Only a few months after reversing the Delaware Court of Chancery’s DFC Global decision, the Delaware Supreme Court did it again. Last week, it overturned the Chancery’s controversial 2016 Dell opinion in which Vice Chancellor Laster found the deal price did not accurately reflect the value of Dell stock. To arrive at fair value, the Chancery relied on its own discounted cash flow analysis.
The impetus for this statutory appraisal action was the 2013 management buyout led by the company’sfounder, Michael Dell. The deal price was $13.75 per share, a 37% premium to the company’s stock price. The court’s DCF value was $17.62 per share.
Problems related to the sales process caused a mispricing whose degree could not be quantified, the Chancery said. It noted a “valuation gap” between the company’s intrinsic value and its market value because the company’s investors were too focused on short-term profit. No strategic buyers participated in the sales process. The participating private equity bidders all used an LBO model to determine their bid price rather than valuing the company as a going concern. This pushed the deal price below fair value. Finally, MBO-specific problems also undercut the credibility of the deal price.
The Supreme Court found the Chancery’s decision not to assign any weight to the deal price was an abuse of discretion. “In fact, the record as distilled by the trial court suggests that the deal price deserved heavy, if not dispositive, weight.” The Supreme Court faulted the Chancery for “ignor[ing] the efficient market hypothesis long endorsed by the Court,” which “teaches that the price produced by an efficient market is generally a more reliable assessment of fair value than the view of a single analyst, especially an expert witness who caters her valuation to the litigation imperatives of a well-heeled client.” In disregarding the deal price, the Chancery overlooked the reality that, where Dell once was “a growth stock trading large multiples to its then-current cash flow,” the market in recent years simply no longer “bought Mr. Dell’s long-term vision,” the Supreme Court said.
Gil Matthews (Sutter Securities), an investment banker and close observer of the Delaware courts, calls the reversal “inevitable” after Chief Justice Strine wrote in DFC Global that "the fact that a financial buyer may demand a certain rate of return on its investment in exchange for undertaking the risk of an acquisition does not mean that the price it is willing to pay is not a meaningful indication of fair value." Matthews points out that the instant decision in effect says that, “DCF, even when properly performed, can arrive at a value that nobody would pay.” He continues: “I have been very concerned for years over the Court of Chancery’s almost automatic default to DCF. The court likes to rely on the supposed ‘precision’ of DCF, but I have always argued that DCF only gives an illusion of precision. We all know that a calculated DCF value can change materially with small changes in the inputs.”
An extended discussion of Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd., 2017 Del. LEXIS 518 (Dec. 14, 2017), and the court’s opinion will be available soon at BVLaw. Subscribers can find a digest as well as the court opinion for the DFC Globalhere.
The implied private company pricing line (IPCPL) is a tool designed to estimate the cost of capital for small private companies. It uses data from the past 15 years on 500 private-company transactions selected from the Pratt’s Stats database. Throughout each quarter in 2017, there was a downward trend in the return expected by those who provide capital. The returns on the cost of capital are calculated across four revenue ranges (see chart below). Companies with revenues of over $10 million but no more than $15 million saw the largest decrease in the expected return, as January 2017 started off with a rate of return of 14.6%, and, by December 2017, the rate decreased to 13.5%. Smaller companies also experienced a downward trend in their rates of return. Companies with revenues of up to $1 million had an expected rate of return of 19.0% in January and finished the year at 18.3%. Companies with revenues of over $1 million to $5 million had a rate of return of 17.3% at the beginning of 2017 and finished the year at 16.4%. Companies with revenues of over $5 million to $10 million had a rate of return at 15.5% and finished at 14.5%.
Feedback wanted: The IPCPL tool is an evolving method, and the developers welcome your feedback. For full information, please visit the IPCPL page.
