Chancery’s controversial Dell fair value opinion
The Delaware Court of Chancery’s just-published opinion in the Dell Inc. statutory appraisal action, which arose out of the 2013 management buyout led by the company’s founder, Michael Dell, has stunned finance professionals. How could the court find the deal price did not reflect fair value while recognizing that the board and Dell himself made every effort to perform a proper sale? The board appointed a special committee, which hired financial advisors, which prepared copious valuations as the transaction unfolded. Moreover, several recent decisions from the Chancery found the merger price was the most reliable indicator of value.
Shareholders shortchanged: In the Dell buyout, the final merger consideration was $13.75 per share (plus a $0.13 special dividend), whereas the court, performing a discounted cash flow analysis that drew on analysis from both sides’ experts, came up with a value of $17.62 per share. There were about 1.76 billion shares outstanding. In other words, Dell sold the company for about $7 billion too little. The crux of the Chancery’s long and dense opinion is that a statutory appraisal determination is not an investigation of a breach of fiduciary duty claim. Although no one in this transaction breached any fiduciary duty, the common stockholders also did not receive fair value.
According to the court, there was “a lack of meaningful price competition during the pre-signing phase,” and the post-signing phase, which included a go-shop period, did not cure this defect. The paramount problem was that the players all were financial sponsors—there was no outreach to strategic bidders—and all the valuations driving the merger were premised on leverage buyout models, which calculate what a financial investor would be willing to pay to achieve a certain internal rate of return. That’s not a “fair value” determination, the court said. “Fair value” under the appraisal statute means “the value to a stockholder of the firm as a going concern as opposed to the firm’s value in the context of an acquisition or other transaction.”
As for the two bids that came in during the go-shop period and that led to a 2% increase in the final merger consideration, they ultimately went nowhere. If anything, the court said, the two bids showed that the original merger price was too low. Worse, for the respondents’ case, the fact that the two bids exceeded the final merger price “undercut the notion that the Final Merger Consideration provided fair value.”
Valuations way apart: At trial, both parties’ experts used a DCF analysis and achieved startlingly different results. The petitioner’s expert said the company had a fair value of $28.61 per share on the closing date; the respondents’ expert said the value was $12.68 per share. “Two highly distinguished scholars of valuation science, applying similar valuation principles, thus generated opinions that differed by 126%, or approximately $28 billion. This is a recurring problem,” the court observed.
The court, which spent most of the opinion discussing appraisal jurisprudence, focused its relatively short DCF discussion on areas of substantial disagreements between the experts. Next week’s BVWire will report on the disagreements and the court’s resolution.
Read the opinion: BVLaw offers a complimentary download of the court’s opinion, In re Appraisal of Dell Inc., 2016 Del. Ch. LEXIS 81 (May 31, 2016). There will be an extended discussion in the August issue of Business Valuation Update.
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BV titans at NACVA’s silver anniversary conference
Shannon Pratt, Roger Grabowski, Jim Hitchner, Nancy Fannon, and Honorable Judge David Laro of the Tax Court are just a few of the valuation thought leaders dubbed by NACVA as “industry titans” who gave presentations at the organization’s 25th anniversary conference in San Diego last week. BVWire was there, and here are some notable quotes from a few of the early sessions.
"The valuation method that is best, whether for large or small target companies, is the one for which you have the strongest support,” says Fannon.
Pratt, Hitchner, and Jay Fishman are the authors of a new book, A Consensus View: Q&A Guide to Financial Valuation. “But the one area where we could not come to a consensus is whether you apply a DLOM to controlling interests,” says Hitchner. “I don’t do it and Fishman doesn’t do it, but Pratt says it’s OK.”
In terms of supporting a DLOM, Pratt says: “The pre-IPO studies have received a bad rap because people haven’t adjusted the data for time periods.”
What are the option models of choice? “We’ve been using John Finnerty’s option model heavily (rather than Black-Scholes) at Duff & Phelps, but we never rely entirely on one option model,” says Grabowski. He pointed out that studies show that actual market behavior is different than what Black-Scholes theory suggests.
