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In This Issue:

In Gatekeeper Role, Court Trains Attention on Expert Methodology, Not Conclusions

Acosta v. Wilmington Trust, N.A., 2019 U.S. Dist. LEXIS 9246 (Jan. 18, 2019)

In this ESOP litigation, both parties tried to exclude the opposing side’s valuation expert testimony under Rule 702 and Daubert. The court noted that, at this stage in the proceedings, its focus was on whether the experts applied reliable principles and methods, not on the experts’ conclusions. This case serves as an important reminder to attorneys and experts that the role of the court as gatekeeper is different from its role as evaluator of the sufficiency of the evidence (as the court in another case, Washington v. Kellwood Co., explained so well). Put differently, simply because the expert opinion is admissible does not mean it will hold up in terms of the ultimate outcome of the case.

Questioning ESOP valuation. The U.S. Department of Labor (DOL) sued the defendant trustee (and others) alleging the trustee violated its duties under ERISA by causing an employee stock ownership plan (ESOP) to purchase the outstanding stock in a graphite processing company (Graphite Sales Inc.). According to the DOL, the purchase was for greater than fair market value, which meant the trustee caused the ESOP to overpay by approximately $6 million. At the time of the transaction, an independent valuation firm appraised the company. As part of the transaction, the sellers received stock warrants that amounted to an 18% equity stake in the company. Also, two officers received stock appreciation rights, representing a 10% equity interest. Further, an investor received rights to a 7% equity stake in the company.

The crux of the case was the valuation of the company. The DOL offered expert testimony that called into question the ESOP valuator’s contemporaneous appraisal. The defendant trustee presented its own trial expert to testify and rebut the opinion of the DOL’s expert. Both parties challenged the opposing testimony under Rule 702 of the federal rules of evidence and under Daubert and its progeny. Further, the DOL argued the opposing expert opinion was inadmissible under Rule 403, which provides for exclusion of relevant evidence on various grounds (unfair prejudice, confusing the issues, misleading the jury, etc.). The court’s discussion focused on Rule 702 and Daubert.

In a nutshell, Rule 702 and Daubert provide for testimony by a qualified expert whose “scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue.” The testimony must be based on sufficient facts and data and must be “the product of reliable principles and methods.” In assessing the testimony, a court considers whether the testimony “has been tested, is the subject of peer review and publication, has a permissible error rate, follows established standards, and receives ‘general acceptance’ within a ‘relevant scientific community.’”

“At this gatekeeping stage,” the court in the instant case said, the court’s focus is “on principles and methodology, not the conclusions that they generated.”

Objections to DOL expert testimony. In trying to exclude the DOL’s expert, the defense broadly claimed the expert’s value opinion was nothing more than ipse dixit, or “I say so.” This argument, the court found, was based on the expert’s statement during his deposition that he “could not speak for the entire industry.” In other words, he suggested different valuation experts might interpret certain facts differently.

“Of course, [the expert’s] concession … does not mean that his own interpretation is made up,” the court said, dismissing the defendant’s argument.

The defendant also attacked the expert’s methodology on specifics. For example, it took issue with the DOL expert’s statement that the ESOP appraiser should have used multiples of revenue and EBITDA, not multiples of EBIT and EBITDA, in valuing the company. The defense claimed the DOL expert’s view conflicted with a cited treatise that said the expert’s proposed approach was applied most frequently to startups and service businesses, neither of which the subject company was.

“The defendant is wrong,” the court said. It noted the treatise “explicitly contemplates” use of the expert’s approach “in circumstances other than start-ups and service companies.”

Secondly, the defendant objected to the DOL expert’s claim that the ESOP appraiser erred by using the exit multiple method rather than the Gordon growth model for its discounted cash flow analysis. The defendant said the expert’s critique was wrong because treatises permit the use of either method.

“Even if true,” the court said, the defense argument does not affect admissibility because it simply contests the DOL’s expert choice among accepted valuation methodologies.

Thirdly, the defendant claimed it was improper for the expert to consider the stock warrants and appreciation rights when valuing the company. The defendant noted that the expert, in deposition testimony, “admitted” that the warrants could be considered part of financing the transaction.

