In a statutory appraisal case with several twists, the Delaware Court of Chancery recently agreed with the parties’ experts that a discounted cash flow analysis was the only way to determine fair value while rejecting, unequivocally, the company expert’s novel approach to calculating beta. The expert’s willingness “to go out on a limb to support a forensic valuation opinion” raised serious questions about the admissibility of his testimony under Daubert and about his entire valuation analysis, the court noted.

This case involved a privately held company that provided process outsourcing and financial technology services to various industries. The petitioners held a minority stake in the company, and several other investors owned the remaining interests. Top executives of the company pursued a number of transactions that culminated in a business combination by which the subject company merged into another company and became a publicly traded company.

Disavowing own expert: Notwithstanding recent case law from the Delaware Supreme Court that embraced the use of market indicators to determine fair value, the court and the parties agreed that here there was no reliable market evidence because the company’s stock was not publicly traded and company managers made no effort to undertake a proper sales process. Accordingly, the parties’ experts relied on “traditional valuation methodologies,” i.e., the DCF, or a variation of it. The court approved of this approach.

But it noted that the experts’ value conclusions were “solar systems” apart. Disagreements between party experts were nothing new, the court observed. What added a twist to this proceeding was that the company “disagrees with its own expert,” the court said. The company claimed its expert’s fair value determination was too high, relying on the testimony of witnesses who were impeached. The court promptly dismissed the company’s value conclusion.

As to the experts’ divergent inputs, the court noted the “most consequential point of disagreement” was over how to calculate the company’s equity beta. The petitioners’ expert, using a generally accepted method, calculated beta indirectly, based on 19 publicly traded comparable companies, the court emphasized. In contrast, the company’s expert said there were no comparable companies and that he could not use “indirect or regression-based betas.” Therefore, he calculated beta “directly by looking to market evidence” of the company’s debt. The court observed the debt was not publicly traded; these were private loans that traded only by appointment. Debt pricing services had observed incorrect and incomplete information as to the company’s debt.

The expert admitted he came up with this approach for this case. He had not used this method before, nor had he seen this method used before, but hoped it would “catch on” in the future.

The court, with disapprobation, said the company’s expert was “[u]sing the courtroom as an incubator for his experiment.” In a footnote, the court added that it was “ill-equipped to assess the merits of the theoretical debate” in which the parties’ experts engaged as to the implications of this novel theory for beta approximation, “much less who will ultimately prevail should the debate continue in the academy where it belongs.” The crux was that the method was new, as the company’s expert admitted, and the petitioners’ expert’s method was “tried and tested.” “As lay fact finder, I place my trust in the generally accepted methodology,” Vice Chancellor Slights said.

The court concluded the petitioner expert’s valuation was “credible and reasonable” and adopted it “in toto,” with a minor adjustment to the expert’s size premium. The petitioner expert’s fair value was $5,100 per share, the company expert’s fair value was $2,800 per share, and the court’s fair value was $4,600 per share.

Takeaways: (1) The DCF has a role to play in Delaware appraisal proceedings featuring privately held companies; and (2) there are venues for experts to introduce and test novel valuation approaches, but the courtroom is not one of them.

A digest of Manichean Capital, LLC v. SourceHOV Holdings, Inc., 2020 Del. Ch. LEXIS 38, 2020 WL 496606 (Jan. 30, 2020), and the court’s opinion, will be available soon at BVLaw.

The ‘big market delusion’ overvalues companies at first

The allure of a big market for an emerging business is hard to resist and causes “irrational exuberance” that initially overprices companies and triggers an inevitable correction. That’s the thesis of a new paper by Bradford Cornell (Anderson Graduate School of Management, UCLA) and Aswath Damodaran (New York University—Stern School of Business). They illustrate using three case studies of industries that have or are going through this phenomenon: dot-com retail, online advertising, and the cannabis market. The authors say that the lesson for valuation professionals is that “pricing based upon multiples and the peer group can lead to significant overpricing.” To avoid this, in-depth valuations, “flawed though they might be, can prove to be the first step in recognizing the big market delusion, and perhaps correcting for it.” The paper is titled “The Big Market Delusion: Valuation and Investment Implications” and is available from the Social Science Research Network (SSRN).

