New definition of goodwill: what we overpaid for the company
The pace of the current economic downturn appears to be slowing: The Dow Jones Industrial Average has inched upward from its low of 6,469.95 (on March 1, 2009) to hover at just over 9,000 (Tuesday’s close was 9,096.49, according to CNN). But the impact on the economy is “continuing to grow,” according to Edward Morris Jr. (Clifton Gunderson, LLP), who presented disappointing economic statistics during last week’s BVR teleconference, Goodwill Impairment in a Troubled Economy. Consider:
- 53 banks have failed this year (as of 7-15-09) compared to only 26 in all of 2008.
- Total U.S. bankruptcies are up 34.5% for Q1 2009 vs. Q1 2008; corporate bankruptcies are up 64.3% and consumer bankruptcies are up 36.5%.
- Office vacancy rates hit 15.9% in Q2 2009.
- National unemployment is at 9.5%, with the broader “U-6” rate (Bureau of Labor Statistics alternative measure of employee “underutilization”) currently at 16.5%.
- Commercial real estate and credit card default rates are still climbing.
- Bank goodwill write-offs are estimated at $25 billion in 2008 and $3.5 billion in Q1 2009, with an additional $290 billion still on the books.
- Among the “top 20 write-offs” as of 12-31-08 are a few predictable sources (AIG at $3.2 billion, e.g.), but ConocoPhillips tops the list at $25.4 billion, and United Air Lines and its parent company post a combined $5.5 billion.
“You can expect more of the same” for the remainder of this year, Morris said, along with continued scrutiny of goodwill by the SEC, bank regulators, and the ubiquitous media. For example—a recent article in the New York Times presented an interesting definition of goodwill as “the amount [companies] overpaid for a business compared to the sum of its parts.”
What does this mean for valuation analysts everywhere? No matter if the subject company is public or private, “be more skeptical” when talking to management and reviewing forecasts, Morris advised. When a company’s market value (or a private company’s public comparables) diverges too far from a DCF analysis, suggesting an implied control premium in the range of 50% to even 90%, try sitting down to talk with management and “find a common ground.” For more on handling the implied control premia, discount rates, and adjusting debt values from Morris and fellow expert presenters Jim Alerding (Clifton Gunderson) and Brian Steen (Dixon Hughes), consider the teleconference “On-Demand” pack, including CD, transcript, and ancillary reading materials.
BV hiring (and firing) world gone ‘topsy turvy’
After years of feverish and at times frustrated searching for qualified BV employees, “the supply-demand pendulum has swung toward the employer with an intensity I never thought I’d see,” says John Borrowman, principal of Borrowman Baker, LLC (Franklin, TN), who describes the current climate of the BV recruitment world as dizzying. “Layoffs at the worker-bee level have combined a firm’s need for cost-cutting with its desire for continued performance assessment. At higher levels in the professional hierarchy, layoffs have been the only way to bring expenses in line with revenues.”
Hiring (and there is some) is now concentrated at either end of the experience spectrum: the lower level analyst whose compensation isn’t much of a factor, and the revenue-generator who will pay for him/herself anyway. “Practices that are hiring at the middle level (manager) are aiming to meet a clearly defined need as opposed to the ‘opportunistic’ approach that was the norm not so long ago,” Borrowman says. Even mid-level positions can be problematic, however. A common tactic is to increase the pool of candidates to regional or even national scope, but even a laid-off BV professional can’t always convince a working spouse to relocate and seek re-employment in an uncertain market. “In the meantime, recruiters who’ve been attracted by the industry’s recent boom years are buzzing around like flies,” he adds. “It’s not unusual to find as many as half-dozen online job ads for the same position.”
Things will get better, he predicts, echoing a sentiment of the inevitable that most in the BV business (and larger world) may feel right now. “It’s just a question of how soon. I don’t expect hiring to pick up materially until Q2–maybe Q3–of 2010. Practice leaders will be loath to part with the additional profit they’ve created by chopping payroll costs. On the other hand (as one senior practitioner suggested to me), when they find themselves pouring over spreadsheets at 2 a.m. for the fourth night in a row, they might decide it’s time to hire some help.”
Dueling Daubert motions question ‘dueling methodologies’ in restaurant valuation case
The Panda Express restaurant conglomerate is trying to construct a new outlet right next to a Chick-Fil-A in central Florida. But Chick-Fil-A owns a restrictive covenant, which bars the building of any “quick service restaurant deriving twenty-five percent (25%) or more of its gross sales from the sale of chicken,” and it has sued to permanently enjoin the Panda Express construction. Predictably, the parties have offered dueling experts and “dueling methodologies” to determine what portion of Panda Express’s gross sales are derived from chicken—and in Chick-Fil-A, Inc. v. CFT Development, LLC, 2009 WL 1754058 (June 18, 2009), they filed dueling Daubert motions, too, each claiming the other’s expert values are unreliable.
Watch the line between legal and valuation conclusions. Interestingly, the court barred both experts from testifying whether the parties are “direct competitors,” because their opinions are not relevant. (The restrictive covenant contains no express requirement that the restaurant be a competitor.) In addition, the court precluded Panda Express’s expert from testifying that the phrases “quick-service restaurant,” “25% of gross sales,” and “sale of chicken” are ambiguous. “While an expert may testify in the form of an opinion…that embraces an ultimate issue of fact, expert testimony that expresses a legal conclusion is inadmissible,” the court ruled, especially when—as in this case, the opinions do not help “explain, clarify, or elucidate” meaning.
