BVWire Issue #166-2 | July 20, 2016


Brexit reinforces need for consistency in cost of capital

Leading global valuation experts and finance professors chimed in on the impact of the Brexit vote on cost of capital during a recent webinar from Duff & Phelps. One message they all stressed is to maintain internal consistency between the elements of cost of capital and the current economic environment. Also, you need to consider that there may be a “new normal” in terms of interest rates, risk premiums, and growth.

Just another crisis: Brexit is simply a “garden variety” crisis similar to others over the past five years, such as the crises in China, Russia, and Greece, according to Aswath Damodaran (New York University Stern School of Business). To treat Brexit differently is a “mistake,” he says. Rather than thinking about the effects of Brexit separately on the three basic elements of valuation (cash flow, growth rate, and discount rate), valuators should instead focus on being internally consistent. He points out that a crisis such as this “muddies the waters” for all three elements, but, if you’re consistent with the way you deal with Brexit with all of the three ingredients, your mistakes will “tend to average out.” If you’re not consistent, that’s “when you get into trouble.”

Speakers Elroy Dimson (Judge Business School, University of Cambridge) and Pablo Fernández (University of Navarra—IESE Business School in Spain) agreed with the idea of consistency. Webinar host Roger J. Grabowski (Duff & Phelps) also agreed and stressed that matching the cash flows to your expectations and the consistency of those expectations with the economic environment are a critical element of your valuation. This includes a consideration that long-term growth may be much lower going forward in the U.S., U.K., and the eurozone than what may have been expected before. “Maybe we are in a ‘new normal,’ with lower interest rates, higher risk premiums and slower growth,” says Grabowski. “It’s something for all of us to consider as we do our valuations.”

No change to U.S. ERP: Duff & Phelps regularly reviews fluctuations in global economic and financial conditions that warrant periodic reassessments of the equity risk premium (ERP) used for developing discount rates. Earlier this year, D&P increased its recommended U.S. ERP to 5.5% for use as of Jan. 31, 2016, and thereafter. This implies a 9.5% (4.0% + 5.5%) “base” U.S. cost of equity capital estimate as of Jan. 31, 2016. During the webinar, Grabowski stated that the preliminary indication as of June 30 is that there is “no change in our recommended ERP” in the U.S. He points out that the risks associated with the China slowdown and now Brexit “come and go” and are “not significant enough” to warrant a change at this point.

The speakers, who also included Yann Magnan, European valuations leader at Duff & Phelps, offer a great deal more insight into the impact of Brexit on the cost of capital. You can listen to a complimentary replay of the webinar if you click here.

The Duff & Phelps Valuation Handbook series includes the 2016 International Valuation Handbook - Guide to Cost of Capital
available now) and its companion volume that focuses on specific industries, the 2016 International Valuation Handbook - Industry Cost of Capital (available in August).

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Daubert case shows when to call in extra help in a damages engagement

Lost profits calculations often require experts with specialized industry knowledge. A recent Daubert case involving a construction contract illustrates what happens when a client retains a relative novice to develop a damages model for an unfamiliar environment. It sends a note of caution about accepting work that is outside the expert’s area of expertise.

Unique industry, unique contract: The plaintiff, a minority and/or women-owned business, entered into a subcontract with the defendants for work on a major construction project, the “Indianapolis Project.” The price of the lump-sum contract was nearly $6.8 million. Ultimately, the plaintiff sued for breach of contract, claiming the defendants never intended to honor the contract but used the plaintiff to fulfill a city MBE/WBE requirement. The defendants counterclaimed.

The plaintiff’s damages expert was a CMA who had worked as a tax preparer and outside accountant for the plaintiff for 10 years. He determined that total damages amounted to over $1.7 million, most of it related to lost profits. The defendants moved to exclude him under Daubert, arguing the lost profits calculation was based on insufficient data and an unreliable methodology.

Many ‘shortcomings’. The defendants did not attack the expert’s qualifications, but the court found his lack of experience worth discussing. The expert testified that different industries calculated lost profits differently. His experience in determining lost profits in general was limited. He said that in a few instances he had calculated lost revenue to businesses that had to close after a fire or flooding, and he had done a business valuation in a marital dispute case. He admitted he had never developed a report “to [the] extent” of the one he prepared for the plaintiff. The court noted he “has not previously offered expert lost profit opinion in a construction industry case.” It also said that “generally speaking expert qualifications are liberally construed.” Considering this principle and the defendants’ decision not to challenge the expert’s qualifications, the expert’s testimony might be admissible “if qualifications were the only shortcoming,” the court said. However, here the problematic work product provided other reasons to exclude the entire opinion.

