March 14, 2012 | Issue #114-2  

On second try, Oracle expert still can’t get it right

Remember when the federal district court essentially gave the plaintiff’s expert a “roadmap” for calculating patent and copyright infringement damages under the entire market value rule in the much-watched (and multibillion dollar) litigation between Oracle and Google? (See BVWire #108-3.) Well, despite this “strong warning” to start with the unsuccessful but “real world” negotiations between the parties and then apportion any reasonable royalty among the 29 asserted claims in the case, the Oracle expert “made a stab” at apportionment in his second attempt, the court found, but then he applied a flawed methodology, including:

  • The Oracle expert used the complete “universe” of patented know-how and technology that existed in 2008-2010—or more than five years after the parties’ hypothetical negotiations would have taken place, resulting in “apples to oranges” conclusions.

  • Rather than make a “claim-by-claim” analysis of damages, the expert made a “patent-by-patent” analysis, treating each patent as “an indivisible whole,” the court said. “It is a mystery why Oracle and [its expert] chose to disregard this aspect of the [prior] order.”

  • The expert also erred by relying on past licenses involving Nokia, Qualcomm, and Apple, because he failed to establish their comparability. In relying on prior settlements of the patented technology, he also confused two litigations and used one involving dissimilar claims.

Despite also warning the plaintiff that this second attempt would be its “last bite of the apple,” the court granted Oracle’s expert a third try to calculate damages, “so long as his methodology conforms to prior rulings.” Oracle agreed to do so, but last February, Google filed a motion to strike its expert’s third damages report as well as a “conjoint analysis report” by its supplemental expert. The parties should have fully briefed the issues as of last Friday, March 9, 2012. Stay tuned…

In the meantime, read the complete digest of Oracle America, Inc. v. Google Inc., 2012 U.S. Dist. LEXIS 2500 (Jan. 9, 2012) in the next Business Valuation Update; the court’s opinion will be posted soon at BVLaw.

One solution to the ‘issues that plague us’

“The fundamentals of what we do in BV are finance and economics, but we as an industry don’t teach it that way,” says Nancy Fannon (Fannon Valuation Group). As a result, much of the lack of understanding (and lack of consensus) on the tougher issues—such as the valuation of pass-through entities, derivation of the discount rate, and the marketability discount—may stem from this institutional lapse.

“I think a lack of understanding of much of this foundational knowledge has led to our general inability to convincingly conclude on the issues that plague us,” Fannon says. “How can we possibly make adjustments from market returns for size, liquidity, and taxes if we don’t initially understand what is already embedded in the market returns we are using?”

Solution requires self-motivation. One way to fill the “educational gap” in BV involves just buckling down. To delve deeper into the discount for lack of marketability, for instance, Fannon suggests that analysts “read Ibbotson’s SBBI cover to cover, then read the academic research that documents and discusses these issues.” Or start with your own particular area of interest—and then “read, read, read,” she says. Recently, Fannon put together a list of the books, articles, and other authorities that she began with for the Business Valuation Update (Feb. 2012). “Mike Crain gave me great advice about reading these types of studies, which can be very dense: Start at the front and back (summaries), then if it interests you, work your way into the body of it.” To help valuation practitioners supplement their professional libraries, we’ve made Fannon’s suggested reading list available as our latest free resource. To download your copy, click here.

Improve the market approach by using three regression analyses

When C. Fred Hall III (Amador Appraisals and Acquisitions) began his business valuation career, he was “frustrated” by the market approach. “I found that the values calculated by the gross revenue multipliers were either considerably higher than the values calculated by the cash flow multipliers, or the gross revenue multiplier values were considerably lower. I had to reconcile two values that were often at opposite ends of the spectrum—and each was clearly wrong.”

Over time, he found that “using three regression analyses significantly improved the market approach.” A regression analysis can identify outliers within an initial selection of comparables, which, in turn, helps produce a smaller, “sanitized,” and more accurate sample. Using the formula produced by a regression analysis, BV appraisers can also plot a company’s variables on a graphic representation of the subject market. This “regression market line enables us to determine the probable value of the subject company,” Hall writes. Look for his complete article, “How Regression Analysis Makes the Market Approach More Valuable,” in the April 2012 Business Valuation Update.

