October 23, 2013 | Issue #133-4  

Should you normalize the risk-free rate?

It’s conference season, and BVWire has been out and about listening to and talking with BV thought leaders about hot topics and current developments in the profession.

In a session at the ASA Advanced Business Valuation conference in San Antonio, Shannon Pratt (Shannon Pratt Valuations) and Roger Grabowski (Duff & Phelps) revealed some of what will be included in their new, fifth edition of Cost of Capital: Applications and Examples, which is the most comprehensive book on this subject. They pointed out that they have written this new edition as though they were “talking to the courts” as to how this topic should be viewed and treated. It’s hard to believe they can improve on this book, but it appears that they have done just that. The new edition will have additional case studies and updated chapters on SFAS 141, 142, 144, distressed companies, convertible bonds, and hybrid instruments.

Fresh look: They’ve also added a full chapter on the risk-free rate. Based on their research, valuation experts should rethink their position about normalizing this rate. Most analysts do not do this, but, after listening to Pratt and Grabowski, conference attendees and speakers agree that the normalization of the risk-free rate is now something to seriously consider.

We’ll have more details in a future BVWire and an expanded article in an upcoming issue of Business Valuation Update.

Where is fair value headed?

Also at the ASA Advanced Business Valuation conference in San Antonio, Mark Zyla (Acuitas Inc.) updated attendees on current trends with fair value measurements. According to Zyla, you can expect to see the following:

  • Increased scrutiny by the SEC and PCAOB;
  • A move toward consistent valuation methodology and standards;
  • Sharper questioning by private companies as to the relevance of fair value in certain instances;
  • Continuing evolution of best practices;
  • More relevance of international valuation standards;
  • Auditors becoming better versed in fair value measurement techniques; and
  • More prominence of this issue in college and accounting/finance programs.

Look for an expanded article on the topic in an upcoming issue of Business Valuation Update.

Valuation tips from the Atlanta BV conference

Last week’s BVWire included some key takeaways from the recent 14th annual conference of the newly reorganized Southeast Chapter of Business Appraisers held in Atlanta. Here are a few more:

Impacts on discounts: Corporate structure, actual operations, and state laws can impact valuation discounts, points out Patrice Riela (Delphi Valuation Advisors Inc.). From shareholder and divorce matters all the way to properly documented buy-sell agreements, a key to proper discount development is to discuss the situation in detail with your client’s attorney up front and agree on the approach. The challenge all business appraisers face is to integrate state statutes, court precedents, entity-governing documents, and the attributes of the interest itself and end up with a supportable set of circumstances for each discount taken.

Real estate vs. BV: In the world of real estate appraisal, all parties are hypothetical. When valuing fractional interest in companies, while the fair market value buyer and seller are hypothetical, the other equity holders can impact the hypothetical buyer’s decisions and perception of value. Dennis Webb (Primus Valuation) talked about these and other differences between real estate appraisal and business valuation. Another major difference can be the impact of the holding periods. The PwC Real Estate Investor Survey has investment horizons built into return rates, which are usually shorter than the typical 20-year holding period used for business valuations.

Transition plans: And for something completely different, Steve Egna (Teal, Becker & Chiaramonte CPAs PC) shared his experience in working with clients developing and executing transition plans. He used case studies to illustrate the challenges of working in this rapidly evolving practice area. Key takeaways included ensuring that the business owners are well educated on the transition process and identifying pitfalls in developing such a practice.

International: U.S. corporate income tax rates are generally higher than those in most other countries, including Canada, United Kingdom, Sweden, and France. Switzerland provides tax incentives for farmers, and Iceland has lower taxation for technology companies. Chris Mellen (Delphi Valuation Advisors Inc.) stressed that understanding the local environment is important, including tax structure and accounting conventions. When valuing international companies, it is also important to make sure that cash flow and rates are treated consistently with regard to inflation and are based on the same currency.

Want to attend this conference next year? The 15th annual conference is scheduled for Sept. 19-20, 2014, also in Atlanta.

Harsh words from the court for underperforming experts

Valuation experts who take on an engagement for which they lack the qualifications or the time risk a tongue-lashing in court, as a recent bankruptcy case demonstrates.

