January 25, 2011 | Issue #100-4  

Is the new management good enough to warrant a control premium? 

In BVR’s recent webinar on The Use and Application of Data for Control Premiums and Discounts, Gene Trevino (Valuation Associates Inc.) challenged a somewhat standard appraisal practice.The key question to ask,” says Trevino, “is can a buyer of a controlling interest do better at managing the company than the current owner? If you can’t do a better job than the current manager then you are hard pressed to apply a control premium. If you are working with the IRS on such a case they will ask you about this.”

Co-presenter Linda Trugman (Trugman Valuation Associates, Inc.) confirmed that the FactSet Mergerstat®/BVR Control Premium Study is the best source of data—as long as you understand where the data comes from and how the premiums are calculated. Some important things to know about the Study:

  • It includes completed domestic and international transactions where the target company was publicly traded
  • Only control transactions (50.1 percent or more) are included
  • Premiums are calculated as a percentage of the unaffected marketable minority price per share
  • The definition of the “Mergerstat Unaffected Price” is the price when the stock was judged to be unaffected by rumors of acquisition
  • Data are presented either including--or excluding--negative premiums (companies sold at a discount)

Is there a cap rate limit?

During the past couple of weeks, a question posted by Keith Borglum (Medical Practice Appraisal Valuation Services) LinkedIn’s BV Professionals Group elicited responses from a handful of valuation practitioners.  Borglum asked: “is there a cap rate limit?”

It is not surprising that some appraisers responded “it depends.” Joshua V. Azran (Azran Financial) said “it depends on is which component that informs the cap rate you are speaking about, the growth rate, or the discount rate.”  Mirtha Guerra Aguirre (MGA Accountants & Consultants) said “the biggest variable is the target company risk factor. Technically there is no limit to that risk factor. It depends on the individual circumstances of the company.”

Keith Pinkerton (Hooper Cornell Valuation) responded: “I do not believe it is correct to make a blanket statement about any particular rate being too high or too low unless viewed in a specific context.”  Pinkerton also added: “in my opinion, discount and cap rates are where appraisers really earn their money. I believe that every assignment is largely about the evaluation of alternative investments--the overall rates of return have to correspond to other risk/reward combinations available do they not? We are simply trying to "fit" a particular investment somewhere on the risk and return spectrum between say, treasury bills and a venture capital.”

Email us with your thoughts, or join the LinkedIn group debate!

Del. Sup. Ct: Should merger price always establish fair value?

You may recall Global GT LP v Golden Telecom, Inc, in which—among many important conclusions—the Delaware Chancery Court declined to adopt an Ibbotson’s historic equity risk premium (ERP) in favor of one closer to supply-side ERP. (For a recap of Roger Grabowski’s comments on the case, see BVWire #96-3.) Based on all the evidence and facts of the case, the Chancery Court ultimately decided that Golden Telecom’s $105 merger price fell short of its statutory fair value by more than $25, and the company appealed, claiming that in an efficient market, the court should have deferred exclusively to the merger price.

But, “there is no basis for a court, in a statutory appraisal proceeding, to conclusively, or even presumptively, defer to a merger price as indicative of ‘fair value,’” the Delaware Supreme Court held. The appraisal process is flexible, and Delaware statutes specifically require courts to consider “all relevant factors” when determining fair value. Setting the merger price as conclusive (or presumptive) evidence of fair value—even in the face of a “pristine” merger process and “wildly divergent” expert opinions—would contravene the statute and the “reasoned holdings” of precedent, the court said. It would also inappropriately shift the responsibility of determining fair value from the courts to the parties.

The court used much the same rationale to reject any “bright line” rule requiring companies to use the same transactional data during a merger process and in any subsequent appraisal proceeding. Such a rule would pay short shrift to the “fair price” valuation at the tender offer stage—which often involves synergies, the court noted, and the statutory appraisal stage—which seeks going concern “fair value.” Finally, it confirmed the Delaware Chancery’s independent valuation in all respects, finding the Vice Chancellor followed an “orderly and logical deductive process.” Read the entire case digest of Golden Telecom, Inc. v. Global GT LP, 2010 WL 5387589 (Dec. 29, 2010) in the March 2011 Business Valuation Update. The court’s opinion will be available soon at BVLaw.

Duff & Phelps on the benefits of preparing transfer pricing and purchase price allocation analyses together

According to a recent Duff & Phelps article, “Maximizing Value through the Integration of Transfer Pricing and Purchase Price Allocation,” valuation practitioners in a business combination scenario should be aware of the hazards of preparing separate analyses - one that deter­mines the fair value of assets and businesses for financial reporting purposes and one to determine the transfer price that should be charged when assets are transferred between related entities.  “Performing these studies separately can lead to the use of inconsistent assumptions, inputs and approaches that can bring about avoidable risks and penalties,” according to the article.

In addition, “Transfer Pricing (TP) and Purchase Price Allocation (PPA) valuations are applied differently but are based upon the same premise. When prepared together, the studies can support each other and provide taxpayers with a strong basis in defending their position if an audit is performed.”  The benefits of preparing transfer pricing and purchase price allocation analyses together include technical and cost efficiencies, the reduction of risk, and the avoidance of penalties.  