For example, for his calculation, the expert relied on data related to a past construction project on which the plaintiff had worked with the defendants. Unlike the Indianapolis Project, however, the earlier project did not involve a lump-sum contract but was based on time and materials spent. Although the expert acknowledged that a lump-sum contract came with the risk of not making any profit, which did not exist in a time and materials contract, he did not analyze this difference.

Using historical data was an acceptable approach for ascertaining lost profits with reasonable certainty, the court said. But for a meaningful calculation the expert must provide an analysis as to why and how the data can reliably project the future loss to the project at issue. Here, the expert did not show that the conditions of the past project were comparable to those in the Indianapolis Project in terms of the type of contract and the scope of work. Without this analysis, the court “was not convinced” that the historical data were credible comparable evidence.

The court also found the expert used an “ad hoc” method that did not lend itself to independent testing and, therefore, was unreliable.

The exclusion of the damages expert opinion left the plaintiff scrambling for ways to get into evidence facts about the company’s economic performance. It tried to qualify the expert as a fact witness, but the court was alert to the backdoor maneuver. “Surely [the expert] cannot offer expert testimony through the cloak of a lay witness,” the court said.

Takeaway: Economic damage calculations are industry and fact specific; no one damages calculation fits every case. To avoid exclusion at trial, and minimize the risk to a potential client’s case, experts need to know what they don’t know and call in an industry expert when necessary.

An extended discussion of RMS of Wisconsin, Inc. v. S-K JV, 2016 U.S. Dist. LEXIS 64224 (May 16, 2016), appears in the August issue of Business Valuation Update; the court’s opinion is available at BVLaw.

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Proposed regs on valuation discounts for LPs and LLCs due out

If the statements of government personnel pan out, we should shortly see the IRC Section 2704 proposed regulations that may impose further restrictions on valuation discounts for transfers of interests in limited partnerships and LLCs. Treasury officials back in May said that the proposed regs would be the first in a series of gift, estate, and trust projects to be released over the “next four to eight weeks,” according to Tax Notes Today (subscription required). Among the uncertainties include the effective date of the new rules (retroactive to date of release or when finalized?), whether or not valuation discounts will be completely eliminated, and what specific entities will be affected. Stay tuned!

Extra: Meanwhile, the IRS keeps scrutinizing FLPs, as the recent estate tax case of Holliday v. Commissioner, T.C. Memo 2016-51, makes clear. There, the court found there was no legitimate and significant reason for creating the FLP. The court went on to say: “Because we have held that the value of the assets is includible in the value of the gross estate, there is no need to consider or decide the amount of any discount attributable to the limited partnership interest.” Consequently, taxpayers who want to benefit from discounts must make sure to set up the FLP correctly.

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Copyrighting an appraisal report may violate USPAP

A question posed in The Appraisal Foundation’s new Q&A Forum brings up the issue of copyrighting an appraisal report. TAF points out: “[I]f the process of registration with the U.S. Copyright Office includes public disclosure of the appraisal report, such registration would disclose assignment results and, therefore, result in a breach of the Confidentiality section of the Ethics Rule of USPAP, unless the appraiser/registrant had the prior approval of the client for such registration.”

Do you have a question for the Appraiser Qualifications Board or Appraisal Standards Board that is not addressed in the existing Q&As? Post it on the new Q&A Forum and receive a timely answer from foundation staff.

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AHLA publishes healthcare transactions guide

Experts in healthcare transactions offer some valuable analyses and commentary in a new guide from the American Health Lawyers Association. The reader audience is healthcare entities, but the articles give some good overview and background material of interest to valuation experts. For example, Duff & Phelps has an article “Are You Paying Fair Market Value?” Stout Risius Ross Inc. offers “Valuations & Fairness Opinions: A Useful Tool in Distressed Hospital Transactions.”

Extra:  AHLA and BVR have just co-published a new guide, which offers guidance and ground breaking innovations in the approaches to healthcare business valuation. The BVR/AHLA Guide to Healthcare Industry Finance and Valuation, edited by Mark Dietrich is now available.

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Final call to participate in the BV Firm Economics Study

Don’t miss the chance to make your data count in an important survey of the business valuation profession, BVR’s Firm Economics Study (FES). Your participation will also help strengthen the profession by allowing appraisers to benchmark and improve their practice management. The confidential survey covers BV firm performance, compensation, billing rates, marketing, practice development, and more.

