking on equity risk premium Gone are the days when you could estimate an equity risk premium using a static approach with historical data. If you do, you’ll get some “very strange-looking numbers in valuation,” says Dr. Aswath Damodaran (Stern School of Business, New York University). Alternative approach: “We live in a world where equity risk premiums are dynamic,” he said during a recent BVR webinar. “They shift and they change on you.” So instead of a using a backward-looking approach in estimating equity risk premium, he proposes an alternative: a forward-looking method he calls the “implied premium approach.” He explains: “I am going to see what you paid for stocks and I am going to back out what your expected future risk premium is. It sounds fancy, but if you ever computed the year-to-maturity in a bond, then you will be able to see why an implied equity risk premium is pretty much the analogous computation looking at equities.” Damodaran, who says that “equity risk premiums are one of my obsessions,” gives full details in his webinar, Equity Risk Premiums: Looking Back, Looking Forward. We’ll also analyze his approach in a future issue of Business Valuation Update. ‘Exciting’ time in evolution of DLOM “There is no one generally accepted computational method” for DLOM, writes John Stockdale Sr. in the upcoming fifth edition of BVR's Guide to Discounts for Lack of Marketability. The book explains 11 different computational models and methods—all of which are controversial. However, most of them give good insight on the amount of the discount in one or more circumstances. Much progress: There has been a lot of progress in terms of new evidence and studies, but disagreements continue about the validity of this new information. Nevertheless, Stockdale insists that these disagreements and conflicting viewpoints are valuable because “they indicate problems that need to be addressed in supporting the final conclusion as to the discount.” Consequently, no single study or method has emerged yet as being the best. Stockdale concludes: “An exciting time for the field of valuation lies ahead as theoretical developments and new evidence shed new light on the determination of the discount for lack of marketability.” Court crafts ‘reasonable estimate’ of ERISA damagesLast year, a complex ESOP case involving a labyrinth of novel transactions resulted in a district court finding that the defendants flouted certain ERISA fiduciary requirements (see BVWire, Oct. 17, 2012). Recently, the court issued a finding on damages and remedies dominated by business valuation issues. The story begins in 2002, when Alliance Holdings, one of the defendants, bought Trachte Building Systems Inc. for $24 million. The idea was to merge the Trachte ESOP into the Alliance ESOP and then flip the company for a profit. Flipped out: By 2007, Alliance could not find a suitable buyer, so it devised a complex leveraged buyout. The Alliance ESOP spun off the Trachte employees' accounts into a new Trachte ESOP, and the Alliance shares in those accounts were exchanged for Trachte shares held by an Alliance entity. Using the shares as loan collateral, Trachte and the Trachte ESOP redeemed or purchased all of Trachte's outstanding equity from the defendants. In the end, the Trachte ESOP paid more than $38 million for Trachte's common equity and Trachte took on $36 million in debt. Trachte’s stock collapsed, and the company folded under the debt load—bringing the account balances of plan participants down with it. Trachte employees sued, alleging that Alliance, its management, the two ESOPs, and trustees breached their fiduciary duties. As the court put it in its liability decision, the transaction was rife with conflicts of interest and acts of negligence—and the Trachte valuation was the outcome of “questionable judgments” and “lack of independent scrutiny.” The court noted that no independent person was looking out for the employees' interests in the ESOPs. Mix and match: To assess damages and remedies, the court had to compute how much the Trachte ESOP overpaid, which, in turn, meant determining the company’s fair market value (FMV) at the time of the 2007 transaction. The parties’ experts, it said, offered “wildly, at times absurdly, different approaches. Ultimately, it arrived at a “reasonable estimate” by correcting and combining two flawed, but contemporaneous, valuations. One was a fairness opinion that a national valuation firm had done in connection with the transaction. Among its problems was that the firm, on orders of the defendants, relied on a company “take-down” letter stating the FMV of Trachte’s common equity was worth $44.1 million in late August 