The Lincoln Middle Market Index is the first fair value index created exclusively from a population of privately held companies. Quarterly, Lincoln International (a global midmarket investment bank) determines the enterprise fair value of over 1,200 companies for approximately 100 private equity sponsors and lenders. These portfolio companies report quarterly financial results to the private equity group or lender. Lincoln obtains this information and computes the enterprise value in accordance with fair value measurement principles of GAAP, AICPA, and ASA.
As the Lincoln Middle Market Index is a fair value index (based on the fair value of private companies), it is comparable to public stock market indices such as the S&P 500 or Russell 2000. To develop it, Lincoln worked with Professors Steven Kaplan and Michael Minnis of the University of Chicago Booth School of Business. The index will be published quarterly—the current version covers the period from 2014 through September 2017, and you can access it if you click here .
A report from the Internal Revenue Service Advisory Council (IRSAC) recommends that the IRS evaluate whether it should follow the principles of the Uniform Standards of Professional Appraisal Practice (USPAP) “in broad valuation contexts by taxpayers and the IRS alike.” It also recommends that the IRS consider whether compliance with USPAP would be helpful in evaluating the competency of expert witnesses and outside valuation experts. The relevant section in the report, which is long, is titled “Issue Three: Generally Accepted Appraisal Standards in IRS Valuations” and starts on page 118.
The 2018-19 version of USPAP is now available from The Appraisal Foundation and has enhanced features available in both print and electronic versions.
The complex, time-consuming task of goodwill impairment needs to be simplified further, the Small Business Advisory Committee (SBAC) told the FASB during a recent meeting. Companies complain that they have to hire expensive valuation experts to figure it out, and investors gripe about the big lag between the actual impairment and when it’s recognized. SBAC supports further changes and would like to see the simplified approach that private companies use be extended to public companies. While the FASB does not plan to take action in the near future, it will keep goodwill on its research agenda.
The Securities and Exchange Commission announced that it has appointed William D. Duhnke III as chairman of the Public Company Accounting Oversight Board (PCAOB). He is currently the staff director and general counsel to the U.S. Senate Committee on Rules and Administration. The SEC also named the following board members:
J. Robert Brown, a professor of law at the University of Denver where he heads the Corporate and Commercial Law program;
Kathleen M. Hamm, the global leader of securities and fintech solutions and senior strategic advisor on cyber solutions at Promontory Financial Group;
James G. Kaiser, a partner and the global assurance methodology and transformation leader at PwC; and
Duane M. DesParte, senior vice president and corporate controller of Exelon Corp.
The PCAOB is working on new auditing standards that put more scrutiny on fair value estimates. Under the proposed rules, the auditor must do more work unless the fair value estimation process is rock-solid.
Rusk O’Brien Gido + Partners is collecting transactional data on the architecture, engineering, and environmental consulting industries (A/E firms) for its A/E Business Valuation and M&A Transaction Study, 5th edition. The study includes data from distinct stock transactions along with supplemental data from publicly available sources and is the most comprehensive and reliable study of its kind for this industry. If you participate in the survey, you will get $200 off the $399 study price. To complete the survey, click here. For comparison purposes, you may want to look at prior editions of this study—you can find them here.
The need for increased transparency and consistency in business valuation was a major theme at the recent RICS Business Valuation Conference in Hong Kong. Paul F. Winkelmann, CEO of the Financial Reporting Council,delivered the keynote presentation and called for “a professional body in Hong Kong that represents all valuers, issues standards and enforces them in the public interest." To enhance business valuation quality from an industry perspective, Steve Choi, RICS’s global director of business valuation, said: "The Certified in Entity and Intangible Valuations (CEIV) credential is designed to enhance consistency and transparency in the fair value measurement process.” RICS, the ASA, and the AICPA offer the CEIV credential.
International Valuation Standards Council reports that IVS 2017 will be available in Arabic. The Saudi Authority for Accredited Valuers (Taqeem), the regulator for the valuation profession in the Kingdom of Saudi Arabia, has created the Arabic translation of the 2017 edition of IVS. Taqeem, as a member of the IVSC, has been working on the localization of the standards and introducing it to all Arabic-speaking valuers since its initiation. The Arabic version of IVS 2017 will be available on the Taqeem website.