The court noted that, in the same testimony, the expert pointed to another “motivation” for the warrants: They were “a form of contingent consideration” and should have been added to the purchase price, he said.

The court said that the defendant would have a chance to probe this issue at trial. However, in terms of admissibility, the defendant failed to show the expert’s view was based on insufficient facts or conflicted with accepted principles and methodologies.

Moreover, the defendant raised questions related to the DOL expert’s application of the principles and method to the facts of the case. For example, the expert criticized the ESOP appraiser’s projections. The defendant, in turn, claimed the expert failed to give proper consideration to the management projections and ignored various other pieces of financial evidence.

The court noted that none of “these purported errors” showed the DOL expert “made up” his revenue projections or used unsound methods. The defendant failed to show that accepted valuation principles compelled the expert to weigh the evidence differently or consider certain evidence, the court said.

Another defense objection was to the expert’s criticism of the ESOP appraiser’s selection of guideline companies and the latter’s choices related to the application of the guideline company method. The defense claimed the expert’s criticism contradicted the expert’s own analysis on other topics. The defendant said there was no reason to use the expert’s preferred method.

According to the court, the defendant’s objection went toward the weight of the opposing opinion, but it did not “even remotely suggest” the opposing expert’s opinion was based on an unsound methodology.

Similarly, the DOL’s expert criticized the ESOP appraiser’s use of a 10% control premium to the guideline companies’ stock. The defendant suggested that the DOL expert’s analysis of control was wrong and made his calculation wrong.

The court disagreed again, noting that this type of application error “would not show that [the expert’s] views are inadmissible.

Objection to defense expert testimony. The court quickly dismissed the DOL’s claim that the defense expert’s testimony was inadmissible because he improperly proposed a damages methodology when doing so was the role of the court.

The court noted the defense expert’s approach—comparing what the ESOP paid for the stock with the fair market value of the stock on the date of the transaction—was the same approach the DOL expert used. Further, this analysis was a legally approved methodology.

In general, the court suggested that the parties mostly quarreled over the opposing expert’s conclusions but failed to show the conclusions were unscientific—the requisite inquiry for purposes of determining admissibility of expert testimony.

Both expert testimonies were admissible in their entirety, the court found.

Editor’s Note: A digest of the above-mentioned case, Washington v. Kellwood Co., 2016 U.S. Dist. LEXIS 92309 (July 15, 2016), and the court’s opinion are available at BVLaw.

Economic Damages Culminate Suit Over War Journalist’s Extrajudicial Killing

Colvin v. Syrian Arab Republic, 2019 U.S. Dist. LEXIS 14641 (Jan. 30, 2019)

A civil suit arising out of the “deliberated” killing of a well-respected American war correspondent illustrates that valuation and damages issues play a critical role in most litigation. The loss of income analysis in this case will be of particular interest to appraisers specializing in personal injury cases.

Marie Colvin was an acclaimed American war journalist who worked for over 25 years for the British paper, The Sunday Times. In February 2012, Colvin, who was a special target of the Syrian government, was killed in a concerted artillery attack in the Syrian city of Homs. Afterwards, members of the Syrian military and intelligence celebrated. Based on evidence, they said: “Marie Colvin was a dog and now she’s dead. Let the Americans help her now.”

Colvin’s youngest sister, Cathleen, and Colvin’s niece and nephew sued the Syrian government under the Foreign Sovereign Immunities Act (FSIA), alleging the reporter’s death was an extrajudicial killing. The plaintiffs sought damages under two legal theories: wrongful death and emotional distress. The court found there was copious evidence (almost 1,000 pages of exhibits, detailed affidavits, declarations, and expert reports) to support a finding that Colvin was the victim of a “deliberated killing” by the Syrian government.

Under the wrongful death theory, all plaintiffs were entitled to monetary damages for the loss of prospective income, benefits, and retirement pay as shown by a reasonable estimate from an expert that was based on well-founded assumptions. The plaintiffs’ damages expert was highly qualified, the court noted. She held a Ph.D. in economics and had worked in valuation for over 10 years, participating in “hundreds of valuation-related projects around the world.” The testimony met the requirements of federal rule of evidence 702, the court found.

