November 20, 2013 | Issue #134-3  

More BV takeaways from the AICPA FVS confab

In the last BVWire, we reported on some interesting bits of information we picked up while attending the AICPA Forensic & Valuation Services Conference 2013 in Las Vegas. Here are a few more:

Let’s get our act together, urged one speaker, who pointed out that valuation analysts are not using a consistent and defined set of terms. Example: The term “alpha” is now being tossed into modified CAPMs and build-up models—but the definitions of the term are all over the place.

No discount for lack of control should be applied if there’s just the mere possibility that something may change down the road, argued one panelist at a session on valuing minority interests. Another panelist said his firm automatically takes a small discount for lack of control. But the first panelist disagreed with this method, finding it “too speculative.”

ESOP opportunities for CPA valuators are in serving as a financial advisor to the CPA’s audit clients that may be considering an ESOP. These services can result in a happy client and a lucrative add-on engagement for a CPA firm. One piece of advice for them: It’s important to select an independent trustee versus, say, the owner’s golf buddy. There are third parties who will do this.

An updated practice aid for business valuation in bankruptcy is in the works at the AICPA. Expected in the first quarter of 2014, it will have eight new sections, will be updated for new GAAP, and will have an increased focus on valuation issues specific to distress situations.

Add annual rate change language to your engagement letters, advised one speaker. If an engagement lasts for years, you don’t want to miss out on the increase.

Use common sense when looking at the results of your valuation was a common theme from several speakers in a number of different sessions. When all is said and done, step back and simply ask yourself: “Would I buy this business at that price?” “Would I be willing to sell this asset at that amount?” If you answer “no,” rework the analysis because you goofed somewhere.

We’ll have details on these and other issues raised at the conference in a future issue of Business Valuation Update.

Court discredits Apple's non-expert lost profits theory

"Brand new," "vague," "untimely." These phrases were used by the district court presiding over the retrial on damages in Apple v. Samsung to characterize, and dismiss, Apple's recent attempt to increase the number of patents eligible for lost profits.

In March 2013, the court found that a good portion of the $1 billion damages award to Apple was based on an “impermissible legal theory" and slashed it by $450 million. It also ordered a retrial on damages, which is now in its early stages. Apple told jurors in its opening that it was seeking a total of $379 million in additional damages, including $113 million in profits on lost iPhones sales.

Apple's former damages expert, the late Terry Musika (Invotex Group), and its present damages expert, Julie L. Davis, a Chicago-based CPA, both built their lost profits damages model on the four-part Panduit test and, most critically here, on Factor 2, which requires the plaintiff to show that no acceptable noninfringing substitute was on the market. In calculating damages, the experts relied on the assumption that, for three patents related to mobile devices, Samsung would have returned to the market with a noninfringing product that appealed to consumers as much as the infringing smartphones and tablets before Apple was eligible for lost profits on those patents. In other words, Apple could not claim any lost profits for these patents. The experts offered no other model.

In an about-face, 48 hours before the retrial, Apple claimed that it could prove lost profits through an assortment of other evidence of Samsung's infringing sales. Samsung swiftly filed an emergency motion to preclude Apple from doing so, claiming the alternative theory was untimely and, in any event, unable to meet the evidentiary burden.

The court agreed. "[T]he nature of Apple's new, non-expert lost profits theory is not wholly clear," it said. Apple failed to articulate how it intended for the jury to construct its lost profits award, arguing only that it could prove an entitlement to lost profits without relying on its experts. "The Court is not convinced." The lost profits calculation for one patent survived.

Find a discussion of Apple, Inc. v. Samsung Electronics Co., Ltd., 2013 U.S. Dist. LEXIS 162863 (Nov. 12, 2013) in the January issue of Business Valuation Update; the court opinion will be available soon at BVLaw. Readers can find digests of prior decisions in the case and the corresponding opinions at BVLaw.

Never assume royalty base analysis ends with finding smallest salable unit, court cautions

Being a plaintiff’s damages expert in the intellectual property arena may be one of the hardest jobs in valuation these days. That was one of the messages we got from last week’s AICPA Forensic & Valuation Services Conference 2013 in Las Vegas.

For a while now, professionals have wrestled with the various legal principles applicable to lost profits and reasonable royalty, but a few guideposts provided orientation, including the notion that unless the patented feature drives demand, the expert would use the smallest salable unit featuring the invention to calculate the royalty base. Increasingly, courts have chiseled away at that bit of certainty, as a recent Daubert ruling from the Northern District of California illustrates.

Stunted apportionment: Both parties were active in the electronic design automation industry. The plaintiff claimed one of the defendant’s verification products contained its patented design-level parallelism (DLP), among numerous other features, and sued for infringement. Its expert calculated reasonable royalty damages resulting from a hypothetical negotiation using the Georgia-Pacific factors as a framework. For the royalty base, he used the sales data from the defendant’s entire verification product, reasoning that this was the smallest salable unit that included the patented component. He made no further apportionment to account for the product’s many nonpatented parts.

