Takeaways from the AICPA FVS conference
BVWire is back from the excellent AICPA FVS conference in New Orleans. Here is an initial look at the valuable information gleaned in formal sessions and informal discussions there. Look for more in the next issue of BVWire as well as expanded coverage in a future issue of Business Valuation Update.
- Does the size premium still exist? Academics and investment pros say the size premium has vanished, based on research that shows it’s been declining over time. But BV experts claim it’s alive and well (e.g., see Pratt and Grabowski’s Cost of Capital, 5th Edition).
- What’s the most likely IRS audit trigger for estate/gift tax returns? It’s the presence of DLOM or DLOC in a valuation, according to a poll of attendees in a session on dealing with the IRS.
- Consolidation is “running rampant” in the auto dealer industry in the wake of Buffett’s purchase of Van Tuhl, the largest privately owned U.S. auto dealership group.
- The IRS still says “no” to tax affecting in valuations, and the agency is looking for a test case to bring to court. But a great deal of research indicates shareholder taxes definitely affect value.
- A terrific overall guide to using restricted stock studies for figuring DLOM is the free FMV Opinions Companion Guide, available here.
- Yes, using rules of thumb may run afoul of BV standards, but they are good for sanity checks and as indicators of industry value drivers.
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Expert raises issues with recent AriZona decision
The last issue of BVWire covered the New York business divorce case involving the valuation of a 50% interest in the company that makes AriZona Iced Tea. The ruling prompted comments from Gil Matthews (Sutter Securities Incorporated), who tells BVWire: “In my judgment, there are two substantial problems with the decision, both of which result in a material windfall to the continuing shareholder.”
Tax rate: In its decision, the court applied a higher tax rate to AriZona as an S corp than would have been applicable if it were a C corp, Matthews points out. The plaintiff’s expert conservatively valued AriZona as if it were a C corp and used a 38% tax rate. But the court noted that this rate was unsupported in the valuation report and in the expert’s testimony. Instead, the court applied a 43.5% rate based on taxes payable on AriZona’s pass-through income.
“This conclusion is illogical because a company structured as an S corp cannot be worth less than it would be if it were a C corp,” says Matthews. “C corps must pay corporate tax prior to making distributions (dividends) to shareholders, who then pay additional tax on the dividends. Investors use pass-through entities to avoid double taxation and to reduce the effective tax rate on income. This double taxation cannot be circumvented by paying high salaries or bonuses to controllers of C corps because payments in excess of ‘reasonable compensation’ are subject to substantial additional tax and/or penalties.”
Matthews urges valuation experts to read the Delaware MRI (898 A.2d 290, Del. Ch. 2006) decision for a realistic valuation of an S corp versus a C corp. This case is available at BVLaw.
DLOM: The plaintiff’s expert argued for zero DLOM because the company was successful and there were a number of “expressions of interest” from potential acquirers. The defendant’s expert asked for a 35% DLOM. The court decided a 25% DLOM was appropriate. This “results in the petitioner receiving 3/8ths of the value of the company, inequitably valuing the continuing shareholder’s half-interest at 60% more than the petitioner’s half-interest,” says Matthews. The court gave four reasons for applying a 25% DLOM. One of the reasons is the transfer restrictions in the owners' agreement, which is relevant to a DLOM, says Matthews. But the other three reasons the court gave seem “questionable,” he says.
- AriZona did not have audited financials. “However, the opinion also states that ‘Arizona's financial statements can be readily audited, particularly when the shareholders are no longer battling with each other,’” Matthews says.
- Extensive litigation between the shareholders. “However, the petitioner should not be penalized for litigating and, in any event, the litigation will be concluded when the petitioner is paid,” he says.
- Uncertainty about AriZona’s S corp status. “However, the court concluded that S corp status did not add to the company’s value,” Matthews observes.
Find an extended discussion of Ferolito v. AriZona Beverages USA LLC, 2014 N.Y. Misc. LEXIS 4709 (Oct. 14, 2014), in the January issue of Business Valuation Update; the court’s opinion will be available soon at BVLaw.
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Healthcare services sector trading performance and multiples
The S&P Healthcare Services Index has increased by 4.6% over the three-month period of July to September 2014, thus outperforming the S&P 500, according to the October 2014 Healthcare Sector Update from Duff & Phelps. The best performing sectors were acute care hospitals (up 20.8%), contract research organizations (up 10.7%), and home care/hospice (up 10.6%). The worst performing sectors were care management/TPA (down 18.2%), diagnostic imaging (down 15.4%), and consumer-directed health and wellness (down 11.1%), says the report.
Latest multiples: The current median LTM revenue and LTM EBITDA multiples for the healthcare services industry overall are 1.51x and 10.9x, respectively. The sectors with the highest valuation multiples include consumer-directed health and wellness (4.11x LTM revenue, 25.3x LTM EBITDA); other services (1.79x LTM revenue, 21.3x LTM EBITDA); and HCIT (3.35x LTM revenue, 19.1x LTM EBITDA).