To calculate the economic loss resulting from the reporter’s premature death, the expert decided to take a conservative view. In determining the expected income, the expert did not include professional earnings beyond Colvin’s employment with The Sunday Times, believing “it was not possible” to quantify with “a reasonable degree of certainty” any future book deals or film contracts that Marie Colvin could have received.

The expert also adjusted the total amount of lost wages for the risk inherent in the journalist’s job (“probability of survival”) and the time value of money and found the economic loss was $2.37 million. The court credited the expert’s opinion but said that, under the relevant case law, the calculation had to be adjusted for consumption costs. Therefore, the court asked for an updated expert report before making a final determination as to the exact amount of loss of income.

The court also awarded Colvin’s sister $2.5 million to compensate for the pain and suffering resulting from the journalist’s death, and it awarded punitive damages of $300 million. However, this is a default judgment against the Syrian government. How much of the award the plaintiffs will ever see remains unclear.

Extra: A well-received movie based on Marie Colvin’s life came out in 2018. It’s called A Private War.

Divorce Court Finds No Personal Goodwill Value in Single-Owner Business

Stephanos v. Stephanos (In re Marriage of Stephanos), Case No. 502013DR007061XXXXSB, Circuit Court of the Fifteenth Judicial Circuit, Palm Beach County, Florida, J. Samantha Schosberg Feuer, Final Judgment (Dec. 28, 2018)

A Florida divorce case is noteworthy for its multifaceted goodwill analysis, which included an examination by the court of which party had the burden of establishing that goodwill was either enterprise or personal in character and was either a marital asset or not. The nub of the problem was that the husband, who held sole title to the contested company, had a damaged business reputation but still claimed any goodwill existing in the business should be attributed to him. The wife, through expert and lay testimony, was able to show all of the goodwill was enterprise goodwill. The husband was not vital to the company’s continuing existence and success. Further, the court found a noncompete analysis (or “real world transaction”) would not change the goodwill attribution.

Owner’s problems with the law. The parties first filed for divorce in 2003. They then reconciled and dropped their divorce petitions. Ten years later, in June 2013, the husband filed another petition for divorce, which, in November 2013, prompted a counterpetition from the wife. The husband was active in the hormone replacement industry. At one point, he and a business partner equally owned a company, Palm Beach Rejuvenation (PBR). However, in 2007, during the reconciliation period with the wife, the husband and his brother became targets of a federal investigation and were indicted by the state of New York. PBR was raided. The events were on the cover of Sports Illustrated in 2007.

The husband pled guilty to a third-degree felony in the state case and was found guilty, placed on probation, and prohibited from ever providing human growth hormone services to anyone in New York state. The wife gave financial support for the husband’s defense and also provided funds for the creation of a separate entity, Nationwide Synergy Inc. (NSI), which operated in the hormone replacement industry but was not a professional practice. The valuation of NSI was a flashpoint during the divorce proceedings.

The parties also argued over whether PBR morphed into NSI or essentially stopped functioning because of the husband’s legal problems. The trial court ruled that NSI was mostly a separate entity, even though the businesses shared similarities and the husband had bought PBR’s assets and opened NSI in an effort to rebrand. Besides those two entities, between 2007 and 2013, the spouses, and the husband’s brother, also created other businesses involved in hormone replacement therapy.

Importantly, the NSI stock was in the husband’s name alone. The court noted the reason for this arrangement was strategic, to protect the wife from potential legal exposure in light of the husband’s past problems regarding PBR.

The husband was CEO, and the wife served as the CFO of NSI. The evidence showed she made an initial contribution of approximately $850,000 of her nonmarital assets and dealt with the company’s financial activities. She also supervised employees and assisted in creating an important database, and she worked on developing a reputation for NSI and the other entities.

In the company’s beginning, the husband recruited salespersons and put in place people who were key to generating cash. But, once the company grew, other employees became key persons, including the spouses’ son and another employee. The latter two developed a network of physicians who performed clinical valuations of potential customers who wanted to buy the company’s products over the internet. This medical assessment became federal law in 2008. NSI’s key employees established the necessary protocol at the company.

