| October 12, 2011 | Issue #109-2 | Printer Friendly Version - Click Here |
Best resources for calculating country-specific COC, brought to you by the globally minded ASA The ASA’s 30th Annual Advanced Business Valuation conference in Chicago this week reflected the country’s broader concern with international markets, starting with the first general session: “International Cost of Capital—A Walk Around the Globe,” by Nancy Czaplinski (American Appraisal). Via a case study, Czaplinski applied six different cost of capital (COC) models to use in today’s global environment, each reaching a slightly different result. “Which is correct?” she asked ASA attendees, not a rhetorical question so much as a practical one that analysts will have to answer more frequently as our economies become more interdependent and foreign investments increase. “As a valuation professional you have to go through the models and see what works, depending on your project [and where it is located]. You have to look at the risks specific to that country and local economy and step back and logically assess how those factors impact your valuation and what adjustments you have to make.” Finding data to use in developing an international cost of capital can be challenging, Czaplinski observed. For example, she uses Bloomberg and Bradynet for debt pricing, Political Risk Services for risk ratings; for country-specific equity and market risk premiums, she refers to the recent article by Pablo Fernandez (University of Navarra, Spain): “Market Risk Premium Used in 56 Countries in 2011: A Survey with 6,014 Answers.” Is the ‘25% rule of thumb’ still alive and well? The Federal Circuit’s decision in Uniloc v. Microsoft to “abolish” the 25% rule of thumb in patent litigation appears to be final and fatal, according to most authorities (including the BVWire). But were reports of the rule’s “death by Daubert” premature? “Despite this holding,” says attorney Andrew S. Dallmann (Jeffer Mangels Butler & Mitchell), in a recent post on Patent Lawyer, “courts appear to continue to use this rule of thumb as a guide in determining a reasonable royalty for patent infringement.” In particular, Dallmann cites a recent decision in which a federal district court rejected the royalty rates proposed by both parties. Instead, it began with the 25% rule of thumb as provided for in Paice LLC v. Toyota Motor Corp., a 2007 Federal Circuit decision that was frequently cited as a framework for establishing prospective royalties—at least, prior to Uniloc. “The court did not rely on the 25% rule as its sole basis for determining an ongoing royalty,” Dallmann comments. Indeed, had it done so, it would have contravened Uniloc—which clearly cites Paice as a prior decision that “passively tolerated” the rule. Nevertheless, Dallmann says, the court’s use of the rule, even as a benchmark, begs the question whether federal jurisdictions will continue to use the 25% rule—post-Uniloc—as a “quick and dirty, royalty rate reality check.” Look for a complete digest of Douglas Dynamics LLC v. Buyers Products Co., 3-09-cv-00261 (W.D. Wis.)(Sept. 22, 2011) in the next Business Valuation Update (November); the district court opinion will be posted soon at BVLaw. Reminder: the full text of the court’s opinion in Uniloc is also available as a free download from BVResources.com. AICPA revised IPR&D Aid should expand valuation techniques well beyond earnings approach The newly revised IPR&D Practice Aid from the AICPA will significantly expand consideration of various valuation techniques, Tony Aaron (Ernst & Young), co-chair of the AICPA task force that’s revising the AID, told ASA attendees this week. For example, compared to the 2001 first edition, in which the valuation chapter contained only 70 paragraphs, the revised chapter will have over 200. The original Aid also focused primarily on the multi-period excess earnings method (MPEEM), said David Dufendach (Grant Thornton), potentially casting the relief-from-royalty method in a negative light. The updated version will contain examples of MPEEM, the relief-from-royalty method, and decision tree analysis, thereby removing any perceived barriers to their use and according them appropriate weight. The revised IPR&D guide will also discuss the “Greenfield approach,” the cost savings method, split methods, and more. “It really opens the doors to whatever we think is the appropriate methodology,” said Dufendach. The ASA presenters indicated that the AICPA hopes to expose a working draft of the IPR&D Aid for public comment sometime this fall, with a final version to be released by the middle of next year. Will it still be called a ‘control premium’? “One of the principles that’s been advanced to The Appraisal Foundation’s third Working Group is that a control premium is more like a premium that may be observed between voting and otherwise comparable non-voting shares,” Dayton Nordin of Ernst & Young (and a member of TAF’s third Working Group on Control Premiums) told ASA attendees. Like the AICPA’s work on IPR&D guidelines, the AF task force is also hoping to release its standards in mid-2012. In particular, this third Working Group is developing a new term for control premium: the market participant acquisition premium (MPAP). This means:
The third Working Group also recognizes the continuing need for a benchmark control premium analysis (e.g., the Mergerstat/BVR Control Premium Study). However, auditors (who are bound by TAF standards) will be more likely to subject benchmark comparables to much greater scrutiny. Is the use of restricted stock data declining? In our recent online survey regarding the IRS DLOM Job Aid, we asked participants what methods they were currently using to determine marketability discounts. This question more or less paralleled one in our 2009 survey on marketability discounts, in which (predictably) the vast majority—over 90%--of respondents replied that they relied on the restricted stock studies. In this latest poll, however, that number dipped to less than three-quarters (71.4%). Interestingly, the percentage of respondents who reported relying on a DCF model such as the QMDM nearly doubled, from 16.7% in 2009 to 33.3% in this current tally. Use of pre-IPO studies stayed flat, at just about 50%, while options added in the most recent survey indicate that only 9.5% of respondents currently use the Liquistat (Pluris) database, but two-thirds (66.7%) use a Mandelbaum-type analysis. None of the results is scientific, of course, but the comments to the current survey do reveal a clear caution against just “quoting studies and picking a discount from a group because it seemed reasonable,” as one respondent said, adding that the IRS Job Aid “certainly shows you are expected to include specific analysis rather than ‘talk around’ a bunch of studies.” Similarly, one respondent professed astonishment “that so much time is spent on ‘studies’ of companies that in the best case have little to do with the subject company.” The ultimate question: “What would someone who is actually thinking about buying a little company do to evaluate it as either a majority or minority interest holder?” To that end, several respondents said they use the company-specific analysis afforded by FMV Opinions, which mirrors the responses to the ’09 survey. Last chance to get the latest analysis: tune into today to BVR’s special 100-minute webinar, FMV Responds to the IRS DLOM Job Aid, featuring Lance Hall (FMV Opinions). DOL’s withdrawal of ERISA proposal may be a ‘pyrrhic victory’ National Football League fans often get giddy with their team’s pre-season start, only to succumb to “despair” as the harsh reality of regular season sets in, quips attorney Richard McHugh (Porter Wright Morris Arthur) in a recent Lexology post. In the same way, opponents of the U.S. Department of Labor’s recent proposal to include ESOP appraisers as ERISA fiduciaries, including many among the BV profession, may soon feel the same way, McHugh says. “This battle is not over and is not yet won.” Why? High-ranking DOL representatives have indicated that, in re-proposing the regulation, they are “not backing down on some of the major tenets of the original,” and that they will “deal with concerns about the regulation’s application to routine appraisals,” such as those in the ESOP sector, McHugh reports. Moreover, the re-proposal—which may be ready as early as next year, “may prove harder to fight, thus perhaps making the recent withdrawal a pyrrhic victory.” Affected entities may still have to fight the fiduciary label—or, as BVWire cautioned when the news first hit our fans, the ongoing administrative scrimmaging may simply drive some BV firms to drop their ESOP practices. As McHugh quotes one DOL representative, “I see a very short line of people in front of our building saying they want to be a fiduciary.” Renewable energy accelerates: Over $11.2 billion in deals reported so far this year Imagine “Houston” and “alternative energy” in the same sentence—even in the same setting. That’s exactly what came together during the ASA Houston’s recent Energy Valuation conference (and thanks to chapter president, Tim Stuhlreyer, Convergent Capital Appraisers, for pointing out the convergence). “The renewable energy sector continues to have a broad appeal and is attracting the full mix of industrials, utilities, and financial acquirers worldwide,” Joseph Omoworare (Duff & Phelps), told ASA attendees in Houston. There were 141 deals announced globally as of Q1 2011, totaling $11.2 billion, according to a recent industry publication. As the industry gradually shifts to