The report also provides data on the pharmaceutical/medical devices/life sciences sectors.
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Fair value and private companies
“Valuation specialists should pay close attention to various PCC proposals,” writes Mark Zyla (Acuitas Inc.) in a recent article in NACVA’s QuickRead. The PCC is the Private Company Council, and in the article Zyla provides a summary of several recommendations the PCC has made to the FASB regarding accounting for goodwill and business combinations.
“Valuation specialists can have a voice in the process,” Zyla writes. He points out that the current proposal for accounting for business combinations has changed “fairly dramatically” from the original proposal, due primarily to comment letters received from interested parties.
More on FV: Zyla is the curator of BVR’s Online Symposium on Fair Value Measurement. He will co-present the final installment, Comparing Fair Value Measurements Under GAAP and IFRS (December 2), with Mauro Bini. These international and domestic experts reveal how best to navigate U.S. GAAP, IFRS, and the FASB amendment seeking to join them together.
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New edition of BVR’s Bankruptcy Case Law Compendium
Bankruptcy matters and valuation issues are always intertwined, which is why BVR’s Business Valuation & Bankruptcy: Case Law Compendium, Second Edition is a must-have resource.
Newly revised: It’s now been newly updated with the most recent court cases featuring business valuation and bankruptcy. You’ll have access to the full court opinion of each case in the report via a special Web link. It also includes summary tables for easy reference so you can quickly find the case name, type of case, date, court, state/jurisdiction, and a snippet summary. In addition, several articles provide insight on the challenges of valuing financially distressed businesses.
To view an excerpt from the Compendium, click here.
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Free webinar on using the new industry cost of capital resource
Last week, James Harrington (Duff & Phelps) presented a free one-hour webinar that gave listeners an in-depth look at what's included in the new 2014 Valuation Handbook - Industry Cost of Capital and how appraisers can put it to work. This free webinar has been posted to BVR’s website. To access the webinar, click here.
The new resource provides the same rigorous industry-level analysis previously published in the green-cover Morningstar/Ibbotson Cost of Capital Yearbook. It includes cost of capital estimates (equity capital, debt capital, and WACC) for over 200 U.S. industries, plus detailed statistics for benchmarking purposes. New and noteworthy is the inclusion of additional methods to calculate cost of equity capital and extra statistics, enabling a more robust benchmarking analysis when developing industry cost of capital estimates.
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BV movers . . .
People: Greg Chin joins Grant Thornton LLP’s Boston office as a managing director in the firm’s Transaction Advisory Services practice … At the AICPA 2014 Forensic and Valuation Services Conference in New Orleans, four individuals were honored: Hubert Klein (EisnerAmper LLP) is the Forensic and Litigation Services Volunteer of the Year; Jason MacMorran (P&N Consulting) is the Business Valuation Volunteer of the Year; Sheri Schultz (Fiske & Co.) is the ABV Champion of the Year; and Elizabeth Woodward (Dean Dorton Allen Ford) is the CFF Champion of the Year.
Firms: CohnReznick LLP and Bethesda, Md.-based accounting, tax, and consulting firm Watkins Meegan LLC announced the completion of their merger … Two Tulsa firms, HoganTaylor and Hartog, Kallenberger & Swarthout LLC, say their merger will be finalized by early 2015 and will continue under the HoganTaylor name … Two central New York firms, Kane, Bowles & Moore PC and Dermody, Burke & Brown CPAs LLC, say their merger will be finalized by January 1 … Ryan, a leading global tax services firm headquartered in Dallas, has signed an agreement to acquire WTP Advisors … The litigation and forensic accounting practice of SingerLewak LLP will merge with Biggs & Co., a specialty firm focusing on bankruptcy, litigation support, and forensic accounting. Based in the Los Angeles area, the groups will rebrand as SLBiggs, a division of SingerLewak.
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Why Your Multiple May Be Wrong: Forgotten Statistical Concepts and Their Invaluable Application (November 19), featuring Robert Dohmeyer (Dohmeyer Valuation Corp.) and Herbert Kierulff (Seattle Pacific University). In this live presentation of their article in the November Business Valuation Update, Dohmeyer and Kierulff explain that many appraisers miss the “statistical and causal subtleties … that say ‘companies with superior margins deserve a premium multiple.’”
Valuations for the SBA: Opportunities & Challenges (December 4), featuring Franz Ross (First Niagara Bank). Despite recent headlines, valuations for the Small Business Administration (SBA) present a large pool of mostly untapped potential for the prepared appraiser. In this webinar, expert Ross addresses what every appraiser should know to take advantage of these opportunities.
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BVWire will be taking a break to enjoy the U.S. Thanksgiving holiday next week. We will resume publication on Wednesday, December 3. We wish you a very happy holiday.
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