Between 2007 and 2016 (the valuation date), the value of the company went from about zero to $5.3 million and $5.7 million, according to the valuations the parties’ highly qualified experts offered at trial.

Equitable distribution principles. The overriding issue was for the court to determine whether NSI was a marital asset that was subject to equitable distribution.

The applicable statute (Fla. Stat. § 61.075) provides for a three-step process. In essence, the court first has to classify the assets and liabilities as marital or nonmarital. Next, the court has to value the “significant” marital assets based on “competent, substantial evidence.” Under case law, a court must not simply “split the difference” between the values the parties proposed but has to “cite to specific evidence or lack thereof in the record to arrive at its conclusions.” Finally, the court must distribute the assets and liabilities under a presumption in favor of equal distribution, “unless there is a justification for an unequal distribution based on all relevant factors.” Also, under the statute, all assets a couple acquires after the date of marriage that are not specifically established as nonmarital assets are presumed to be marital assets and liabilities. This presumption may be overcome by showing that the assets are nonmarital assets.

Residual method. The court’s inquiry focused on whether there was goodwill value in the company. The question was how to calculate the goodwill value and how to determine whether it was personal or enterprise goodwill.

The applicable statutory provision (Fla. Stat. § 61.075(3)(b)) and case law require a valuation based on the fair market value standard of value.

The clearest method would be the fair market value approach, which is best described as what would a willing buyer pay, and what would a willing seller accept, neither acting under duress for a sale of the business. The excess over assets would represent goodwill. See Thompson v. Thompson, 576 So. 2d 267 (Fla. 1991) (available at BVLaw).

The court explained that Thompson was the controlling case on the issue of business goodwill in the divorce context. Thompson says that enterprise goodwill is value attributable to the company/entity as opposed to value related to the reputation or continued presence of a particular person (“the marital litigant”). In Florida, enterprise goodwill is a marital asset, whereas personal goodwill is not.

The court noted that, when it came to the overall valuation of NSI, the parties’ experts achieved a fair market value determination that was remarkably close. The difference was less than $250,000. The wife’s expert found the company was worth $5.3 million, and the husband’s expert determined it was worth $5.7 million.

The more contentious issue was the goodwill calculation. The court noted the husband’s expert suggested he was unable to extrapolate any goodwill value from the fair market value. Although it respected the expert’s opinion, the court found the claim somewhat “dubious” given the expert’s “extensive expertise and knowledge in the area of business valuation and goodwill.”

In contrast, the wife’s expert used the residual method to determine the value of goodwill, which the husband’s expert allowed was a proper approach. By subtracting the net asset value from the entity’s FMV, the expert achieved a residual value (goodwill) of $2.2 million.

Burden of proof issue. The court noted that it found no reported cases that addressed which party had the burden of establishing the value of enterprise goodwill. Here, the husband claimed that all of the goodwill at the company was personal, whereas the wife claimed personal goodwill in the company was nonexistent or negligible. Accordingly, the husband contended the wife should have the burden of showing all of the goodwill was enterprise goodwill, while the wife argued the burden was on the husband to show he was entitled to the goodwill value as he claimed it was personal to him. Both parties cited cases to support their positions. The court concluded that, since the wife claimed there was goodwill, it was appropriate that she had the burden of showing that enterprise goodwill existed—”through competent and substantial evidence”—and that, therefore, the goodwill was a marital asset.

The court rejected the husband’s position that it was impossible to extract the value of personal goodwill from the residual value. Instead, the court relied on testimony from the wife’s expert as to the purchase price allocation approach and on other testimony and factors to come to the conclusion that there was no personal goodwill attributable to the husband.

The court specifically noted that the husband was a convicted felon who was “unable to compete in certain markets”; his reputation was blemished. He could not point to any customers his efforts brought in. He had no role in developing the database or sales force, both of which were critical parts of the business. He had no relationships with the company’s physician affiliates. Further, all employees of NSI had signed noncompetes and, therefore, were precluded from aligning themselves with the husband in a similar business. In addition, members in the physician affiliate network were bound by noncompetes and confidentiality agreements to protect NSI’s intellectual property. The physicians in the network had relationships with the two key employees, not the husband. The company’s advertising did not mention the husband because the company specifically determined that, if his affiliation with the company were known, it could hurt the business. Most of the company’s revenue stream was generated by website sales; the website in turn was managed by another employee, not the husband. Any web domains and phone numbers belonged to the company and would transfer in the event of a sale.