“I'm coming to the conclusion that appraisers should include a sensitivity analysis in their reports so the judges can see the impact of assumptions,” says Judge Laro. “That would make a huge difference in how reports are received by the courts.”
We’ll have more takeaways in the next issue of BVWire plus additional coverage will be in the August issue of Business Valuation Update.
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Record attendance at ASA fair value conference in Los Angeles
There was a full house at the ASA/USC 11th Annual Fair Value Conference in Los Angeles last week. BVWire was there, and here are a few takeaways from some of the sessions, all of which were excellent.
Comments are due June 24 on two exposure drafts related to the new fair value credential, Anthony Aaron (E&Y) reminded the audience (see the June 8 issue of BVWire). Aaron is the chair of the performance requirements workstream group for the Fair Value Quality Initiative designed to strengthen fair value in financial reporting.
When valuing a financial instrument, consider its principal market, advises Kristopher Shirley (SEC), who says the agency sees problems in this area. He says that, if you identify a market but can’t access it, you can’t rely on it for the valuation, but you can use it as an input.
The FASB will soon issue an invitation to comment about internally generated intangible assets, says Adam Kamhi (FASB),to determine whether this should be added to the FASB’s rule-making agenda (current rules don’t allow recognition on the balance sheet).
A proposed guide on valuing contingent consideration will be out in a “few months,” says Alok Mahajan (KPMG), chair of the working group under The Appraisal Foundation.
The three “pillars” of focus for transaction due diligence are: (1) the quality of earnings; (2) net working capital; and (3) debt (or debt-like) items, says Mike Kim (E&Y). Think of net working capital as the gas that fuels a car—it really makes a difference how much gas is in the tank, adds Razmik Libarian (E&Y).
Your help is needed in research on the role of specialists in developing and evaluating the fair value estimates used in audited financial statements. The University of Wisconsin-Madison is conducting a survey on this issue, announced Stephani A. Mason (DePaul University), who handed out the survey to the audience. You can take the survey if you click here (you’ll get a $10 Starbucks gift card).
More coverage of the conference will be in the August issue of Business Valuation Update.
Extra: Part 4 of BVR's Special Webinar Series on Fair Value continues on June 21 with Navigating a Fair Value Audit Review with Kesh Iyer (RSM) and Lindsay Hill (RSM).
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The most comprehensive study of BV firm management and economics
Now is your chance to contribute to the largest and most thorough analysis of best practices in the business valuation profession. Join your peers in responding to BVR’s Firm Economics Study to see how growth and change are accelerating in the business valuation profession. Once all responses are compiled, the Firm Economics Study will show you where your firm falls in relation to your peer firms’ performance, compensation, billing rates, marketing and practice development, and more. The survey, which is now open, will result in the largest and most thorough analysis of best practices in financial management, marketing, human resources and compensation, and professional and ownership standards that you will find anywhere. BVR conducts this confidential survey regularly to help appraisers benchmark and improve their practice management. Those who participate will receive a free Executive Summary of survey results, plus a special offer to purchase the full report for $99 (regular price is $299). The deadline for responses is July 8, 2016. Click here to participate now.
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Updated guide for FMV restricted stock study
The complimentary 2016 edition of the FMV Companion Guide is now available, and you can’t afford to miss the new updates. This free guide serves as the premier source of methodology for applying DLOMs and thoroughly analyzes data from The FMV Restricted Stock Study™, the largest fully vetted DLOM database.
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Global BV news:
Computer trademark values
We all use a computer, and we’re all familiar with computer brands. Some of the most famous corporations in the world, such as Apple, IBM, HP, Dell, and Acer are in the computer business. A closer look at the value of 13 different computer brands reported in transactions is rather sobering.
Low multiples: This month’s peer group analysis from Markables includes brands such as Compaq, Gateway, Sun, IBM, and Packard Bell, among others. Enterprise valuation multiples indicate low profits for the sector, with sales/EV multiples ranging from 0.18x to 0.64x (see the table below). Many businesses struggle to keep pace with critical mass, mass market commoditization, short product life cycles, and new technology. Trademark royalty rates range from 0.4% to 1.5% on revenues, with a median rate of 0.5%. Considering the high portion of trademarks with short useful lives, trademark value accounts for an average 10% of enterprise value.
