BVWire Issue #163-1 | April 6, 2016


Damodaran updates his annual data-rich ERP article

Professor Aswath Damodaran (New York University Stern School of Business) has updated his article, “Equity Risk Premiums (ERP): Determinants, Estimation and Implications – The 2016 Edition.”The 136-page article provides a detailed picture of ERPs. While most appraisers use the ex post approach (historical information), some experts consider the ex ante approach. Damodaran is a strong proponent of implied equity risk premiums, which are forward-looking estimates that are extracted by examining stock prices today and expected cash flows in the future. His article and his website offer very rich data on ERP and other aspects of valuation—all of it free.

In the updated article, he also seeks to dispel what he calls widely held misconceptions about equity risk premiums:

  • Estimation services ‘know’ the risk premium. Historical data are available to everyone, so “there is no reason to believe that any service has an advantage over any other, when it comes to historical premiums,” he claims.
  • There is no right risk premium. This is the flip side of Myth No. 1, that the data are “so noisy” that “any risk premium within a wide range is therefore defensible.” The paper points out that it is entirely possible to come up with “outlandishly high or low premiums, but only if you use estimation approaches that do not hold up to scrutiny.”
  • The equity risk premium does not change much over time. “Shocks to the system,” such as the events of 2008, can cause premiums to jump quickly. “A failure to recognize this reality will lead to analyses that lag reality.” Damodaran estimates an implied ERP monthly.
  • Using the same premium is more important than using the right premium. If everyone consistently used the same premium without testing it, there would be “systematic errors in valuation.”
  • If you adjust the cash flows for risk, there is no need for a risk premium. This is “technically correct,” he points out, but says that “adjusting cash flows for risk has to go beyond reflecting the likelihood of negative scenarios in the expected cash flow.”

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Final means final in dispute over valuation agreement

Another case of seller’s remorse. Two parties agree in writing to the buyback of one party’s shares based on the price a valuator of their choosing determined. The contract prohibits judicial review, but inevitably one party disagrees with the valuation and sues. In a recent case, the flashpoint was the valuator’s application of a minority discount.

'Final and binding’: The plaintiff held a 30% interest in a Volkswagen dealership. After he asked for a corporate dissolution, the company obtained permission to buy back his shares. The court specifically urged the parties to take charge of the valuation process by jointly hiring an appraiser in order to avoid “the needless expense of a ‘battle of appraisers.’"

The parties agreed to retain a sole appraiser—whom they both knew from past appraisals he had done of the company. In a court hearing that preceded the formal engagement of the appraiser, the parties raised the issue of whether to apply a minority discount. The court declined to take a position on this issue. But it said the minority discount question should be “part of the discussion” the parties needed to have on the appropriate valuation method. The two sides eventually stipulated in court that the appraiser’s value determination “shall be final and binding, with no right of appeal for any party.”

The valuator determined the FMV of the plaintiff’s “un-discounted" interest in the company was worth about $385,600. After the application of a 25% minority discount, the plaintiff’s interest was worth almost $100,000 less—$289,200. In response, the plaintiff asked the court to decide whether it was appropriate to use a minority discount. Notwithstanding the contract’s "final and binding” language, the parties “did not agree that [the appraiser] would determine whether or not any discount should be applied to the Plaintiff’s shares,” the plaintiff claimed.

The court declined to get involved. “A stipulation is final, conclusive and binding as to those matters the parties fairly intended to include within its terms,” it said. Also, the appraiser was a known quantity to both parties in light of his prior valuation of the company. And the language of the stipulation was unequivocal. It said "with no right of appeal for any party.” Unless there is an indication of malfeasance, of which there was none here, “contracts voluntarily and fairly made should be held valid and enforced in the courts,” the court said and approved the appraiser’s calculation.

Takeaway: Forget about taking back a commitment to a valuation agreement. When the parties voluntarily enter a valuation contract and expressly relinquish the right to challenge an appraiser’s value determination, courts are unlikely to unmake the agreement—no matter how painful it turns out to be for one party.

Find a digest of Curran v. Curran, 2016 Conn. Super. LEXIS 77 (Jan. 12, 2016), in the May issue of Business Valuation Update. The court’s opinion will be available soon at BVLaw.

Similar case: A recent case in front of the Delaware Court of Chancery follows the same playbook. There, too, the court was unwilling to interfere with the parties’ unambiguous valuation agreement. That case, also available at BVLaw, is PECO Logistics, LLC v. Walnut Inv. Partners, L.P., 2015 Del. Ch. LEXIS 311 (Dec. 30, 2015).

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New index fills gap for middle-market economy

U.S. middle-market business conditions are at 116.6 in the first quarter of 2016, a 1.4% uptick from the fourth quarter of 2015, according to the inaugural edition of the “RSM Middle Market Business Index” (MMBI). Developed in partnership with Moody's Analytics, the index is designed to reflect business conditions in the U.S. middle market, while providing a statistically significant measure of the health and outlook for these businesses. The middle-market segment of the U.S. economy represents more than 200,000 companies, 40 million jobs, and one-third of private-sector gross receipts, according to RSM. The national accounting firm says that, up until now, there has been no comprehensive index for the middle market and it plans to publish updated MMBI data quarterly.

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Academics reject proposals to stifle appraisal rights litigation

The use of the appraisal remedy by dissenting shareholders in Delaware has surged in recent years, fueled by appraisal arbitrage. Proposed reforms to limit or eliminate appraisal arbitrage in Delaware should be rejected, according to a new draft article to be published in the Delaware Journal of Corporate Law.