lower-carbon options, by 2035 electricity generation from renewables (measured in kilowatts per hour) is projected to increase 75% from 2009 levels, Omoworare said. Natural gas generation is expected to rise by 40% while dependency on coal will continue to decrease. In the renewable sector, the focus is now on wind and solar, which accounted for most if not all of the recent surge in M&A activity. “I’m positive about solar,” Omoworare said. Solar companies are trading at low multiples right now, due largely to competition from the Chinese. But this competition is also reducing costs of production, predicted to decrease by 50% over the next three to four years, Omoworare noted, and “there’s enough motivation to keep driving those costs down” to help build domestic solar capacity in the future. FASB exposes its new standards-setting process for private companies Just last week, the board of trustees of the Financial Accounting Foundation (FAF) issued a request for public comment on a new plan intended to improve the standard-setting process for private companies, according to a recent release:
The FAF board of trustees would oversee the PCSIC, replacing the Private Company Financial Reporting Committee (PCFRC), a FASB advisory-only body formed in 2006. At least one financial organization has endorsed the proposal. George W. Beckwith, chairman of FEI’s Committee on Private Co. Standards, says he is pleased with the exposure draft and believes that “the basic theme of the FAF’s proposal” is a “big step” and shows that the “FAF has been listening to the concerns of its private company constituents.” The complete FAF plan and press release are now available. “We encourage you to visit the FAF web site to review and offer comments on the plan,” says the FAF. Public comments are due by Jan. 14, 2012. Will the Tax Court ever permit tax-affecting? This and other questions continue to bedevil the BV profession in its estate and gift tax practice. For example: are the guideline public company method and its use of comparable entities/transactions under heightened scrutiny by the Tax Court? And what about the income approach—how do BV experts prove the credibility of their normalization adjustments, reliance on management projections, calculation of the cost of capital (including the discount rate); and of course, that continuing tempest in the Tax Court, determination of marketability discounts? The IRS’s fractional interest model continues to cause quite a stir, as does the ever-present specter of a Daubert challenge to expert testimony and valuation reports. Where can you find all the answers—plus learn what tax attorneys expect from valuation experts and how to improve these vital referral relationships? Consider attending BVR’s fourth annual Tax Summit in its new, interactive web format. Four programs on the intersection of valuation and tax law present Tax Court judges, expert appraisers, attorneys, and IRS representatives, including:
Register for all programs in the series (at a discount), or attend each separately. Carla Glass receives ASA’s highest honors Congratulations to Carla Glass (Hill Schwartz Spilker Keller), who just received the ASA Lifetime Achievement Award at the ASA Advanced BV conference. The ASA honored Glass for her leadership, commitment, and dedication to excellence in advancing the business valuation profession. Her notable contributions include:
Global economic turmoil warrants convergence of valuation standards, IVSC tells G-20 Last Friday, the Private Sector Taskforce of Regulated Professions and Industries released its final report to G-20 Deputies. The report responds to the G-20’s request for the International Valuation Standards Council (IVSC), a member of the Taskforce, to analyze the gaps in regulatory convergence. To close the gaps across financial professions and industries, the Taskforce’s report recommends that the G-20:
“The IVSC fully supports the analysis and recommendations of the Private Sector Taskforce,” says Michel Prada, chair of the IVSC board of trustees in the release. “The on-going economic turmoil confirms the need for a more efficient approach to the valuation of all types of assets,” and the IVSC will continue to actively pursue “a comprehensive set of international standards” that will restore confidence in financial markets worldwide. View The Taskforce’s full report here. Convergence on PE and VC valuations is also a goal: The same release also announced that the IVSC had just signed a memorandum of understanding with the International Private Equity Valuations (IPEV) board. As part of their proposed cooperation, the two bodies plan to prepare and publish technical guidance and methodology for international PE and also venture capital valuations.
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