BVWire Issue #159-2 | December 9, 2015


Chancery again puts trust in merger price over questionable DCF

Don’t second-guess the result of a robust, arm’s-length sales process! That’s the view the Delaware Court of Chancery has been taking lately in statutory appraisal actions—and it recently did so again.

‘Wildly divergent’ DCF results: The suit involved the sale of one of the largest software companies in the world to a group of private equity firms for $46.25 per share. Following the M&A playbook, arbitrageurs petitioned the Delaware Court of Chancery for a statutory appraisal of their shares. They alleged an activist investor had forced the company to sell itself below its value.

At trial, both sides’ experts agreed that a discounted cash flow (DCF) analysis was the way to determine the stock’s fair value at the time of the merger, but they reached very different results. The petitioners’ expert arrived at $67.08 per share, i.e., 145% of the merger price. The company’s expert calculated a $37.88-per-share price—just over half of the value the opposing expert proposed. The court noted the “wildly divergent” outcomes stemmed from differences over key inputs. It decided to perform its own DCF calculation.

Irreducible uncertainty: For example, both experts relied on the same management projections, but the company’s expert reduced the projected revenue by 5% because in the past the company repeatedly had missed its revenue goals. The court agreed that the projections revealed “a bias toward optimism” but for purposes of its DCF found them to be reliable. It called the downward adjustment “too speculative to accurately account for that bias.” There was a marked difference in the experts’ discount rate that had to do with the equity risk premium (ERP). The petitioners’ expert used a supply-side ERP, reasoning that valuation calculations were forward-looking. The company’s expert used a historical ERP, calling it “the most generally accepted ERP” and saying “any model that attempts to estimate future ERP is subject to intolerable estimation errors.” The court noted that recent decisions from the Chancery favored a supply-side ERP. But it also said that which ERP to use was “a vigorously debated topic, not just between these two experts, but in the financial community at large.” The court added “scholarship may dictate other approaches in the future.” For its DCF, the court used a supply-side ERP to arrive at a discount rate of 10.5%. The court’s DCF analysis yielded a $48.00-per-share price.

But ultimately the Chancery opted to use the merger price as the indicator of value, expressing concern over irreducible uncertainty surrounding the key DCF inputs. It pointed to the company’s history of “problematic” projections, such that the figures “could distort value,” and it said the record did not point to a reliable method to adjust the projections. Also, the continuing debate over the ERP created still more uncertainty that compromised the DCF analysis.

In contrast, there was integrity in the sales process. The company staged two auctions over a period of several months to test the market and evaluated numerous bids before settling on the final price, $46.25. There was no evidence that pressure from the activist investors led to a rushed, ineffective sale, the court determined.

Takeaway: Another loss for merger arbitrageurs. Lacking “complete confidence” in critical aspects of the DCF analysis, the Chancery once again stuck to the merger price as the indicator of fair value.

Find an extended discussion of Merion Capital LP & Merion Capital II LP v. BMC Software, 2015 Del. Ch. LEXIS 268 (Oct. 21, 2015), in the January edition of Business Valuation Update; the court’s opinion will be available shortly at BVLaw.

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FASB proposes improvements to fair value disclosures

The FASB issued a proposed Accounting Standards Update (ASU) titled Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value, which is intended to improve the effectiveness of disclosure requirements on fair value measurements. The proposed ASU would improve existing disclosure requirements related to fair value measurement, clarify disclosure requirements, as well as identify ways to improve the board’s decision process.

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Goodwill impairment by U.S. firms up 18% in 2014, per D&P study

The dollar amount of goodwill impairment recorded by U.S. companies rose 18%, to $26 billion, in 2014, according to a report from Duff & Phelps. The consulting firm’s “2015 U.S. Goodwill Impairment Study” says that the number of goodwill impairment events increased by 24%, to 341, for the same period, while the average impairment amount fell 5%, to $75 million.