When you talk about prominent and successful business valuation practitioners, the name Gary Trugman (Trugman Valuation) has to come up. He has built an incredible practice, and his book, Understanding Business Valuation: A Practical Guide to Valuing Small- to Medium-Sized Businesses, is an absolute must in every BV library. What has been his best tactic for landing new BV clients? Advertising in law journals, he told Rod Burkert (Burkert Valuation Advisors LLC) during a recent interview. This works well because he has done this continuously over many years, not just running one-time ads here and there. Plus, he attends bar association meetings, and that, along with the ads, helps to let attorneys know that he is around and that he has a particular expertise. It’s great to be an authority, but people need to know about it! The interview was part of Burkert’s webinar series, Practice Development INSIDER, that features some of the leading valuation practitioners revealing their time-tested ideas behind building a practice. The next webinar will be March 12 and will feature James Koerber (The Koerber Co. PA). For more information on the series, go to Burkert’s website.

In late March, a free trial will be available for BVR’s new Guideline Public Company Comps Tool (GPCCT), which has been built exclusively for the business valuation community. Very soon, every practitioner will have access to an affordable yet robust source for complete financial statements, financial ratios, and multiples for comparable guideline public companies on U.S. exchanges for any selected period. A web page has just been set up for the GPCCT that has some highlights of the new tool plus how to sign up for the free trial or attend the free webinar on
April 1.

Ever since the housing crash, residential and commercial construction has been in a steady state of rebound. Through 2024, the global construction industry “is expected to have good opportunities in the residential, nonresidential, and infrastructure industries,” writes Pasquale Rafanelli (Empire Valuation Consultants) in a new guide, What It’s Worth: Valuing Residential and Commercial Construction Companies. Growing opportunities for firms in this industry to expand their businesses has increased the need for appraisers to play a pivotal role, the guide says. Not only can appraisers provide valuation services, but they can also act as advisors and give clients in this industry the help and tools they need to better position themselves in the growing market. The guide includes a discussion of value drivers, market trends, exit planning, a case study, market comps from the DealStats transaction database along with industry intelligence from The Business Reference Guide. To see the guide’s table of contents, click here.

For the second year, BVR is pleased to partner with the Houston Chapter of the American Society of Appraisers (ASA) to present a live webcast of the Energy Valuation Conference, which will take place on May 13 in Houston. The conference agenda will feature presentations from nationally recognized speakers who are profession leaders, covering a range of important topics in the industry. There will also be some exceptional networking opportunities. Early-bird pricing for attending in Houston is available through March 31.

Heightened tensions in the Middle East, the UK leaving the EU, and signs that the trade dispute between China and the U.S. is subsiding are all addressed in the latest edition of KPMG’s International Valuation Newsletter (11th edition), published quarterly. There is also an update on recent capital market data relevant to any valuation analysis. Highlights of the report’s market update are:

• Major stock market performances: All indices gained on a quarterly and yearly basis, with the Nasdaq outperforming all (+12.2% on a quarterly and +35.2% on a yearly basis);

• EURO STOXX 600 sector multiples: Valuation multiples of most sectors have risen over the past four quarters; and

• Current risk-free rates for major currencies: Interest rates rose in Q4 2019 for the first time since Q3 2018 for all areas except Switzerland.

The report also focuses on the valuation of ships and points out that, because shipping companies may be making significant changes to their fleets, the long-term asset value (LTAV) method is “more relevant than ever,” the report says.

The European Financial Reporting Advisory Group (EFRAG) is looking for experts to serve on its Advisory Panel on Intangibles. The group is researching suggested disclosures and current best practice in this area while considering the related costs and effort. The deadline for applying is February 21. For more information, click here.

Preview of the March 2020 issue of Business Valuation Update

Here’s what you’ll see:

• “Introducing the Rudich/Jaroudi BIZCOMPS DLOM Study” (Ronald D. Rudich, Business Valuation Group, and Baria Jaroudi, Briggs & Veselka). The authors do an analysis of the BIZOMPS database of sales of small private companies to uncover an imbedded discount for lack of marketability (DLOM) in a specific industry. The authors would like feedback on this study and methodology.

• “Update on U.S. Cannabis Valuations From PKF’s Practice Leader” (BVR Editor). Noam Hirschberger talks about the rapid growth and heavy regulations that have triggered a need for financial and advisory services, including valuation and tax planning, that will be critical to the ongoing success of firms in the cannabis industry.

• “Goodwill Amortization Controversy and CEIV Highlight Fair Value in 2020” (BVR Editor). Mark Zyla (Zyla Valuation Advisors) gives some highlights of what’s on the front burner for fair value in 2020, including issues surrounding the FASB’s invitation to comment on the impairment of goodwill, an important update to the Certified in Entity and Intangibles Valuation (CEIV) credential, the increasing globalization of the profession, and upcoming guidance.

