BVWire Issue #144-3 | September 24, 2014


Joan Rivers case points up inherent risks of ASCs

The market for ambulatory surgical centers (ASCs) is strong. When valuing an ASC, experts need to be aware of potential serious risks these entities face, especially with older patients, who represent a major segment of ASC customers. The recent high-profile case of Joan Rivers illustrates this, as a visit to an endoscopy clinic for a routine procedure ended in her death. In addition to treatment-related risks, there are other risks that valuation experts need to examine.

Risk assessment tool: In a recent BVR webinar, Todd Sorensen and Kevin McDonough (both with VMG Health) discussed the valuation of ASCs and presented a tool for assessing the risks inherent in ASCs. The ASC Risk-Assessment Matrix measures risk along a number of lines, including service-area growth, competition, location, physician ownership, and more.

The tool produces a single score but gives different weights to different categories and subcategories based on their relative importance to measuring risk. The weighting may be adjusted based on specific facts and circumstances, but, typically, the highest weights are assigned to categories that directly affect volume and reimbursement expectations (e.g., the physician utilization profile, market reimbursement risk analysis, and market competition).

Free download: The ASC Risk-Assessment Matrix is included in a chapter on valuing ASCs written by Sorenson in the BVR/AHLA Guide to Healthcare Valuation, Third Edition. BVR offers this chapter in its Free Resources section. To download it, click here (free registration required).

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Delaware Chancery has second thoughts over lump-sum lost profits award

In the latest round of a high-stakes pharmaceutical case, the Delaware Court of Chancery felt compelled to re-evaluate its earlier position on the plaintiff’s lost profits testimony. Under the court’s new ruling, the plaintiff stands to win—big.

‘Seller’s remorse’: The parties are biotech firms whose eight-year-long fight centers on a promising drug to treat smallpox, ST-246, which they expected to sell to the U.S. government. The defendant had acquired the drug but in 2005 ran out of money. It also lacked the institutional experience to take a drug to market. Consequently, it pursued collaboration with the plaintiff. While the plaintiff wanted a merger, the defendant insisted on outlining a license agreement, which included a term sheet that set forth key terms. By late 2005, the defendant valued ST-246 conservatively at approximately $1 billion. During merger negotiations, the defendant achieved important milestones in the development of the drug and received millions of dollars in funding from the U.S. government. ST-246 suddenly looked more like a multi-billion-dollar drug. The defendant experienced “seller’s remorse” and reneged on the merger. Ultimately, it also walked away from discussions with the plaintiff over a license agreement.

In December 2006, the plaintiff sued in the Delaware Court of Chancery, arguing that the term sheet was a binding agreement, which the defendant had breached. The Chancery disagreed but found the defendant had violated its contractual obligation to negotiate in good faith a license agreement, the terms of which were substantially similar to those in the term sheet. As a remedy, the Chancery awarded the plaintiff an “equitable payment stream or equitable lien” based on the defendant’s future profits from the successful commercialization of the drug. Then the Chancery found that lump-sum expectation damages were too speculative. The Delaware Supreme Court subsequently affirmed the Chancery’s bad-faith finding but remanded for a damages award based on contract liability only. The Chancery read the higher court’s opinion as an invitation to reconsider its prior rejection of a lump-sum award. Any meaningful review required a re-examination of the original expert testimony on expectation damages, it said. And a re-evaluation of the testimony required the court to take into account the $460 million government contract the defendant was able to procure following the wrongdoing. According to the Chancery, this fact greatly reduced the court’s earlier concern that the drug might never generate a profit.