Company employees spoke of the husband’s limited role and said they did not know what he actually did there. One key employee said that, if the husband were to leave for a year, the company would continue to function as it always had. Also, as of 2016, the husband had limited his role in the company. He was rarely in the office and only communicated sporadically via email.

There was no credible evidence that showed the husband was key to the company, the court found. It decided that the entire residual value was enterprise goodwill. This amount was a marital asset, subject to equitable distribution.

Noncompete goodwill theory. That said, the court also considered the husband’s alternate theory in support of his position that the goodwill was personal to him. He and his expert contended that, in the real world (i.e., in an actual, as opposed to a hypothetical, transaction), a buyer would only be willing to purchase NSI’s stock if the husband executed a noncompete agreement.

The court noted, however, that the ASA’s business valuation standards do not require consideration of a noncompete when calculating fair market value. The court also noted it was not aware of any precedent “from any substantive authority in this State wherein the specificities regarding value and methodology address the criteria to value a covenant not to compete in a ‘real world’ situation.” In other words, there was no specific appellate opinion addressing the valuation of a noncompete.

The wife’s expert proposed looking to Internal Revenue Service guidelines for the purpose of valuing a noncompete. The nine factors included:

  1. The seller’s ability to compete;
  1. The seller’s intent to compete;
  1. The seller’s economic resources;
  1. The potential damage to the buyer the seller’s competition posed;
  1. The seller’s business expertise in the industry;
  1. The seller’s contacts and relationships with customers, suppliers, and others in the business;
  1. The buyer’s interest in eliminating competition;
  1. The duration and economic scope of the covenant; and
  1. The seller’s intention to remain in the same geographic area. See Langdon v. Commissioner, 59 Fed. Appx. 168 (8th Cir. 2003) (citing Lorvic Holdings, Inc. v. Commissioner, 1998 Tax Ct. Memo 283 (1998).

The court said it would rely on the analysis of the wife’s expert for the calculation of value (assuming there was any) of a noncompete. Several case-specific facts were critical, including the fact that all 16 sales force members of the company had executed noncompete, nonsolicitation, and confidentiality agreements, as did the 14 “non-sales force” employees.

Further, all 32 physicians in the company’s physician affiliate network were bound by noncompetes. The company had established a proprietary database related to customers. And there was an established relationship between the entity and the patients/customers the company served.

Considering all the restrictions in place, the court found a real-world transaction analysis that centered on the existence or nonexistence of the husband’s noncompete also would not change the outcome as to personal goodwill. Under either continued presence or noncompete analysis, the goodwill value personal to the husband was nonexistent or negligible, the court concluded.

In the final analysis, the court awarded the company to the husband. For equitable distribution purposes, the court adopted the $5.3 million valuation the wife’s expert had proposed as well as this expert’s determination that goodwill in the company was about $2.2 million and was enterprise goodwill that was subject to marital distribution.

Editor’s note: Hat tip to Josh Shilts (Villela & Shilts LLC) for alerting us to this important goodwill decision.

Court Chooses DCF to Determine Fair Value in ‘Straightforward’ Appraisal Case

Kendall Hoyd & Silver v. Trussway Holdings, 2019 Del. Ch. LEXIS 72, 2019 WL 994048 (Feb. 28, 2019)

Several standard valuation methods were in play in a statutory appraisal case arising out of the minority shareholder’s petition to the Delaware Court of Chancery for a fair value determination. Neither the aborted sales process nor the market approach produced reliable indicators of fair value, the court found. Instead, it relied on a discounted cash flow (DCF) analysis and, in so doing, discussed and resolved disagreements between the parties’ experts over various inputs, including management projections, beta, and residual value. As the subject company was not a public company, the Delaware Supreme Court’s Dell and DFC Global decisions did not guide the Court of Chancery’s analysis.