Two opposing aspects influence trademark value: business profitability and brand strength. While large brands in the mass market show some signs of brand strengths, they often have weak profitability. On the other side, specialized niche offerings show better profitability but are rather unknown brands. Most computer trademarks are assumed to have finite lives and are to be replaced by new brands and new products sometime in the future.
(Click on graph to view in full size)
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Preview of the July issue of Business Valuation Update
Here’s what you’ll see:
- “Internet Domain Valuation: Not Just Economic Theory” (Jim Horvath and Jeff Horvath). For many people, establishing the value of an Internet domain name appears to be a well-defined black-and-white process that considers a variety of economic variables and formulae to obtain a satisfactory conclusion. But, ultimately, determining that amount is much more an art than a science.
- “Debate Rekindles Over Private Company Cost of Capital Model” (BVR Editor). A recent issue of The Value Examiner devotes a good deal of space to the implied private company pricing line (IPCPL), a model designed to better estimate the cost of capital for small private companies.
- “Debunking the Myth That Business Appraisers Lowball Brand Values” (Christof Binder). How does something as emotional and intangible as brands and someone as fact-based and conservative as an accountant fit together? Not particularly well, according to marketers and brand valuation specialists.
- “Government Crackdowns, M&A, S Corps in Spotlight at NYSSCPA BV Conference” (BVR Editor). Some of the profession’s hottest topics were covered at the annual business valuation conference of the New York State Society of CPAs (NYSSCPA) in New York City. Here are some key takeaways.
- “Sneak Preview of New Material in the BVR/AHLA Healthcare Valuation Guide” (BVR Editor). Groundbreaking research is included in the “complete revision” of the BVR/AHLA Guide to Healthcare Industry Finance and Valuation, edited by Mark O. Dietrich (Mark O. Dietrich, CPA, PC). The research deals with the common misuse of surveys in determining the fair market value of physician compensation.
- “Book Review: The Comprehensive Guide to Economic Damages, Volume 1 and 2, 4th ed.” (Michael Pakter). A review of the new edition by Nancy J. Fannon and Jonathan M. Dunitz.
The issue also includes:
- Regular features: “BV News At-a-Glance,” “Ask the Experts,” “Tip of the Month,” Pratt’s Stats MVIC/EBITDA Trends, Economic Outlook for the Month, and Cost of Capital Center.
- BV case update and analysis: The latest court cases that involve business valuation issues.
To read these articles, regular features, and case digests, see the July issue of Business Valuation Update.
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BV movers . . .
People: Arlene Ravalo-Jao has joined Cherry Bekaert’s Fort Lauderdale, Fla., office as a senior manager on the valuation services team … David Rogers has joined Naperville, Ill., firm Business Appraisal Services as director of litigation services … Richard Wise, founder and partner in MNP’s Montreal office, received the 2016 Thomas R. Porter Lifetime Achievement Award from NACVA at its annual conference in San Diego.
Firms: Perkins & Co., the largest locally owned accounting firm in Portland, Ore., announced it will add the local boutique firm Thompson Kessler Wiest & Borquist on July 1; 18 employees and five shareholders will join the Perkins team.
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Upcoming CPE events
Navigating a Fair Value Audit Review (June 21), with Kesh Iyer (RSM) and Lindsay Hill (RSM). This is Part 4 of BVR's Special Series on Fair Value.
Valuation Techniques for a Physician Practice: Getting it Right (June 23), with Mark Dietrich. This is Part 2 of BVR's Special Series presented by the BVR/AHLA Guide to Healthcare Industry Finance and Valuation.
Litigation Dynamics and Daubert Challenges: Excelling as an Expert (June 28), with Weston Anson (Consor).
Important note to webinar attendees: To ensure that you receive your dial-in instructions to BVR’s training events, please make sure to whitelist firstname.lastname@example.org.
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