When the Delaware Court of Chancery recently decided to rely on the unaffected market price for fair value, in a major statutory appraisal case, it provided an in-depth critique of the experts’ traditional valuation analyses, which valuators want to be familiar with. The court’s discussion of the expert’s DCF models is particularly informative. The court decided neither analysis was entirely convincing but adopted inputs from both for its own DCF model. The court then used its DCF value as corroboration of the market price.

‘Fantastically divergent conclusions’: This appraisal action arose out of the acquisition of Jarden Corp. by Newell Rubbermaid for cash and stock yielding a merger price of $59.21 per share. The unaffected market price, the court found, was $48.31 per share.

To determine fair value, the petitioners’ trial expert performed a comparable companies analysis as well as a DCF analysis and arrived at a per-share value of $71.35. Jarden’s (respondent’s) expert relied on the DCF analysis to arrive at $48.01 per share. (He only did a comparable companies analysis for “the sake of completion.”) The court’s DCF resulted in $48.13 per share.

The court gave no weight to the comparable companies value conclusions, finding the experts did not show that the peer companies were truly comparable. Regarding the experts’ DCF analyses, the court noted the “fantastically divergent” values the experts achieved, calling this “the classic case where … very-well credentialed experts are miles apart.”

In searching for an explanation, the court noted that the experts’ disagreement over the terminal investment rate (TIR) accounted for 87% of the difference in the DCF valuations. The petitioners’ expert calculated a TIR of only 4.9%, whereas Jarden’s expert calculated a TIR of 33.9%.

The petitioners’ expert argued that Jarden’s expert improperly was “using accounting data as if it were economic concepts. That doesn’t work.” He said Jarden’s expert incorrectly assumed that any new investment post-projection period would not create any value. Also, Jarden’s expert improperly defined investments to include only working capital and capital expenditures, which did not account for real-world economics. And Jarden’s expert defined investment as investment above depreciation, which again was an accounting definition that did not fit when calculating TIR. Finally, in calculating WACC, Jarden’s expert used accounting rates of return instead of economic rates of return, the petitioners’ expert said.

The court, in turn, found the petitioner expert’s rate was too low where Jarden’s five- year average historical investment rate was 21.6%. TIR, the court said, should reflect the company’s historical investment rate “but account for a slight increase to accommodate sustained growth in the Terminal Period.” The court calculated a TIR of 27.75%.

A digest of In re Appraisal of Jarden Corp., 2019 Del. Ch. LEXIS 271 (July 19, 2019), and the court’s opinion, will be available soon at BVLaw.

20- and 10-year spot yields on T-bonds favored for risk-free rate

Two-thirds of survey respondents say they use the spot yield on Treasury bonds for their risk-free rate when developing an estimate for the cost of capital, according to BVWire’s latest survey. Most (58%) use the 20-year spot yield and the rest (9%) use the 10-year spot yield. A quarter of respondents use a “normalized” risk-free rate developed by Duff & Phelps, and the remainder use something different (e.g., a 30-year spot yield) or a custom rate. Most respondents who use the spot yields get their information right from the U.S. Treasury website.

The concept of normalizing the risk-free rate emerged around the time of the financial crisis and is generally based on historical rates. A number of thought leaders strongly disagree with the use of a normalized rate, such as Chris Mercer of Mercer Capital (see his post on this topic) and Professor Aswath Damodaran of the New York University Stern School of Business, who writes that “a valuation is an assessment of the future as of right now, and you have to use the current risk-free rate.”

We had 70 responses to our survey, so our thanks to those who participated! We’ll have the next installment in our series of cost of capital surveys in the next issue of BVWire.

Look to industry groups for new clients

So advises Jim Hitchner (Financial Valuation Advisors), especially if you’re trying to develop a practice niche around a particular industry. “They’re always looking for articles for their association newsletter or for people to speak at their events,” he told an audience during a recent webinar, and this leads to connections. For instance, he once did the enormous consumer electronics convention in Las Vegas and gave a presentation on how to value a business, something every association’s members want to hear. The webinar is part of a new series hosted by Rod Burkert (Burkert Valuation Advisors LLC) titled Practice Development INSIDER that feature some of the leading valuation practitioners revealing their time-tested ideas behind building a practice. The next webinar will feature Nancy Fannon (September 6). To register, go to Burkert’s website.