Nine-year projections. The dispute related to the conversion of a corporation into a limited liability company. Trussway Holdings Inc. (Trussway) had a wholly owned subsidiary, Trussway Industries Inc. (TII), that was the leading manufacturer of prefabricated trusses and other components for the multifamily housing market. TII was the company whose value was in dispute. It had six manufacturing facilities in the U.S. and approximately 930 employees.

In mid-2016, TII contemplated a sale and hired an investment firm to develop a valuation of the company. The financial adviser came up with a value range of $202 million to $298 million. It contacted over 75 parties. At the end of 2016, TII made presentations to seven interested parties. The focal point was nine-year projections (2017 to 2025). The projections envisioned revenue for 2016 to be $218.2 million, increasing in 2017 to $235.9 million. Afterward, revenue was expected to grow from 2.2% to 14.9% annually through 2025. These numbers were very optimistic compared to the numbers appearing in internal management projections for 2015 and 2016. For example, the 2015 projections anticipated an increase from $196 million in 2015 to $204 million in 2016 and an annual decline thereafter, to $132.76 in 2019. The record showed one board member foresaw declines in multifamily housing starts. Internal five-year projections for 2016 also anticipated a decline in revenue through 2020.

A company representative said in his deposition that the nine-year projections were adjusted downward during the sales process “because the business wasn’t performing as was anticipated.”

Importantly, the nine-year projections added to the base case projected costs, revenue, and EBITDA related to four strategic initiatives. The effect was an increase in revenue and EBITDA. By 2025, the initiatives accounted for 39% of revenue and 43% of EBITDA in the nine-year projections.

In December 2016, Trussway’s board of directors approved a merger that transformed Trussway and its subsidiaries, including TII, into LLCs. The transaction was driven by one majority shareholder that owned about 95% of the company’s stock. Two minority shareholders held roughly 5% of the company’s stock and did not vote on or consent to the merger. Instead, the minority shareholders filed for statutory appraisal under section 262 of the Delaware appraisal statute.

While the merger went forward, the negotiations over the sale of TII were ongoing. In February 2017, one offer emerged. The bidder offered $170 million. It later withdrew the offer, and the sale went nowhere.

The parties agreed to the value of the corporate assets and liabilities but did not agree on the value of TII. Ultimately, one minority shareholder settled in principle with Trussway (the respondent). The other shareholder’s petition went to trial in the Delaware Court of Chancery.

Both the petitioner and the respondent offered expert valuation testimony.

Applicable law. Section 262 of the Delaware appraisal statute entitles dissenting shareholders to petition the Delaware Court of Chancery for a determination of the fair value (intrinsic value) of their shares as of the merger date. The fair value determination must exclude “any element of value arising from the accomplishment or expectation of the merger.” The court “should first envisage the entire pre-merger company as a ‘going concern,’ as a standalone entity and assess its value as such.” Under the statute, the court must undertake a case-by-case analysis that considers “all relevant factors.” Both parties have the burden of proving their valuation positions.

Court rejects market approach. In a nutshell, the petitioner’s expert determined the petitioner’s interest in Trussway was $387.82 per share, which was made up of the value of TII, plus the agreed-upon value of the corporate assets, minus the agreed-upon amount of liabilities.

The company’s expert (respondent’s expert) arrived at a fair value of $225.92 per share.

The petitioner’s expert performed a DCF analysis to which he assigned 60% of the weight, a comparable companies analysis that he weighted at 30%, and a precedent transactions analysis that he weighted at 10%.

The company’s expert relied on the results of two DCF analyses. One analysis was based on the nine-year management projections. In a second analysis, the expert modified the nine-year projections to become five-year projections. He assigned a 25% weight to the DCF using the nine-year projections and a 75% weight to the DCF based on the five-year projections.

Neither party claimed that the unsuccessful sales process revealed a value that represented fair value. The court said the one bid emerging during the sales process, $170 million, and other indications of interest, at best, served as “a very rough reasonable check.”

