Chancery’s controversial Dell fair value opinion: Part 2
As we reported in last week’s BVWire, the discounted cash flow analysis discussion takes up relatively little space in the Delaware Court of Chancery’s exhaustive and controversial Dell fair value decision.
At trial, both parties’ experts used a DCF analysis to determine the going concern value of the company on the date the merger closed, October 2013. But because they disagreed sharply over critical inputs, including forecasts and taxes, they reached significantly different outcomes. The petitioner expert’s per share price was $28.61 as opposed to the respondent expert’s $12.68.
Court does DCF: Neither analysis was entirely credible, the court found. The petitioner expert’s result suggested that the merger undervalued the company by $23 billion. “Had a value disparity of that magnitude existed, HP or another technology firm would have emerged to acquire the Company on the cheap,” the court observed. On the other hand, the respondent expert’s result was below the final merger consideration ($13.75 per share, plus a $0.13 special dividend). If, as the court found, the deal price undervalued the company, the respondent expert’s valuation did even more so. The court performed its own DCF by drawing on elements from both experts.
The projected cash flows underlying the experts’ analysis accounted for much of the difference in value, the court said. Both experts used projections an independent third-party expert had prepared at the request of the special committee, after it had started the merger process. The court found the projections “impressively thorough, with over 1,100 assumptions. The resulting model was dynamic and transparent.” At the same time, they were done nine months before the valuation date and never updated. Only the respondents’ expert adjusted them to ensure they had not become stale by the time of closing.
Another credible set of projections was closer in time to the closing date, but the respondents’ expert made adjustments to account for nonrecurring restructuring expenses and stock-based compensation.
Litigation-driven adjustments are somewhat suspect, the court noted. Normally, the Chancery prefers valuations “based on contemporaneously prepared management projections.” In this instance, however, the respondents’ expert “persuasively justified his changes.” The court adopted the projections for its own analysis.
Tax rate: Taxes also figured prominently in the valuations. The petitioners’ expert used a 21% tax rate throughout his forecast period based on rates in the valuations models the company’s financial advisors prepared. The respondents’ expert used a 17.8% rate during the projection and transition periods, but a 35.8% marginal tax rate for the terminal period. He justified the latter by citing to academic literature.
The court adopted the 21% rate. It noted the company had not paid taxes at the marginal rate since at least 2000. In the five years leading up to the merger it paid effective rates of between 16.5% and 29.2%. Its cash tax rates ranged from 9.6% to 24.1%. The low effective rate stemmed from the company’s “indefinite reinvestment election,” meaning it represented to auditors that it planned to defer indefinitely paying U.S. taxes on overseas profits. To suggest, as the respondent expert’s model did, that the company would in the near future pay a marginal tax rate of 35.8%, not to mention perpetually, contradicted historical practice, the court said.
Ultimately, the court arrived at a fair value of $17.62 per share—almost $4 per share more than the deal price.
Read for yourself: 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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NACVA confab spotlights economic damages
Lost profits and economic damages was a hot topic at NACVA’s annual conference in San Diego. Four sessions were devoted to this growing area of practice. Insights from these sessions follow:
Key pitfalls: A major cause of problems with a damages analysis is that experts often do not understand the appropriate remedy for a particular action, according to Nancy Fannon (Meyers, Harrison & Pia), co-editor with Jonathan Dunitz, Esq. (Verrill Dana), of the newly published Comprehensive Guide to Economic Damages, Fourth Edition. Another tricky issue the editors raise is dealing with the nuances of how to calculate the damages—including those with respect to the jurisdiction you’re in or which of several available remedies fits the current situation.
In another session, Brian Buss and Doug Bania (both with Nevium) talked about calculating damages from the misuse of intellectual property and defamation over the internet. For example, trademarks can be hidden in metadata to misdirect a competitor's customers who are doing a web search. Also, social media can be a breeding ground for potentially libelous statements using Facebook, blogs, Twitter, and the like. There are tools you can use to ferret out, calculate, and prove damages with respect to internet infringement and defamation. These tools, such as Google Analytics, do not replace, but rather supplement, existing valuation and damages methodologies. Buss and Bania wrote a chapter on this topic in the new Fannon/Dunitz book.