CEIV logjam continues

Upwards of 150 individuals have earned the Certified in Entity and Intangible Valuations (CEIV) credential so far, but many more individuals have either enrolled in the program (630 actual enrollees but up to an estimated 800 individuals) or have inquired but not yet enrolled (three to 500 individuals), according to speakers at the recent ASA/USC 14th Annual Fair Value Conference in Los Angeles. Why are there so many still in the pipeline? The Big Four, as well as some smaller firms, have stopped short of credentialing their people pending the finalization of the quality monitoring process. Under this process, all CEIV holders would have to submit a report and work file in the first year for inspection and compliance review. Firms have several concerns here. including the confidentiality of client information, whether the review is a firm-level or individual review, and whether all three VPOs (ASA, AICPA, and RICS) can come in and do an inspection. Also, if valuation is just part of a large project, how do you ensure that the inspection just looks at the valuation piece and not the other disciplines. Alternatives being looked at are a self-reporting mechanism for firms and a rigorous recertification process, where CEIV holders would be retested in order to maintain the credential.

Even with almost half (49%) of small to midsize businesses claiming that the current business financing environment restricts growth opportunities, businesses appear to be confident about the future, with 68% of them expecting increases in revenue over the next year. This is according to the Q2 2019 Private Capital Access (PCA) Index, a study conducted by Pepperdine Graziadio Business School with support from Dun & Bradstreet.

The Summer 2019 Insights from Willamette Management Associates focuses on valuations for estate and gift tax purposes and is edited by Weston C. Kirk. Some of the articles are: “Kress v. United States of America—All Experts Consider Private Company’s S Corporation Income Tax Status” (Thomas M. Eichenblatt), “Valuation for the Expatriation Tax—‘So Long, It’s Been Good to Know Yuh’” (Curtis R. Kimball), “Guaranty Fee Analysis for Intrafamily Promissory Notes” (Weston C. Kirk), “What Tax Counsel Needs to Know About Working With a Valuation Specialist” (Robert F. Reilly), and more.

Based on EV/EBITDA, most sectors in Q2 2019 for the Euro STOXX 600 experienced an increased multiple level (e.g., energy, industrials, or materials) while several EV/revenue multiples remained flat (e.g., consumer discretionary, energy, or industrials), according to the KPMG International Valuation Newsletter for the second quarter of 2019. “Following a sharp fall in the last quarter of 2018, the EV/EBITDA multiple of the information technology sector rose at its highest levels for two quarters in a row in 2019, hitting a one-year high by June 2019,” the newsletter says. KPMG also gives an update on country risk premiums and inflation-adjusted risk-free rate for BRICS countries and risk-free rate and equity risk premia for the Austrian capital market. In addition, there’s an interesting discussion on the effects of the IFRS 16 leasing standard on valuation issues.

BV movers ...

People: Kory Felix, MAI, has joined AltaView Advisors’ Orange County, Calif., office as a principal; he specializes in real estate valuation and has experience valuing special-use properties such as golf courses, senior housing, self-storage facilities, and marinas … Judy F. Mason, CPA, CVA, MST, MBA, has been appointed to the position of president of the Illinois Chapter of the National Association of Certified Valuators and Analysts (NACVA) … Katie Gilden, CPA/ABV/CFF, CFE, CVA, has been promoted to director of valuation, forensic, and litigation services at Fiske and Co. (Fort Lauderdale, Fla.); she joined the firm in 2009.

Firms: Valuation Resource Group (VRG) has expanded into Albany, N.Y., with a new location at 159 Wolf Road, off Northway I-87; the firm will retain its existing office in East Greenbush, N.Y., as a satellite location … New York-based Prager Metis expanded its presence into the Washington, D.C., area with the acquisition of Frank & Co. of McLean, Va. … Rucci Bardaro & Falzone (RBF) of Woburn, Mass., has joined Princeton, N.J.-based WithumSmith+Brown, bringing five partners and about 30 team members to the firm; the RBF team will remain in Woburn … Expanding its advisory services, Chicago-based BDO USA has acquired Loughlin Management Partners & Co. (LM+Co), a boutique business advisory firm focused on corporate restructuring and turnaround services; this group will operate as BDO Consulting Group … Milwaukee-based Wipfli LLP is building a hedge fund niche with the acquisition of Patke & Associates of Lincolnshire, Ill. … Brentwood, Tenn.-based LBMC has acquired Think Data Insights, a national data analytics company.

Please send your professional and firm news to us at editor@bvresources.com.

Upcoming BVR training events

• Terminal Value: A Perpetual Issue in Valuation (August 8), with Michael Vitti (Duff & Phelps) and Seth Fliegler (Duff & Phelps).
  
  Time to take a fresh look at the nuts and bolts of determining the terminal value, as well as issues that are brought up within the business valuation community and mistakes to avoid.
  
  

• Reasonable Compensation for Closely-held Businesses + RCReports Demo (August 15), with Stephen Kirkland (Atlantic Executive Consulting) and Paul Hamann (RC Reports).
  
  Practitioners armed with the knowledge and the proper tools can easily determine reasonable compensation for any company. The discussion includes a demo of RC Reports software in action.