Energy hit hard: The energy sector was particularly hard hit, with the amount of goodwill impairment nearly tripling in 2014, to $5.8 billion, primarily due to charges taken in the exploration and production sector. Among other industries, consumer staples, financials, information technology, and industrials all recorded an increase in goodwill impairment, while healthcare, consumer discretionary, telecom, materials, and utilities all recorded declines.

The study also finds that the qualitative goodwill impairment test known as Step 0 by public-company survey respondents indicates record use, increasing to 54% from the 43% reported in 2014.

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‘Purchase Price Allocation Study’ for 2014 released

Houlihan Lokey has completed its “2014 Purchase Price Allocation Study,” analyzing the portion of purchase consideration allocated to tangible assets, intangible assets, and goodwill in merger and acquisition transactions completed by U.S. public acquirers during 2014. In this 14th annual edition of the study—which is complimentary—Houlihan Lokey reviewed public filings for a total of 1,265 completed transactions. Several statistics, other data, and a comparison to certain 2013 results are provided.

During a recent webinar on purchase price allocation, Nathan DiNatale (SC&H Group) mentioned that it is a “really a great study that they put together on an annual basis. I would recommend getting this study every year because the content is excellent to use in comparing purchase price allocations.”

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Global BV news:

MNE profit shifting puts heat on intangible values

The proposed Pfizer-Allergan deal points up the continued trend of multinational companies shifting profits away from the high U.S. corporate tax rates and into countries with lower tax rates. A lot of these deals involve tax inversions, where a company relocates its headquarters to a lower-tax nation, often via a merger. Another way is to use transfer pricing to shift profits to a subsidiary or division located in a lower tax jurisdiction. Intangible assets, such as brands, provide a great deal of revenue, so the transfer of those assets can be used as part of this strategy. Of course, the valuation of those assets that are transferred will affect the level of profits.

BEPS project: An article in Financial Director alerts us that the transfer pricing landscape is under scrutiny by the OECD and the BEPS project. The Organisation of Economic Co-Operation Development (OECD) is currently investigating base erosion and profit shifting (BEPS), which the G20 group is endorsing. These investigations are in place to counteract tax planning strategies that shift profits to low-tax jurisdictions to avoid or pay very little corporate tax. Action 8 of the BEPS plan highlights intellectual property and intangible assets as a particular area of concern.

Because of this, the validation of an intercompany transaction—that is, to confirm that the transaction is consistent with other similar independent transactions—becomes more important. This can be done, for example, by using a third-party data source to examine similar transactions in case of a challenge. The common sources are ktMINE (available from Business Valuation Resources), Royalty Connection, RoyaltySource (AUS Consultants), RoyaltyStat LLC, Licensing Economic Review, License Royalty Rates (Aspen Publishers), Intellectual Property Review (publishes three royalty rate books), and Markables (trademarks and brand names). That way, you can find independent evidence that third parties are agreeing to similar terms and use it to support intercompany transactions. Keep in mind that benchmarking a transaction often requires going beyond the royalty rate information, so having access to actual agreements becomes important.

Even though the shifting of profits may not run afoul of the law, some companies have felt public backlash because of their plans to move their headquarters outside the U.S. The U.S. federal government is exploring ways to prevent this from happening. Some people, however, say that what the government should be doing is fixing the corporate tax code so that this strategy would not be so advantageous.

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Big difference in RF and MRP in U.S. vs. Europe

New research finds that there is a “huge dispersion” of both the risk-free rate (RF) and the market risk premium (MRP) used by analysts in the U.S and six countries in Europe. The authors note that the most unexpected result is that the dispersion is higher for the RF than for the MRP.

Pablo Fernandez, Alberto Ortiz Pizarro, and Isabel Fernández Acín have prepared the new research, “Huge Dispersion of the Risk-Free Rate and Market Risk Premium Used by Analysts in USA and Europe in 2015.”