Of course, the “meat” of the experts’ dispute was how to determine the percentage of chicken sales from Panda Express “combo meals.” The restaurant does not allocate sales between side and combo orders; and it has never used either proposed method (the defendant’s expert focused on volume and plaintiff’s used the restaurant’s “a la carte” pricing data). The court acknowledged that the former “raises some serious concerns,” but permitted both experts to testify at trial, because cross-examination and presentation of contrary evidence would better test the “certainty and correctness” of the opinions than a Daubert challenge. Look for a complete case abstract in the September 2009 Business Valuation Update™, and a copy of the court’s opinion at BVLaw™.
Restaurant values not just a matter of a simple multiple
The opportunity to perform restaurant valuations continues to be abundant, especially in the current economy, but as the Chick-Fil-A case makes clear—restaurant valuations are not always fast or easy. Too often, business appraisers might be tempted to base their value conclusions on a simple earnings multiple, neglecting additional and critical considerations. Indeed, it would be ironic if “a restaurateur [worked] his or her entire life and then determined the value of this life’s work with a simple multiple,” says Ed Moran, author of the soon-to-be-released BVR’s Guide to Restaurant Valuation (September 2009).
How to correctly value restaurants. Moran will also host “Valuing Restaurants,” the next teleconference in BVR’s Industry Spotlight Series, on August 6, 2009. Joining Moran is experienced BV appraiser Kevin Yeanoplos and John T. Hall, a 30-year veteran of McDonald’s finance and operations. The expert panel will cover topics ranging from franchise valuations to restaurant financing, appropriate research sources and the applicability of any rules-of-thumb. Two CPE credits are available for attendees; for more information and a special, combined discounted price on “Valuing Restaurants” and BVR’s Guide to Restaurant Valuation, click here.
Butler-Pinkerton Calculator™: new name and new offer
It’s now the Butler Pinkerton Calculator™ (formerly the Butler Pinkerton Model™)—a name change because “Calculator” simply represents better what the product does: It calculates the company-specific risk (and the total cost of equity, TCOE) of a public company, which is then available as a proxy for an appraiser’s calculation of company-specific risk in a private company valuation. The calculations are still based on long-standing financial equations (including total beta), so there’s been no change to the fundamentals.
Have you tried the Butler Pinkerton Calculator yet? More appraisers are using this calculator to confirm their cost of equity and company-specific risk conclusions. Because it's based on empirical data, the discount rates derived from the Butler Pinkerton Calculator (in addition to other sources such as Duff & Phelps and SBBI data) offer valuation experts—and their clients—the maximum protection against challenges in court and in practice. Free trials are now available: Contact firstname.lastname@example.org for a free, two-week trial of the Calculator. Annual subscriptions are available to new customers for $125; for more information, click here.
FASB plans to keep all financial instruments at fair value
In its most recent meeting (July 15, 2009), the Financial Accounting Standards Board proposed a model to improve financial reporting for financial instruments. According to a related release, the Board reached the following preliminary decisions:
- The Board agreed to propose that all financial instruments will be presented on the balance sheet at fair value with changes in value recognized in net income or other comprehensive income with an optional exception for own debt in certain circumstances, which will be measured at amortized cost.[…]
- The Board agreed to propose that changes in an instrument’s value may be recognized in other comprehensive income on the basis of qualifying criteria related to an entity’s management intent/business model and the cash flow variability of the instrument. The Board will provide additional guidance on how to apply those qualifying criteria.[…]
- The Board agreed to propose to require one statement of financial performance with subtotals for net income and other comprehensive income. It also agreed to propose to continue to only require earnings per share for net income.
Compare this to IASB’s latest proposal. As reported in last week’s BVWire™, the International Accounting Standards Board has proposed permitting companies to continue carrying many financial assets at historical cost, including loans and debt securities. The Boards are scheduled to meet July 24th in London to discuss their contrasting plans. “The scope of the FASB’s initiative, which has received almost no attention in the press, is massive,” comments a new Bloomberg article. Only time will tell whether the FASB will be able to withstand international pressure as well as “stand up to the banking industry over mark-to-market accounting.”
M & A activity on the rebound?
“Merger and acquisition activity began to pick up in 2Q ‘09 as markets bounced back from the low experienced in the first quarter,” reports Mike Rosendahl (PCE Investment Bankers). “After the substantial drop-off from 4Q ‘08 to 1Q ‘09, M & A activity increased as more buyers and sellers tested the market. Financial and strategic acquirers began to actively seek opportunities across nearly all sectors due to the widely held assumption that transaction values have decreased, providing the opportunity for higher returns. This belief, coupled with substantial capital waiting to be deployed, should help increase activity in the coming months. Additionally, business owners, having lowered their valuation expectations, should see an opportunity to affiliate with a well capitalized partner that can help position their company’s future growth when the economy rebounds, as well as pull some money out of their company.”
Deal activity has improved in all valuation segments. “Transactions with values between $100 million and $250 million experienced the greatest increase, improving 45.7%,” Rosendahl adds. “Transactions above $250 million underwent the smallest expansion, increasing 2.0%. Growth in transactions below $50 million was 11.6% while transactions with a valuation between $50 million and $100 million improved 22.2%.” Deals under $250 million have experienced the largest growth, due in part to the difficult credit environment that has made financing any transactions above this threshold difficult. “Valuations for transactions between $100 million and $250 million underwent the greatest improvement, increasing from 3.3x in 1Q ‘09 to 9.8x in 2Q ’09,” he observes. “The depressed level in 1Q ‘09 seemed abnormally low, bringing into question the reported data. The valuation level in 2Q 09, while high, is historically in line with multiples for this segment.”
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