PwC annual patent litigation study reflects large damage awards

PricewaterhouseCoopers’s annual PwC's 2010 Patent Litigation Study, based on the firm’s database of patent damages awards from 1980 through 2009, shows “patent holders are winning considerable awards of damages as US patent trial success rates near their highest level in history. The largest ever patent damages award of over $1.8 billion was issued in 2009, for a case that is currently in the appeals process.”   

It will be interesting to see how the recent Uniloc/Microsoft case will affect patent damage awards in the future. Patent attorney Jimmy Nyugen (Wildman Harrold) told BVWire  “the Federal Circuit has signaled for some time that it is scrutinizing large damage awards.  This ruling will go a long way to curbing what many people view as excessive patent damage awards.”

Mike Crain’s article on size effect makes
“top 10” list

Mike Crain’s (Financial Valuation Group) article “A Literature Review of the Size Effect was recently listed on SSRN's Top Ten download list for Behavioral & Experimental Finance (Editor's Choice) eJournal. Congrats, Mike—and were proud that BVU was among the first to cover Mike’s research!

Expert Insights on ESOP independent financial adviser issues

The following articles from the most recent issue of Willamette Management Insights (Winter 2011) are available on WMA’s website:

These and the remaining Insight articles will be added to the BVResearch library soon.

Further evidence that “strategic acquisitions” are leading M&A activity out of the slump

“M&A transaction activity saw significant improvement in 2010. A recovery in business valuations leading to more motivated sellers, an easing in the financial credit markets and the global economic recovery,” reports George Steinbarger (PCE Investment Bankers) in “State of the M&A Markets Year End 2010.” PCE’s report, based on data from Capital IQ, indicates “valuation multiples also continued to show impressive growth. The greatest improvement was in the $50 to $100 million segment, increasing from 6.9x EBITDA in 2009 to 12.1X EBITDA in 2010.

This week learn the latest on motions to exclude financial experts

This Friday (January 28) BVR’s Advanced Webinar Series on Lost Profits Damages concludes with “The Latest on Motions to Exclude Financial Experts: The Now-Routine Trial Tactic that Works,” an in-depth examination of the methods by which experts are questioned and how they may best prepare for these challenges.  The program features two of our favorite experts on this topic, attorney Jonathan Dunitz (Friedman Gaythwaite Wolf & Leavitt) and Robert Lloyd (University of Tennessee College of Law). For more information, or to register, click here.

Here’s your chance to learn option pricing modeling from one of the best…

On February 24 BVR will host Mark Zyla in the “Advanced Workshop on Option Pricing Modeling.”  Zyla leads the workshop from his Atlanta office, and a great collection of OPM-related materials is included for attendees. Register before February 11 and receive a special early bird discount!  For more information, click here.

Appraisers responsible for certain provisions of HIPAA privacy rule
During yesterday’s webinar Healthcare Reform: One Year After, presenter Mark O. Dietrich told listeners that the Health Information Technology for Economic and Clinical Health Act (HITECH Act) makes “business associates” like appraisers directly responsible for complying with certain provisions of HIPAA privacy rule and all of HIPAA’s security rules. He recommended that engagement letters be modified to specify that clients should not provide the appraiser with any HIPAA-covered information without first obtaining a Business Associates Agreement.
In addition, when valuing physician practices, appraisers need to ask the physicians whether they expect to qualify for the HITECH Act incentive payments for implementation and “meaningful use” of Electronic Health Records. “For providers who have already incurred the expense, this is a windfall straight to the bottom line which adds value,” explains Dietrich. “For those who currently implement and qualify for the incentive payments, there could be a capital expenditure reduction, which again affects value.”
For more information on the HITECH Act’s “Business Associates Contract” click here.

IVSC reviews DCF valuation method

The International Valuation Standards Council (IVSC) just issued Technical Information Paper on the Discounted Cash Flow Method for Real Property and Business Valuations. This exposure draft appeals for public comment on debates such as:

  • The DCF method should not be judged on the basis of whether or not the explicit cash flow assumptions are ultimately realized but rather on the degree of market support for the assumptions at the time they were made.”
    • Do you agree that the DCF method, if properly applied, can be used as a method to arrive at market value?
  • The discount rate should be determined based on the risk associated with the cash flows (para 10), whether the DCF model is being used to determine a market value or investment value.
    • Do you agree, or do you consider that other matters should be taken into account in determining the appropriate discount rate?

Comments on this Exposure Draft are invited before 30 April 2011. All replies may be put on public record unless confidentiality is requested by the respondent. Comments may be sent as email attachments to CommentLetters@ivsc.org or by post to the International Valuation Professional Board, 41 Moorgate, London EC2R 6PP, United Kingdom.

Updated! BVR’s Guide to Discounts for Lack of Marketability

Highlights of this new edition include summary and analysis of:

  • Practitioner methods
  • Comparative factor analysis and methods for tiered entities
  • Volatility
  • Disposal period
  • Controlling interests
  • DLOM court cases
  • Restricted stock studies, pre-IPO studies, and minority public stock evidence (including LEAPS and Bid-Ask spread)
  • Matched Pairs Approach and discounts in private companies
  • Computational models and method

To read more or to order this book, click here.


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