The court agreed with the company’s expert that the petitioner expert’s comparable companies analysis did not generate a meaningful value indicator because the companies used as comparables were insufficiently similar to the subject company in regard to size, public status, and products. The company further contended that the court should disregard the result of the opposing expert’s precedent transaction analysis since that analysis was based on only one reliable transaction. The court agreed and used the DCF for its determination of fair value.

DCF disagreements. Here, the experts used a similar methodology to perform their DCFs but had consequential disagreements over a few key inputs, the court noted.

Projections. The issue was how reliable the nine-year management projections were. The petitioner’s expert used them in their entirety, finding they were based on “the best currently available estimates and judgments of the management of the company.”

The company argued that a valuation should use only the base projections, thus ignoring the strategic initiatives. Alternatively, if the strategic initiatives were part of the analysis, the valuation should assign greater weight to the first five years of company projections, as the company’s expert had done.

In discussing the reliability of the nine-year projections, the court noted the company “routinely” created projections. The projections were done in the course of business and, in this instance, the company intended to use them in the context of a sales, the court observed. Sales considerations generated optimistic projections, the court noted. It also found the projections were longer than the common five-year projections. One explanation for the extended period was that the multifamily housing industry was cyclical. The longer projections aimed to correct “cyclic distortion,” the petitioner argued.

The court agreed that the projections were “the best predictor” of the subsidiary’s performance. Moreover, it found that the strategic initiatives were part of TII’s “operative reality” and should be considered in valuing the company as a going concern. “TII had the unilateral choice to pursue the initiatives, and projected that they would do so,” the court noted.

The court acknowledged there was “a degree of huckster’s optimism in these predictions” and noted that the petitioner’s expert seemed to acknowledge as much by adding a 1% risk premium to account for the uncertainty surrounding the forecasts. However, there was no basis for the 1% risk premium adjustment, the court found. It adopted a modified version of the approach the company’s expert took regarding the projections. The court weighted the results of the two DCF-generated values equally. One value resulted from using the nine-year projections and the other from using the same projections but beginning the terminal period after five years. The court said its analyses applied the calculation the company’s expert made from the nine-year projections of management’s projected annual cash flows and expected debt and equity levels.

WACC and beta. Although the experts largely agreed on how to calculate WACC, they disagreed over beta. The petitioner’s expert used adjusted beta, assigning two-thirds of the weight to raw beta and one-third weight to a mean beta of 1.0. The company’s expert used historic beta.

Further, the petitioner’s expert used the Hamada method to unlever and relever beta. In contrast, the company’s expert used the Harris-Pringle method. The methodologies differ in their treatment of debt, which can result in “notably disparate beta calculations,” the court noted.

The petitioner’s expert obtained a WACC of 13.4%, whereas the company’s expert calculated a WACC of 15.4%.

The court disfavored the use of an adjusted beta “for this small, private corporation.” It also said that any error in using a historic beta would be minimized because the court assigned a 50% weight to a DCF that used the nine-year projections with very optimistic growth forecasts.

Also, since the court leaned heavily on the DCF analysis of the company’s expert, it accepted his use of the Harris-Pringle model. The difference in the approaches was de minimus, the court said. The court’s beta was 1.74, and its WACC was 15.4%.

Residual value. To calculate the terminal value, both experts used the Gordon growth model. However, the plaintiff’s expert also used the exit multiples approach, which the opposing expert said doing so improperly increased the residual value. The company’s expert used a 2.3% growth rate, which the petitioner claimed was too low.

The court said use of the exit multiples approach with its high-growth-rate assumptions was inappropriate considering the court already used the optimistic nine-year forecast. Therefore, the court decided to use the Gordon growth model and a 2.3% growth rate.

The court’s inputs generated two values. A DCF analysis based on the nine-year forecast resulted in a value for TII of $197,800. A DCF analysis based on the first five years of the projections resulted in a valuation of $168,800. Weighting each result equally, the value of the company was about $183,300. Adding the other agreed-upon values for assets and liabilities and dividing the result by the shares outstanding, the court obtained a per-share value for Trussway Holdings of $236.52—thus a value close to the fair value calculated by the company’s expert.

Based on its DCF analysis, the court decided the fair value of the company as of the merger date was $236.52 per share.


Jay Cunningham Director, Litigation & Dispute Services

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