Deadline is July 22. When you participate, you’ll receive a free Executive Summary of survey results, plus a special offer to purchase the full report for $99 (regular price is $299). Click here to take the survey now. Thank you!

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Trademark values for multilevel and network marketing firms

Avon calling! Direct-to-consumer sales, also designated as multilevel marketing (MLM) or network marketing businesses, have been around for ages. Does this distribution strategy—in particular, the circumvention of multibrand retailers—have positive or negative impacts on brand value? That’s the focus of a peer group analysis from MARKABLES that includes notable players such as Avon, Tupperware, and Weight Watchers.

Wide variety: The peer group includes 24 multilevel marketing businesses in six countries acquired between 2002 and 2015 with various product lines, including International Beauty (cosmetics), Rexair (vacuums), Silpada (jewelry), Herbalife (nutritional supplements), Ginza Stefany (cosmetics), and others. Revenues range from less than $1 million to over $1 billion.

Enterprise value multiples of these firms are rather low, with a median EV/sales multiple of 0.7x compared to 1.5x for nutraceutical or cosmetic businesses. As a result, the value of their intangibles assets is also lower. Average trademark royalty rates are 6.5% on net revenues for normal product distribution, versus 3.8% for distribution through multilevel marketing networks (see chart below). A plausible explanation is that customers often put more trust in the personal relationship with the distributor, while the trust in the brand name is less important. In general terms, a direct-to-consumer distribution system seems to have a higher total cost of distribution, although sales are made at higher-end consumer (retail) prices. Moreover, direct-to-consumer products seem to incorporate less technology, R&D, differentiation, and IP protection, making it more difficult to get approved and listed by major retailers. Long-term stock performance of corporations following a direct-to-consumer business model confirm these profitability issues.

MARKABLES, based in Switzerland, now has a database of over 8,200 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).

Extra: MLMs face a special risk in that they can trigger regulatory scrutiny because of a business model that rewards participants for recruiting other sales reps. Under a recent federal settlement, Herbalife must pay $200 million and restructure its compensation structure to avoid being classified by the U.S. as a pyramid scheme.

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Global BV news:
Pratt’s Stats adds European transactions

As part of its global expansion, Pratt’s Stats has just added 250 European transactions to its database, including 132 deals from the United Kingdom and 38 deals from Germany. All European deals have been converted into U.S. dollars so that the data are comparable to the 25,000-plus U.S. deals in the database.

Average deal $285 million: The U.K. transactions have a median deal price of $45 million and an average deal price of $285 million, and they are diverse across industries, including technology, financial services, manufacturing, healthcare, and consulting, among others. “With the successful incorporation of these new European deals into the Pratt’s Stats database, BVR plans to continue its expansion of Pratt’s Stats for a more global reach,” says Doug Twitchell, BVMarket data publisher. To search for these new deals, visit the Pratt’s Stats webpage.

Extra: A companion product from BVR partner Epsilon Research offers additional European transaction analysis reports and multiples. The Epsilon Multiple Analysis Tool (EMAT) is a sophisticated search engine to help you identify reliable acquisition multiples on small and midmarket M&A and LBO transactions by industry sector. Please contact BVR’s Lexie Gross for details.

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PitchBook expands international GPC data

BVWire recently learned that PitchBook now covers most of Europe, expanding its global reach of guideline public company (GPC) data, comprehensive financials, and links to source documents, income statements, balance sheets, and statements of cash flow. In the “Location” tab in PitchBook’s search engine, you’ll now see Europe separated into four distinct regions with many countries under each region. We also hear that PitchBook should have the world completed “by year end.” For more information, click here.

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Preview of the August issue of Business Valuation Update

Here’s what you’ll see:

  • “Adjustment Mapping and the Public-vs.-Private Company Discount Debate” (Mike Smith, ASA, CFA, CVA). A follow-up to a previous article that urges the development of a common language and framework to clearly explain the reasons for discounts.
  • “Wrestling Match Over Valuation of Hulk Hogan Sex Tape” (BVR Editor). The valuation expert who testified in the Hulk Hogan sex tape case explains how he fended off a Daubert challenge over his methodology in estimating damages from Gawker’s unauthorized posting of the tape. He also reveals details of the methodology.
  • “Economic Damages Experts Offer Top Advice at NACVA Confab” (BVR Editor). Four sessions were devoted to this growing area of practice at the recent annual conference of the National Association of Certified Valuation Analysts in San Diego.
  • “How to Avoid Harsh HIPAA Penalties When Doing Healthcare Valuations” (BVR Editor). Valuation experts can inadvertently run afoul of the expanded requirements for patient data security under the Health Insurance Portability and Accountability Act of 1996. Mark O. Dietrich, the editor of the BVR/AHLA Guide to Healthcare Industry Finance and Valuation, explains how to avoid this trouble.
  • “Changes in Regs and Standards Take Center Stage at ASA Fair Value Event” (BVR Editor). Updates from the FASB, SEC, and PCAOB that impact fair value for financial reporting. Also, details emerged about the new fair value quality initiative (FVQI) that includes a new valuation credential.
  • “A Dozen Action Ideas From NACVA’s 25th Anniversary Conference” (BVR Editor). Some valuable tips on management forecasts, engagement letters, the use of statistics, practice development, and more.