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Top 10 most popular BVU articles for 2015

Court case analyses, double dip, goodwill, and the size premium are a few of the topics that made the list of the most popular articles in Business Valuation Update for 2015. For those of you who are not BVU subscribers, the articles in the following list can be purchased individually at BVLibrary or access them along with thousands of other articles with a subscription to BVU::

  • “Top 10 Noteworthy BV Cases of 2014” (January 2015);
  • “The Cost Approach May Be the Best for Construction Firms—Here’s Why” (March 2015);
  • “The Double Dip Concept Is Often a Misconception” (July 2015);
  • “Personal Goodwill and Noncompete Agreements: Folklore vs. Common Sense” (August 2015);
  • “S Corp Valuation, DLOM Rulings Highlight NYSSCPA BV Conference” (July 2015);
  • “Takeaways From Six Recent Business Valuation Cases” (January 2015);
  • “Valuation Concepts Have Undergone Massive Changes in Thinking” (October 2015);
  • “Different BV Standards Have More in Common Than You Might Think” (February 2015);
  • “Data About the Size Premium Challenge Conventional Wisdom” (February 2015); and
  • “Expert Shares His Approach for Determining Reasonable Compensation” (January 2015).

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BV movers . . .

People: Walker Bridges, who specializes in business valuation, strategic planning, and multistate tax planning in the timber industry, was promoted to Tax Senior III at Lanigan & Associates in Tallahassee, Fla. … John Chilton, co-founder and partner at Mountjoy Chilton Medley in Louisville, Ky., was appointed state budget director by Matt Bevin, Kentucky’s governor-elect … Shannon Farr has joined LBMC as director in valuation and litigation support services in the firm’s Chattanooga office, bringing over 20 years of expertise in the healthcare valuation arena … Brett W. Neate was named partner at Zinner & Co. in Beachwood, Ohio … Karen Norris joined Dickson Realty’s Truckee, Calif., office as a commercial real estate and business broker … Edward Webb was named partner in the consulting practice group of Burr Pilger Mayer Inc., San Francisco.

Firms: The Costa Rican firm Asesores Fiscales Integrales SA has joined Grant Thornton Cotera y AsociadosBKD LLP of Indianapolis merged with Peterson, Peterson & Goss, a CPA and advisory firm in Wichita, Kan., on December 1 … The Mongolian firm CNM Audit joined the global accountancy network HLB International and was rebranded as HLB Mongolia Audit LLC Dean Dorton Allen Ford PLLC announced its intent to merge with the Lexington, Ky., firm Barr Anderson & Roberts PSC on January 1.

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Special encore of S corp workshop

By popular demand, the hottest topic of the year is back, as BVR will replay its four-hour Advanced Workshop on Taxes and Value: Guidance on the S Corporation Valuation Puzzle (December 15), with Nancy Fannon (Meyers, Harrison & Pia) and Keith Sellers (University of Denver). There will be a live Q&A segment.

The presenters challenge traditional notions about the differences in value between a pass-through entity and the public-market C corporation and reveal an abundance of research that shows that shareholder-level taxes do indeed affect a firm’s value. The “S corp experts” will guide participants through the evidence they need to support their valuation conclusions with a new, more direct approach to pass-through entity valuation.

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CPE events to wrap up 2015

Valuing Brand Names (December 10), with Chris Mellen (Valuation Research Corp.) and PJ Patel (Valuation Research Corp.). This is Part 8 of BVR's 2015 Special Series on Intellectual Property.

Expert Insights: Q&A with Ron Seigneur (December 16), with R. James Alerding (Alerding Consulting LLC) and Ronald Seigneur (Seigneur Gustafson LLP).

Valuation of Complex Financial Instruments in the Energy Sector (December 17), with Matthew Goldberg (BDO), Ernie de Lachica (BDO), and Pablo Alfaro (BDO).

Automotive Dealership Valuation—Navigating the Obstacles (December 29), with Travis Flenniken (HHM Litigation and Valuation Group).

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 the editor, Andy Dzamba at: or (503) 291-7963 ext. 133
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In this issue:

Merger price = FV

FASB: FV disclosures

Goodwill impairments up

New PPA study

Global BV news

Most-read BVU articles

BV movers

S corp workshop replay

CPE events












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