2007. Also, it applied a $1.9 million tax shield relating to the Trachte plan’s ability to take principal and interest deductions for the 2002 purchase of Trachte. Ultimately, it concluded the FMV of the common equity was between $26.2 million to $40.1 million. The court first subtracted $1.9 million for the tax shield, which it said was a benefit to the Trachte ESOP but was a feature “unique to an individual buyer” and as such not part of the FMV calculation. Moreover, it applied a 10% discount for lack of marketability (DLOM)—the fairness opinion included none—saying that expert testimony suggested a range from 1% to 10%. It decided the highest figure was appropriate because a private auction did not generate a price that was acceptable to the seller. In the final analysis, the company’s common equity value was $30 million, which meant the Trachte ESOP had overpaid by over $8.32 million, the court concluded. Find an extended discussion of Chesemore v. Alliance Holdings, Inc., 2013 U.S. Dist. LEXIS 80969 (June 4, 2013), in the September issue of Business Valuation Update; the opinion is available at BVLaw. Interesting BVR LinkedIn dialogueThe Business Valuation Resources LinkedIn group, now with over 2,200 members, has some notable recent comments and discussions: Control premiums: The most active discussion remains “The Value of Control,” started by Lance Hall (FMV Opinions), who takes issue with The Appraisal Foundation’s discussion draft on control premiums. That draft states that control premiums for most publicly traded companies are either nonexistent or very small. International valuation: Grégoire Buisson (Epsilon Research) pointed out the release of the Q2 2013 Argos Mid-Market Index, which measures the level of private midmarket company valuations in the euro zone. “While M&A activity continues to decline and hit historical lows this quarter, Eurozone private company valuations showed a slight increase from 6.6 to 6.7 times EBITDA,” the index reveals. Credential choice: Cuthbert I. Thomas, a CPA, wants to get into valuation and asked about what credential to pursue. There has been no heated discussion—yet, anyway. Commenters so far recommend the ABV credential and the AICPA training since he is already a CPA. BVWire urges you to join the group and start a discussion—or add your two cents to one already going on. BV conference in the nation’s birthplaceNeed to brush up on lost profits damages? Hear a new spin on calculating DLOM? Discover the pitfalls of healthcare valuations? These topics—and more—will be featured at the upcoming Virginia Society of Certified Public Accountants Business Valuation, Fraud & Litigation Services Conference. Now in its 14th year, the conference, to be held September 19-20 in Richmond, Va., features top-notch, national speakers—many of whom teach for the AICPA's annual business valuation conference. Speakers include James R. Hitchner (Financial Valuation Advisors Inc.), Mark O. Dietrich, Kristopher A. Boushie (Stout Risius Ross Inc.), Donald Kinner, Esq. (U.S. Department of Justice), and more. Check out the agenda for details. BVR will be there—we hope to see you! Preview of the September issue of Business Valuation Update Here’s what you’ll see:
To read these articles—plus a digest of the latest court cases—see the September issue of Business Valuation Update. Summer still hot with CPE eventsChanges to the healthcare industry in general, and pharmaceuticals in particular, have affected the values and valuations of pharmacies of all types. So tune in to Valuing Pharmacies,Part 8 of BVR's 2013 Online Symposium on Healthcare Valuation on August 27. Experts James Lloyd and Jeff Milam (both Pershing Yoakley & Associates) will reveal what every appraiser should know about this piece of the healthcare industry valuation puzzle. How are claims and remedies of unjust enrichment defined, argued, and quantified? What must financial experts know when preparing or presenting such an analysis? The answers will be revealed on September 10, in Unjust Enrichment, Part 7 of BVR's 2013 Online Symposium on Economic Damages, with expert George Roach (George Roach Litigation Consulting). Despite years of research, regulatory and judicial guidance, and real-world testing, consensus on pass-through entity valuation techniques remains elusive. Still, an effective, reliable, and defensible technique appears close at hand. On September 12 in S Corps … What a Long, Strange Trip It's Been, expert Nancy Fannon (Myers Harrison & Pia) reviews the history of thought in pass-through entity valuation with an eye toward creating a simple solution to this complex problem.
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