The issue also includes:

  • Regular features: “BV News At-a-Glance,” “Ask the Experts,” “Tip of the Month.”
  • BV data spotlight: Pratt’s Stats MVIC/EBITDA Trends, ktMINE Royalty Rate Data, Economic Outlook for the Month, and Cost of Capital Center.
  • BV case law update and analysis: The latest court cases that involve business valuation issues.

To stay current on business valuation, see the August issue of Business Valuation Update.

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New BVR website launches next week

BVR is thrilled to announce the launch of our highly anticipated redesigned website next week. The new website offers a streamlined design with efficient navigation on all devices, making learning about and searching BVR's suite of products and content easier than ever. We’ve also included topical areas of interest so you can easily find all the resources you need, plus a current business valuation news feed with access to historical coverage. And one of our most celebrated new benefits for subscribers is the ability to login to your BVR accounts in one place. To learn more about the new website before the launch, bookmark this page and check back often for updates.

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Act now to save on ASA’s 2016 Advanced BV Conference

You have just two days to take advantage of early bird registration (ends July 22) for the 2016 Advanced Business Valuation Conference of the American Society of Appraisers (ASA). It will be held on September 11-14 in Boca Raton, Fla., at the Boca Raton Resort & Club. This year’s event features over 30 sessions to choose from in three areas of educational focus: business valuation, fair value, and cost of capital. BVR is proud to be a sponsor of this event. For a complete listing of all topics and presenters, click here.

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BV movers . . .

People: Carleen Gaskin was promoted to partner at the Princeton, N.J.-based WithumSmith+Brown … John Levitske has joined Huron Consulting Group’s Chicago office as senior director in the Commercial Dispute Advisory Services practice … Nick Talbot, industry veteran of Ernst & Young, KPMG, and RICS, was appointed CEO of the International Valuation Standards Council (IVSC) and will be based in London … The Milwaukee Business Journal named Jamie Truog, CFO of Valuation Research Corp., “CFO of the Year.” This annual award recognizes CFOs who play vital roles in the success of their businesses or organizations and make valuable contributions to their profession and communities.

Firms: Armanino launched its Corporate Finance practice this month with the goal of advising clients on M&A activities as well as sales of intellectual property and patents … Mazars, an international organization specializing in audit, accountancy, tax, and consulting services, acquired the Corality Financial Group, a financial modeling consultancy and training course provider with offices in Sydney, London, and New York … Upon welcoming Jeremy Bronson as managing partner to the Perrysburg, Ohio-based Tebay & Associates LLC, the firm has officially rebranded as Tebay Bronson & Associates LLC Valuation Research Corp. was honored as the “2016 Valuation Firm of the Year” at the 2016 International M&A Awards sponsored by The M&A Advisor—for the third year in a row!

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Upcoming CPE events

Misuses of IP Over the Internet: Searching for Value (July 21) with Brian Buss (Nevium Intellectual Property Solutions) and Doug Bania (Nevium Intellectual Property Solutions). This is Part 4 of BVR's Special Series presented by The Comprehensive Guide to Economic Damages.

Tax Issues Arising in Valuations (July 26), with Patrice Radogna (Valuation Research Corp.) and Heather Tullar (Valuation Research Corp.).

Valuation of Options and Option-Like Instruments, (July 27), with Oksana Westerbeke (Grant Thornton) and Jared Hannon (Grant Thornton).

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 Andy Dzamba (Executive Editor) or Sylvia Golden (Executive Legal Editor) at:
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In this issue:

Brexit advice

Daubert trap

IRC Sec. 2704 regs

Report copyright

Healthcare insights

Last call for FES

MLM trademarks

Global BV news

BVU preview

BVR website launch

ASA's BV conference

BV movers

CPE events

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