Reversal of fortune: On remand, the Chancery found that the plaintiff proved that at the time of the breach it had a “reasonable expectancy” that it would make a profit from the sale of the drug. Then it already was likely the government would want to buy the drug for the strategic national stockpile. The court generally approved of the damages calculation the plaintiff’s expert originally had presented but ordered adjustments to key components, most importantly the number of sales. The expert’s computation assumed roughly 14.9 million sales to the U.S. government, including the defense department, and 14.7 million sales to “the rest of the world” at $100 per treatment. The price was reasonable, the court found, but the number of sales to foreign governments was not. Therefore, it struck damages based on those sales. By the expert’s original calculation, lost profits amounted to over $1 billion. Even though the Chancery’s modifications cut into this amount, the ruling augurs a big award. Given the parties’ fierce fighting, another challenge also is likely.

Takeaway: It ain’t over ’til it’s over. Even the Delaware Chancery is not above reversing itself and saying so in great detail. Interestingly, the court finds it is appropriate to use post-breach information—sparingly—to determine the expectation of the parties at the time of wrongdoing. Also noteworthy is the court’s dismissive attitude toward the defendant’s rebuttal expert. His credibility was undermined, it said, because “he merely attempted to discredit [the opposing expert’s] analysis without providing an alternative calculation of his own.”

Find an expanded discussion of PharmAthene, Inc. v. SIGA Technologies, Inc., 2014 Del. Ch. LEXIS 142 (Aug. 8, 2014) in the November issue of Business Valuation Update; the court's opinion will appear soon at BVLaw.

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Tax Court can’t pull a discount out of thin air

When valuation experts use discounts, they must be substantiated. That goes for the Tax Court as well.

New case: A decedent owned fractional interests in valuable paintings. His estate took a fractional ownership discount for lack of control and marketability and offered valuation reports and testimony of three expert witnesses as proof. The IRS took the position that no discount was allowable but offered no evidence. The Tax Court concluded that a nominal discount of 10% should apply but also offered no evidence to back up that percentage.

The case was appealed to the 5th Circuit. In its ruling, the appellate court rejected both the IRS’s and the Tax Court’s findings on the discount. The court said that the discounts determined by the estate’s experts “are not just the only ones proved in court; they are eminently correct.” The estate was therefore entitled to a refund of more than $14 million.

It’s interesting that the IRS did not prepare any evidence just in case the Tax Court decided that some discount was appropriate (which it did).

Estate of Elkins v. Commissioner, 2014 U.S. App. LEXIS 17882 (5th Cir, Sept. 15, 2014)(overturning Estate of Elkins v. Commissioner, 2013 U.S. Tax Ct. LEXIS 6 (2013))

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Proposal exempts private firms from breaking out certain intangibles

During a recent meeting, the FASB’s Private Company Council (PCC) voted to finalize an alternative that would exempt private companies from separately recognizing and measuring certain intangibles. The new rule would apply to noncompetition agreements and customer-related intangible assets that are not capable of being sold or licensed independently in a business combination.

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Five common errors in business valuation

Unrealistic cash flow projections head a list of common errors made in business valuations, according to Howard Johnson, managing director of Veracap M&A International Inc. and Campbell Valuation Partners Limited in Canada. In an article, Johnson explains this and the other common errors he sees: reliance on the multiple of EBITDA methodology, reliance on comparable company multiples, technical errors in rates of return and valuation multiples, and missing the balance sheet.

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Act now on special preorder price for the Industry Cost of Capital book

The preorder price expires soon for the 2014 Valuation Handbook—Industry Cost of Capital, published by Duff & Phelps. Place your preorder here and pay just $350 per book plus shipping and handling (versus the list price of $395). Print copies are expected to ship in October.

This resource replaces the discontinued Morningstar/Ibbotson Cost of Capital Yearbook and will include additional methods to calculate cost of equity capital and new statistics previously unavailable that will allow for a more robust analysis. Over 200 U.S. industries are represented in the 2014 Valuation Handbook—Industry Cost of Capital, which will have data through March 2014. Quarterly updates (June, September, and December) are also available for $250 per year, but they are an optional add-on and not sold separately. Purchase the book with updates here.