Here’s the picture: When Eastman Kodak filed for Chapter 11 bankruptcy in January 2012, a group of shareholders requested the appointment of an equity committee, which the Bankruptcy Court (S.D.N.Y.) denied. As its bankruptcy moved along, Kodak gave up its dedicated capture devices business and sold its digital imaging patent portfolio for $527 million, much less than it had expected to collect. Also, in a settlement with its largest creditor, it sold the personalized imaging and document imaging businesses for $650 million. Its June 2013 disclosure statement set the company’s enterprise value at $498 million as of fall 2013 (the date of the reorganization plan). This valuation “was the result of hundreds of hours of work by recognized professionals,” one of its financial experts testified.

The shareholders claimed Kodak had underestimated its reorganization value by over $2 billion. They offered two expert reports that said there was significant undisclosed value in the company’s patent portfolio and in its brand. Kodak opposed the admission of these reports under Daubert. The first appraiser had graduated from law school less than five years previously and set up his own company to provide intellectual property (IP) services. He performed a discounted cash flow (DCF) analysis and said, in a three-page letter to the shareholders in June 2013, that he believed “the intrinsic value of Kodak’s U.S. patent portfolio to be $1.6 billion to $2.5 billion.” The analysis assumed that at that time Kodak had slightly more than 8,500 U.S. patents in force, with an average remaining term of 8.177 years. Based on a January 2012 lender presentation and on licensing figures from recent years, he concluded the annual patent revenue was in a range of $250 million to $350 million.

A Kodak expert countered by saying that the company’s recent settlement reduced the number of worldwide active patents to 7,000 and active U.S. patents to 4,400. Moreover, Kodak had granted licenses to “virtually all” of the retained patents to a consortium that participated in the sale of the digital imaging patent assets. It needed to hold on to any unlicensed patents for its core business following reorganization. The most recent public financial statements projected 2013 IP revenue of only $35 million. The shareholders’ expert had not reviewed the most recent financial information but said he was aware of the 2013 asset sales.

Not a Kodak moment: The court bristled at this testimony. “Whatever the strength of his background, he spent only five hours and his firm spent a total of ten hours on valuing Kodak’s patents,” it said, highlighting his contradictory attitude. Although he admitted that his firm would need 5,000 hours to do a full analysis of the value of the patent portfolio, he “did not take the position that he could not provide any opinion testimony until such analysis had been performed.” Based on assumptions “that have no validity whatsoever,” the testimony was not “useful or admissible” as to current value. The brand expert’s analysis didn’t fare much better with the court.

Find an extended review of In re Eastman Kodak Company, 2013 Bankr. LEXIS 3325 (Aug. 15, 2013) in the November issue of Business Valuation Update; the court opinion will be available soon at BVLaw.

GPC research tool update

BVR reported new features and upgrades to the PitchBook/BVR Guideline Public Company Comps Tool in the October 2 edition of BVWire. These include dedicated search tabs for key fields, SIC codes, industry, location, financials, multiples and ratios; a searchable glossary; real-time display of comps count by industry; and an even more user-friendly interface. An updated tutorial is available by clicking here.

CPE training events

Valuing Marijuana Dispensaries (October 24): How should appraisers treat a newly legalized marketplace? What impact will disparate local and federal laws have on value? Presenters: Ronald Seigneur (Seigneur Gustafson LLP) and Jim Marty (Jim Marty and Associates LLC).

Valuing Dermatology Practices: Get Some Skin in Your Game (October 29): Learn how to parse the many income streams of dermatology practices, which have expanded their scope of service and procedural offerings over the past 10 to 20 years. Presenter: Mark Dietrich. Part 10 of BVR’s Online Symposium on Healthcare Valuation.

Calculating Damages for Insured Claims (November 5): Jonathan Dunitz (Verrill Dana), co-curator of BVR’s Online Symposium on Economic Damages, joins BVR for the ninth installment of the series, focusing on the quantitative and analytical methods required when assessing damages for a claim against “business interruption” or “time element” insurance.


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