What’s in the January 2018 issue of Business Valuation Update
Here’s what you’ll see:
“Inside Pratt’s Stats: Impact of Entity Form on Selling Price (Part 2)” (Eric J. Barr, Marks Paneth, and Peter L. Lohrey, Montclair State University). This is the second part of a two-part article that explains how transaction size and the entity form of the buyer and seller support the existence (and the magnitude) of the “pass-through entity premium” where the buyer is able to take advantage of the pass-through status of the seller. This article is based on the results of various statistical analyses of Pratt’s Stats transactional data.
“Use and Misuse of Survey Data to Set Physician Compensation.” This is an excerpt from the recently released BVR/AHLA Guide to Valuing Physician Compensation and Healthcare Service Arrangements, 2nd edition. Timothy Smith (one of the book’s co-editors) interviews Meghan Wong, assistant director, data solutions, Medical Group Management Association (MGMA).
People: Joshua Lefkowitz has joined Cohen & Co. as a partner leading the valuation services practice; he’s formerly with BDO and is in Cohen’s Pittsburgh office … Carli D. Lehr has been promoted to a partner at RLH CPAs & Business Advisors; she joined the firm as an intern in 2004; RLH has offices in Pennsylvania and Maryland … Kansas firm Sink, Gordon & Associates promoted Seth Gordon to the senior manager level; he manages the firm’s business valuation division … The Alliance of M&A Advisors has named Terrel “Terry” Bressler, managing director at Prairie Capital Advisors, as a finalist for the 2017 Middle Market Thought Leader of the Year Award … The Securities and Exchange Commission announced that Mark Kronforst, chief accountant of the SEC’s Division of Corporation Finance, plans to leave the agency in early January 2018 after 13 years of public service there … Kentucky firm Dean Dorton has named Jim Tencza as market leader in Louisville, directing the strategy and operations of that office … Alan Fox of Fox and Fiorino (Reisterstown, Md.) is joining Maryland firm Glass Jacobson Financial Group … Mark Emrich has joined Murray Devine Valuation Advisors as a managing director in the firm’s New York City office on alternative investment firms and financial service intermediaries; he’s formerly with Anagenesis Capital Partners.
Firms: CliftonLarsonAllen LLP expands its presence in the Los Angeles area with the acquisition of NSBN LLP, effective Jan. 1, 2018; the deal adds 19 partners and more than 90 total staff members to CLA … South Florida firm Kabat, Schertzer, De La Torre, Taraboulos & Co. (KSDT) has acquired JL Hofmann & Associates of Coral Gables … After 58 years in downtown Baltimore, Gross Mendelsohn will move to the city’s McHenry Row complex; it signed a lease for 23,000 square feet in a new building scheduled to be completed October 2018… BizEquity has partnered with Envestnet, a wealth technology platform for advisors, to offer its cloud-based business valuation platform to Envestnet’s 60,000 wealth advisors…The $1.75 billion acquisition of Duff & Phelps by the Permira Funds implies a 2.5x valuation multiple on FY16 revenue according to Equitec; the transaction is expected to close during the first quarter of 2018 … Gettry Marcus, based in Woodbury, N.Y., has acquired Manhattan-based JM CPA, bringing on board 15 people including three new partners … Barfield, Murphy, Shank & Smith continues its trek across Alabama by announcing a merger with Hindsman PC, a Gadsden-based CPA firm; the combined entity will have about 170 employees … Wipfli has acquired Sattell, Johnson, Appel & Co. of Milwaukee, adding 33 professionals to its ranks; this is the fifth firm to join Wipfli in 2017 … The Bonadio Group of upstate New York has acquired Vincent J. Muffoletto, a western New York CPA firm; it’ll join Bonadio’s Buffalo office.
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