• “Don’t Automatically Reject the Asset Approach for Going Concerns” (BVR Editor). Many valuation analysts immediately reject the asset-based approach for operating businesses, but this is a problem, say Robert Reilly and Weston Kirk, who are both with Willamette Management Associates. The method is rejected too often because analysts are not familiar enough with the asset approach or they have misconceptions about when (and when not) to apply it.

• “SRO Crowd Sees Latest Update to Leading Pre-IPO Study” (BVR Editor). The largest audience for a BVR webinar in recent memory watched as Brian Pearson put the Valuation Advisors Lack of Marketability Discount Study through its paces. Pearson, the creator of the study, discussed new data added in 2019, misconceptions and criticisms of pre-IPO data, and uses for the data that extend beyond estimating a DLOM.

• “More Ups and Downs for Patent Valuations in the UK and Beyond” (BVR Editor). Business valuers can expect further changes in the UK landscape for intellectual property (IP) creation and commercialization. Intangibles now represent almost 90% of the market value of the largest listed companies, so these changes may be the most significant factor in many current business valuations.

The issue also includes:

• An expanded section of “BV News and Trends/Global BV News and Trends.”

• Regular features: “Ask the Experts” and “Tip of the Month.”

• BV data spotlight: “DealStats MVIC/Revenue Trends,” “Stout Restricted Stock Study and DLOM Calculator,” “Economic Outlook for the Month,” and the “Cost of Capital Center.”
  
  
• BVLaw Case Update: The latest court cases that involve business valuation issues.

To stay current on business valuation, check out the March 2020 issue of Business Valuation Update.

People: Taylor West, CVA, has been admitted as a partner at New York City-based Marcum; he is in advisory services in the firm’s Houston office, and he specializes in the valuation of corporate debt, equity and derivative securities, partnership interests, and intangible assets of privately held and publicly traded businesses … Daren Mesrobian, ABV, has been admitted as a partner at Los Angeles-based Holthouse Carlin & Van Trigt; he is in the Pasadena office and leads the firm’s valuation advisory services practice and has extensive experience performing valuations of business enterprises, equity securities, and intellectual property for a variety of purposes … Paul Fullerman, CPA/ABV, CVA, was named partner at Bodine Perry, a public accounting firm with offices in Ohio and Florida; he has extensive experience in business valuations for a variety of industries … Sareena Sawhney, CFE, CAMS, MAFF, has joined Princeton, N.J.-based Withum as a principal in the firm’s forensic and valuation services group; she is in the New York City office and focuses on complex fraud investigations, forensic accounting examinations, and services related to commercial litigation and damage analyses … Jimmy S. Pappas, CPA, CFE, CFF, ABV, has joined New York City-based Marcum as national leader of forensic advisory services and is based in the firm’s Boston office; he has more than 20 years of experience advising on accounting, internal control, and complex financial matters related to internal investigations, civil and criminal litigation, and corporate governance.

Firms: Union City, Tenn.-based Alexander Thompson Arnold has formed a partnership with Adelsberger Marketing of Jackson, Tenn., a digital marketing firm that offers videography, content marketing, digital advertising, social media, websites, and branding … Richmond, Va.-based Cherry Bekaert has acquired Icimo, a data analytics and services firm located in Cary, N.C., adding more than 25 technology professionals to the firm’s digital solutions and services practice … Pittsburgh-based Schneider Downs has opened an office in the Washington, D.C., region, in Tysons Corner (McLean), Va.

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

Upcoming BVR training events

• Valuation Adjustments & Potential Forensic Implications in Litigation Thursday, February 20, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET Featuring: Karolina Calhoun (Mercer Capital).
  
  In a valuation related to a dispute, the issues can be multifaceted and may require additional forensic investigative scrutiny. This webinar will discuss the potential forensic implications of valuation adjustments because they may lead to other analyses.
  
  

• Valuing Customer Relationships: The Do’s and Don’ts of the Distributor Method (part of BVR’s Special Series on Fair Value). Tuesday, February 25, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET Featuring: Edward Hamilton (Valuation Research Corp.) and Sean Woodward (Valuation Research Corp.).
  
  A discussion of the strengths and weaknesses of customer relationship valuation methodologies and how an alternative method (the distributor method) can help decrease subjectivity in this process.