New PitchBook study shows potentially greater correlation between private and public markets

Last week PitchBook published its Fund Returns Report, 1Q 2012 Edition (sponsored by BMC Group). Compiled from the PitchBook Platform, the report covers a decade of fund returns data for several asset classes, including private equity (buyouts and growth), venture capital, mezzanine, and real estate, with an emphasis on recent performance. One interesting insight from the data is “that the overall economy and financial markets actually have a significant impact on returns over the short and medium terms,” says the introduction to the report. This leads to the conclusion “that there might not be as low of a correlation as previously thought between the public and private markets.” For example:

The J-curve of private equity and venture capital funds is traditionally a phenomenon relating to the age of the fund; however, it turns out that the economy can actually have a large impact, driving both the depth and length of the J-curve. Another area that is always important when evaluating performance is the spread in returns between strong and weak performers, and the corresponding impact that investing in a bottom quartile versus low quartile fund has on returns for investors.

These are just a few of the areas that the new PitchBook report covers; to access your copy, click here.

A new(ish) model for estimating the ‘Risk Premium Factor’

“Most approaches to deriving the equity risk premium (RFP) involve calculating a fixed spread between historical equity returns and the risk-free rate,” says Stephen Hassett (Hassett Advisors). His new model “differs significantly, in that the ERP is simply a function of the risk-free rate times a constant called the Risk Premium Factor (RPF), where Equity Risk Premium = Risk Free Rate x RPF.” Further:

The RPF Model is built on a simple constant growth equation where P = E / (C - G), and explains S&P Index levels with good accuracy for 1960-present using only the long-term Treasury yields, S&P 500 operating earnings, and some simplifying assumptions. P is predicted price for the index, E is index earnings, C the cost of capital, and G, the expected long-term growth rate.

Hassett first introduced his “Risk Premium Factor” model in 2010, in the Journal of Applied Corporate Finance, in the article, “The RFP Model for Calculating the Equity Market Risk Premium and Explaining the Value of the S&P with Two Variables.” More recently, he’s posted an article that focuses on earnings as the driver of P/E, and another on interest rates. Analysts who want to look further into this subject can read Hassett’s book, The Risk Premium Factor, which Roger Grabowski (Duff & Phelps) recommends (on the back cover) for its explanation of “the economic interrelationships that drive the pricing of the broad stock market and the equity risk premium."

One-stop shop for all your company and market data

Ascanio Salvido, an Italian valuation and litigation support expert, is currently looking for “company fundamental and market research data” that’s available on a subscription basis, he tells BVR’s LinkedIn discussion group (registration required). BVR’s offerings that address Ascanio’s needs include:

  • First Research Industry Reports: 370 industry profiles covering 900 industry segments (over a third of those include international coverage);
  • BizMiner Reports: covers 6,500 lines of business;
  • To some extent PitchBook: over 15,300 companies;
  • Pratt’s Stats: 18,000+ deals;
  • Public Stats: 3,000+ deals; and
  • BIZCOMPS: 12,000+ deals

To access any and all of these company and market resources, visit BVMarketData.

IVSC issues new guidelines on fairness opinions

“A valuation or valuation analysis is often at the core” of a fairness opinion, says the International Valuation Standards Council (IVSC) in a news release. Although some countries regulate the conditions surrounding fairness opinions—including who may provide them and what they should contain—these requirements “are not consistent,” the IVSC says, “and many companies are domiciled in countries with no regulation at all.” Further, because a typical fairness opinion contains more than valuation advice, they often fall outside of the International Valuation Standards and the related ethical framework.

To bridge this gap and to promote the key principles of “independence, objectivity, and transparency,” the IVSC has just issued a new exposure draft of its Procedural Guidelines for Fairness Opinions. Comments are due by the end of May; download a copy of the draft here.

Last chance to register for PCOC debate

This Thursday, March 15, tune in to Point/Counterpoint: Debating the Private Capital Markets Project, featuring John Paglia (Pepperdine University) and Kevin Yeanoplos (Brueggeman and Johnson Yeanoplos). In this 100-minute webinar Paglia—who is also the lead researcher and analyst for Pepperdine’s Private Capital Markets Project and its associated Private Cost of Capital (PCOC) database—will present the most current data from the project, and Yeanoplos will lead the discussion on how BV analysts can best put the project’s research and data to use.

Healthcare Symposium continues with SNFs

On Tuesday, March 27, join Dennis Peronne and Jean-Pierre LoMonaco (both Valuation & Information Group) for Valuing Skilled Nursing Facilities, an in-depth look at one of the most peculiar but pervasive business entities in the healthcare sector. This 100-minute webinar is part 3 of BVR’s Online Symposium on Healthcare Valuation, which continues with monthly installments through the end of this year.

Intrinsic Valuation expands

Last week Intrinsic Valuation (Denver) announced that it was adding forensic and advisory services to its core valuation services, led by Josh Harrison. To further expand the firm’s valuation expertise, Scott Bryan has joined the firm and will be opening Intrinsic's Texas office.

Do you have recent additions or firm expansions to report? Email the editor.



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Copyright © 2012 by Business Valuation Resources, LLC
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