The defendant challenged the calculation under Rule 702 and Daubert. The court agreed that it was inadmissible. At the outset, it acknowledged the difficulty in calculating a royalty base in a product where one component has patent protection, while other components do not. “Courts—including, to be fair, this one—have struggled with whether and how to evaluate an apportionment of the royalty base in this scenario.” The court looked to precedent for guidance.

Under the Federal Circuit’s Lucent decision, absent evidence that the infringing feature drives demand, the patent holder must apportion the royalty base to isolate the value of a patent-related feature. But, said the court, Lucent did not deal with the critical issue “of exactly how one is to apportion the base.” Under Chief Judge Rader’s holding in Cornell, a patent holder must use the smallest salable unit as the starting point for the royalty base. This principle, said the court here, did not imply that apportionment necessarily stopped with the smallest salable unit; rather, Cornell expressly rejects the use of the entire market value where the patented feature is not driving consumer demand for the product that contains it. Put differently, there is no logical basis to drop the apportionment requirement in a case “where the alleged smallest salable unit plainly is not closely tied to the patented feature,” the court in the case at bar concluded.

Here, the protected component, DLP, was an optional feature in the defendant’s product, and it was just one component, the court stated with emphasis. Instead of pinpointing DLP’s value relative to the product’s other components, the plaintiff’s expert made a blanket—and wrong—assumption that his analysis ended with his determination that the defendant’s entire product was the smallest salable unit. His royalty base was fundamentally flawed, and the opinion was inadmissible on this basis alone. The court also discredited the expert’s royalty rate analysis but—perhaps in sympathy with the Herculean task damages experts face—allowed him to submit a revised report.

Find a discussion of Dynetix Design Solutions, Inc. v. Synopsis, Inc., 2013 U.S. Dist. LEXIS 120403 (Aug. 22, 2013) in the January issue of Business Valuation Update; the court opinion will be available soon at BVLaw. The Lucent and Cornell decisions are accessible at BVLaw.

10 current issues in bankruptcy valuations

Robert Reilly (Willamette Management Associates) discussed current issues in bankruptcy valuations during his session at the recent AICPA Forensic & Valuation Services Conference 2013 in Las Vegas. They are:

  1. There is no bankruptcy code definition (or standard) of the term “value”;
  2. The use of hindsight in the valuation is discouraged;
  3. The valuation analyst’s reliance on management-prepared financial projections is often questioned;
  4. The analyst’s selection of valuation variables is often questioned;
  5. Current interest rates may be considered reasonably low;
  6. The reasonableness of the analyst’s due diligence is often questioned;
  7. Consider all of the income tax effects on the debtor value;
  8. Use of industry valuation rules of thumb is often questioned;
  9. Performing the cash flow test within a solvency analysis; and
  10. Use of the market approach in an inactive market is often questioned.

These points are a small sampling of the expert information provided in A Practical Guide to Bankruptcy Valuation by Robert Reilly and Dr. Israel Shaked, available at BVR.

We need your help with a survey about goodwill impairment

On behalf of researchers at the Albers School of Business and Economics at Seattle University, BVWire would like to respectfully request your participation in a research project on the important issue of fair value judgments. Please put aside about 20 minutes of your time to take a survey that entails reading a brief case and responding to questions.

We feel that this project is a valuable contribution to existing research, and the researchers intend to share the results with the business valuation community as well as publish the results in an internationally recognized academic journal. The research design requires a large number of participants, so we hope that you will invest a little of your valuable time to help with this research project and our common, collective goal of enhancing our understanding of fair value judgments.

To participate, click here. Thanks for your help!

Upcoming CPE events

Valuing Synergies (November 21). Learn how to analyze, quantify, and assess the economic benefits of business synergies from the firm and partnership levels. Featuring: Jeff Litvak and Brent Miller (both FTI Consulting).

Forensics in Lost Profits Cases (December 3): The final installment of BVR’s 2013 Online Symposium on Economic Damages examines the intersection of forensics accounting methods and procedures and lost profits cases. Featuring: Peter Resnick (Grant Thornton).

The Relief From Royalty Method (December 5): Maligned, misused, and misunderstood, the relief from royalty method has been prominently featured in some recent court cases. Learn its proper implementation and debunk pernicious myths. Featuring: Brent Sloan (Alvarez & Marsal).

Advanced Workshop on Fractional Interest Valuation (December 12). This intensive, four-hour workshop examines how to recognize and overcome obstacles presented by divided and undivided interests in any asset. Featuring: Dennis Webb (Primus Valuation).

Holiday hiatus

BVWire will be taking a break to enjoy the U.S. Thanksgiving holiday next week. We will resume publication on Wednesday, December 4. We wish you a very happy holiday.

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