Potent remedy: The authors, Charles Korsmo, associate professor of law at Case Western Reserve University School of Law,and Minor Myers, professor of law at Brooklyn Law School, say the increase in appraisal activity benefits public shareholders in circumstances where they are most vulnerable. “We have shown that these appraisal specialists focus their resources on a small number of transactions and that those transactions exhibit proxies for legal merit: abnormally low merger premia and insider involvement.”

While they say the reforms suggested by both respondent companies and deal advisors should not go through, they suggest other reforms to improve the effectiveness of appraisal, such as requiring disclosure of more financial information in M&A transactions subject to appraisal.

New amendments: Subsequent to the paper being released, the Corporate Council of the Corporation Law Section of the Delaware State Bar Associationhas once again proposed some changes to Delaware’s appraisal statute. The proposed changes are intended to: (a) set a floor for the number and value of shares asserting appraisal; and (b) permit M&A targets to prepay some or all of the merger consideration to dissenters to avoid the accrual of interest on such prepaid amounts. There are no specific proposals to eliminate or limit appraisal arbitrage.

Note: We should point out that the paper’s authors are principals of Stermax Partners, which provides compensated advice on stockholder appraisal and manages appraisal-related investments, and they have economic interests in the outcome of appraisal proceedings.

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Auto dealership values driving higher—for now

Values of auto dealerships jumped last year amid a surge of buy-sell transactions, according to “The Blue Sky Report™ 2015 Full Year Report.” Top luxury brands had the biggest increases in blue sky value, which is the dealership’s intangible value, expressed as a multiple of adjusted pretax income. For example, BMW had a blue sky value range of 6.0 to 8.0-plus in 2015, up from 5.5 to 6.5 in 2014. The biggest value driver: new vehicle sales per franchise. Other drivers include location and earnings growth expectations. The robust transaction activity could run out of gas during the second half of this year due to an expected rise in interest rates, the report says.

Extra: BVR recently released a new guide, What It’s Worth: Automobile Dealership Value (formerly Key Trends Driving Auto Dealership Value). Contributors to the guide include auto industry accountants, brokers, M&A executives, former dealership employees and owners, and other consultants.

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BV questions answered by the masters

Three renowned business valuation experts have joined forces on a unique book, A Consensus View: Q&A Guide to Financial Valuation, 2016 edition. Shannon Pratt, Jay Fishman, and Jim Hitchner answer over 150 of the most important business valuation questions they’ve been asked over the years. The questions range from basic to advanced and fall into four categories: the income approach, cost of capital, discounts and premiums, and professional standards and ethics. Future editions will include new topics and expanded chapters.

The May issue of Business Valuation Update will include a review of the book by Harold G. Martin Jr. (Keiter).

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Global BV news:
DLOM in offshore tax havens

Local ownership rules may trigger a DLOM for business valuations in offshore locations, says James V. Andrews, senior managing director of IRR, a valuation firm based in the Cayman Islands. In a post in BVR’s LinkedIn group, he points out that in the Caymans there's a requirement for 60% local ownership in some cases. But only about half of the residents are Caymanian citizens, which limits the potential pool of investors. This is particularly true for businesses that are commonly foreign owned, such as tourist-related businesses. For the other industries, Caymanians are the likely investors if the level of investment is right. “In any event, one has to consider the relatively small population and the level of investment required to determine if a discount is warranted for a business that is operating locally in Cayman,” says Andrews.

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BV movers . . .

People: Both Marianna Todorova-Larkin and Carla Nunes were promoted to managing directors at Duff & Phelps. Nunes is based in the Philadelphia office and is one of Duff & Phelps’ experts in addressing valuation issues related to cost of capital. Todorova-Larkin also works out of the Philadelphia office and provides technical interpretation and guidance on valuation issues in the context of financial reporting.

Firms: The Democrat & Chronicle and WorkplaceDynamics honored the Rochester office of Freed Maxick as one of the Top Workplaces 2016 … Grant Thornton has acquired most of the assets of Arryve LLC, a Bellevue, Wash.-based business consulting firm. Sixty professionals from Arryve plan to transition to Grant Thornton, and this new Bellevue location will become Grant Thornton’s 59th office … Guinazu & Asociados SpA of Santiago, Chile, has joined the global accountancy network UHYRosen, Sapperstein & Friedlander, based in Owings Mills, Md., acquired SHR Associates, a healthcare consulting firm based in Annapolis … T.A.L.I.S. Tax Audit Legal International Services, based in Tirana, Albania, and HLB Nasser Al Khalifa in Doha, Qatar, are the latest members of the global accounting network HLB International.

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April CPE events

BVLaw Case Update: A One-Hour Briefing (April 6), with R. James Alerding (Alerding Consulting LLC) and Sylvia Golden (Business Valuation Resources).

FREE WEBINAR: Valuing Intangibles: From Search to Valuation (April 21), with David Jarczyk (ktMINE) and Fernando Torres.

Event Studies in Security Litigation: Strategy and Tactics (April 26), with Paul Seguin.
Part 1 of BVR's special series presented by The Comprehensive Guide to Economic Damages.

Important note to webinar attendees: To ensure that you receive your dial-in instructions to BVR’s training events, please make sure to whitelist

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We welcome your feedback and comments. Contact Andy Dzamba (Executive Editor) or Sylvia Golden (Executive Legal Editor) at:
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In this issue:

Damodaran's ERP

No valuation do-over

Midmarket index

Appraisal rights

Blue sky values


Global BV news

BV movers

CPE events












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