When engaged in a damages case, “stay in your lane,” advises Chris Hamilton (Arxis Financial Inc.). You’re not the lawyer and the lawyer is not the expert, he points out. For example, your reports should not be citing the law. Also, the issue of causation is up to the lawyer, not the expert. He also stressed the importance of telling the story (“communication is key”) and making sure you understand the case at the outset and your role in it (e.g., is there personal injury involved, and, if so, will you be doing that piece of the case?).
Another pitfall when calculating damages is the failure to use an industry specialist when it’s necessary, according to Lari Masten (Masten Valuation). Some industries are unique and require a specialized expert able to issue a report that the damages expert can cite. Don’t let ego or any other reason stop you from advising counsel that an industry expert is needed. Masten cited Blair-Naughton, LLC v. Diner Concepts (available here from BVLaw—subscription required). In this case the expert was excluded because he relied on information from his client, who the court said was not an expert in the industry.
There will be more detailed coverage of these sessions in the August issue of Business Valuation Update.
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Importance of fairness opinions stressed at Transaction Advisors M&A Conference
BVR had the good fortune to partner with and attend the Transaction Advisors M&A Conference last month in San Francisco. A deep-dive feature was a panel on “Valuation Trends and Fairness Opinions” led by Chris Janssen, a managing director at Duff & Phelps. On the panel were Michael O’Bryan, Esq., a partner at Morrison & Foerster, and Ra’ed Elumurib, investor and advisor and the former EVP of corporate development at PMC-Sierra.
A must-read case: All discussion points led back to In re Trados Inc., a seminal 2013 case in which the Delaware Court of Chancery highlighted the value (and necessity) of obtaining a fairness opinion in a merger or acquisition. BVLaw’s case digest is available to readers as a complimentary download. In re Trados makes for a riveting read for many reasons, not the least of which is the Chancery’s clear and plain reprimand because of a complete disregard for common shareholders. The common shares were ultimately deemed worthless after the merger because they had been proven worthless (due to zero growth prospects for the target company). But Janssen highlighted the court’s observations that the “directors had not even thought about [common shareholder] issues; at least designate a few people to think about it!” O’Bryan added that “common shareholders didn’t get the attention they should have.” Eric Nath (Eric Nath & Associates LLC) exchanged observations with Elumurib on the rates of return he uses on deals and how he derives them, especially when working with financial projections from management.
Watch it: You can watch a video of this session—and all the conference sessions—if you click here.
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FASB issues new impairment guidance for financial instruments
The Financial Accounting Standards Board has released a long awaited accounting standards update for credit losses. This is Accounting Standards Update (ASU) No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.
Earlier reporting: Financial statements will have to show credit losses on loans and other financial instruments in a more timely fashion under the new standard. Entities will be required to measure all expected credit losses for financial assets held at the reporting date. “Financial service entities will be heavily affected,” says PwC in a report. “However, given its broad scope, which includes trade and lease receivables, all entities will need to evaluate the ASU’s impact.” PwC will host a webinar to explain the new standard on July 25.
The ASU is effective for U.S. SEC filers for fiscal years beginning after Dec. 15, 2019, and later for other entities.
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Reminder: Participate in the only BV-specific firm economics survey
Find out about BV firm performance, compensation, billing rates, marketing, practice development—and more—by taking part in BVR’s Firm Economics Study. Once all responses are compiled, you’ll see how your firm stacks up against others. This is the largest and most thorough analysis of its kind, and those who participate will receive a free Executive Summary of survey results, plus the opportunity 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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Use a ‘strategy canvas’ to jumpstart BV firm growth
The success of your BV firm depends on differentiation and the ability to develop untapped opportunities your competitors have not identified, according to Mel Abraham (Mel Abraham Inc.) and Rod Burkert (Burkert Valuation Advisors).
Useful tool: One way to get started is to use the “strategy canvas,” a tool developed by Blue Ocean Strategy. During a recent webinar, Today’s Leading Edge Tools for Practice Growth, Abraham and Burkert (who are co-founders of the Practice Builder Academy), illustrated the use of this tool to assess a BV firm/practitioner (see below). For example, this practitioner (the blue line) is more “niche known” than the competition, so this may represent a “blue ocean” where the practitioner will find less competition, and where the competition would not be as well educated in that niche. (A “blue ocean” is one with no red blood from a shark feeding frenzy.)
During the webinar, they offered the audience a free download of a strategy canvas template that can be used to help devise a plan to grow your practice. They’ve agreed to give access to BVWire readers, and you can download the template if you click here.