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Certificate in Private Capital Markets

The Certificate in Private Capital Markets (CIPCM) is a three-day, curriculum-based training program developed by Dr. John Paglia in association with his groundbreaking research in Pepperdine University's Private Capital Markets Project (PPCMP). The program, now led by Dr. Craig Everett, offers in-depth critical analysis and evaluation skills for transacting successful financing deals within the private capital markets and the valuation methods used by capital providers when evaluating transactions. Instructors include both Pepperdine faculty members and industry experts.

The next program will be offered October 20-22 in Malibu, Calif. For more information, click here.

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In the October issue of Business Valuation Update

Here’s what you’ll see in the October 2014 issue of Business Valuation Update:

  • FMV’s Two-Year Equivalent Discounts for Lack of Marketability Methodology and Calculator (Lance S. Hall, ASA, and David Bertucci). A new methodology has made current restricted stock data meaningful in the determination of DLOM for private companies.
  • Getting Your Head Out of the Model: Valuing a Multinational Company (James T. Budyak, CPA/ABV, CFA, ASA). The author presents a framework to develop a more realistic valuation and cost of capital for global firms.
  • Update on Key Health Reform Measure That Impacts Healthcare Valuations (BVR Editor). Don Barbo (Deloitte Financial Advisory Services LLP) and Robert Mundy (Pershing Yoakley & Associates, P.C.) give a rundown of how the different provisions of the Affordable Care Act (ACA) are affecting valuations in the healthcare industry.
  • Opportunities and Special Considerations in the Valuation of Hotels (BVR Editor).No longer the exclusive domain of real estate appraisers, hotels and resorts present a good opportunity for business valuation experts.

To read these articles—plus a digest of the latest valuation-related court cases—see the October issue of Business Valuation Update (subscription required).

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BV movers . . .

People: Aimee Burgess was promoted to manager at Warren Averett LLC in Alabama … Elizabeth Butchart was promoted to manager at Clayton & McKervey PC based in Detroit … Nick Carbone joins Davis, Grim and Co. P.A. as the director of assurance and business advisory services in the Orlando, Fla., office … Susan Delgado was promoted to managing director at Andersen Tax (formerly WTAS) in Boston … Addie K. Grissom joins CDPA PC of Athens, Ga., as a senior audit associate … William Huber joins CohnReznick as a managing director … Frank Pina, managing director and leader of the forensic and litigation practice at the N.J.-based Mercadien Group, was presented with the “Forty Under 40” award by NJBIZ … Jasper Rodewijk joins Mazars Berenschot as senior advisor in business valuation at its Amsterdam office … Thomas Sloop as managing director of the Houston office at Deloitte Corporate Finance … Jessica Tien is a new principal at Ernst & Young’s International Tax Services Transfer Pricing practice in San Francisco.

Firms: Marks Nelson Vohland Campbell Radetic LLC of Kansas City, Mo., has changed its name to MarksNelson LLC Happy 40th anniversary to the largest minority-controlled professional services firm in the U.S. and member firm of EY, Mitchell & Titus LLP.

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ESOPs and physician practice valuations in latest CPE events

ESOP Regulatory Update: The DOL Fiduciary Process Agreement (September 24), featuring Jeffrey Tarbell (Houlihan Lokey), Theodore Becker (DrinkerBiddle), and James Staruck (GreatBank Trust Co.). What does the DOL Fiduciary Process Agreement mean for ESOP appraisers and appraisals? Find out from an appraiser, attorney, and ESOP trustee.

Misapplications of Standard Valuation Methods in Valuing Physician Practices (September 30), featuring Timothy R. Smith (American Appraisal). Find out how standard valuation techniques should be utilized when valuing a physician practice with one of the foremost experts in healthcare valuation. Part 9 of BVR’s Online Symposium on Healthcare Valuation.

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We welcome your feedback and comments. Contact the editor, Andy Dzamba at: or (503) 291-7963
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In this issue:

Valuing ASCs

Big lost profits win

Fractional interest case

Private firm intangibles

Common BV errors

Industry Cost of Capital guide

CIPCM course

October BVU preview

BV movers

CPE events








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