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Auditors skeptical of claim that M&As add value
Some audit professionals estimate that only 30% of M&A transactions add value, and they want to see realistic projections and a bridge to future performance, according to PJ Patel (Valuation Research Corporation), who has been leading a series of Leadership Roundtables around the country. These roundtables help CFOs, CAOs, corporate controllers, tax directors, and corporate development executives discuss current issues and regulatory pressures faced in today’s deal-making environment.
As far as the auditors’ skepticism is concerned, they “do not want to be involved in a restatement, which most often focuses on deficiencies in documentation, evidence, and controls,” says Patel, who points out these other significant issues:
- Tax inversions—the new Obama administration policy announced in April adds to the already high level of IRS scrutiny;
- Transfer pricing—companies with international operations face significant changes as BEPS reporting comes online;
- New lease accounting rules—rules which went into effect in 2015 will especially affect operating leases;
- Valuing customer relationships, deferred revenue, inventory;
- Reconciling the premium paid in a strategic deal; and
- Pre-deal accretion/dilution analysis.
The Leadership Roundtables are invitation-only events, and three more are scheduled: June 23 (McLean, Va.), June 28 (Palo Alto, Calif.), and June 29 (Denver). To request your pass to attend, click here.
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Global BV news:
iiBV announces new board
The International Institute of Business Valuers (iiBV) has a new board of global business valuation professionals for 2016-17. The new board includes chair Edwina Tam (Hong Kong) and members Laurent Després (Canada), Peter Ott (Canada), Liying Han (China), Soltan Aljorais (Saudi Arabia), Ray Moran (U.S.), Michelle Levac (Canada), Vesna Stefanovic (Serbia), Andrew Strickland (United Kingdom), and Jeff Tarbell (U.S.). Tam thanked Robert B. Morrison, past chair, for his significant leadership contribution to the iiBV.
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Hulk Hogan v. Gawker . . . StoneEagle v. Pay-Plus. Hear the Experts from the two hottest cases in BV
Get the view from inside the courtrooms of two of the most recent high-profile cases to hit the BV world and beyond. In BVR’s upcoming webinar “Litigation Dynamics and Daubert Challenges: Excelling as an Expert,” Weston Anson shares the expertise earned in presenting an unproven methodology in court. “The judge allowed me, as plaintiff’s damages expert, to offer royalty rate analysis without reference to any of the Georgia-Pacific factors in the matter StoneEagle Services, Inc. v. Pay-Plus Solutions, Inc. and to provide testimony based on market approach valuation theories. Plaintiffs received a favorable outcome—a jury award of $2.2 million in royalties,” Anson explains.
Jeff Anderson, director of valuation and analytics at CONSOR, was the testifying economic expert on behalf of Terry Bollea (Hulk Hogan), who is poised to collect damages awards of $55 million, economic; $60 million, noneconomic; and $25 million, punitive from the gossip website Gawker (see the May 11, 2016 BVWire). As IP valuation experts, the CONSOR team was asked to provide an opinion and to quantify the benefit to Gawker, as measured by the increase in value of the website that resulted from Gawker posting the Bollea sex tape. Join us Tuesday, June 28, to get insight into the world of high-stakes courtroom testimony.
BV movers . . .
People: Wendy Cama, audit partner at the NYC office of Crowe Horwath, has been elected chair of the executive committee. She is the first woman to lead this group ... Dick Shuma, former managing director at BMO Harris Bank of Chicago, has joined the Oakwood Terrace (Ill.) firm, Prairie Capital Advisors, as managing director focusing on employee stock ownership plan (ESOP) advisory services and business development ... Ken Yormark, former director at Navigant Consulting, has joined Grant Thornton’s forensic and valuation services practice as managing director. He is based out of the New York City office but will focus on the New England region.
Firms: Moss Adams has announced its intention to merge in the Dallas-based CF Accountants & Consultants and its entire staff of 57 (including seven partners) on June 30 ... Lear & Pannepacker (L&P) has merged in the firm of Jay Lesser CPA, PC, in Plainsboro, N.J. This is L&P’s sixth combination in the past few years.
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Upcoming CPE events
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).
Damages Estimation and Valuation: How to Use Survey Research (June 29), with Leon Kaplan (Princeton Research & Consulting Center Inc.) and Larry Chiagouris (Lubin School of Business, Pace University). This is Part 3 of BVR's special series presented by The Comprehensive Guide to Economic Damages, Fourth Edition.
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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