Bankruptcy Court highlights comparables selection in assessing experts’ valuations

BVWireIssue #208-3
January 22, 2020

expert testimony, comparable companies analysis, discounted cash flow (DCF), enterprise value (MVIC)

A meaningful comparable company analysis requires careful selection of comparable companies, the Bankruptcy Court recently emphasized in a case in which it ruled on the debtor’s proposed reorganization plan.

The debtor was a group of related entities that mined and produced silica sand used in hydraulic fracturing, i.e., fracking. It headed into Chapter 11 bankruptcy as a result of industry-related problems and events specific to the company. After unsuccessfully pursuing an out-of-court restructuring, the debtor, in July 2019, began in-court proceedings. The issue was whether the debtor’s reorganization plan was confirmable over the objection of several parties, including a class of general unsecured claims holders (Class 6) that would get nothing under the plan. A committee represented the interests of Class 6 at the plan confirmation hearing.

Under the Bankruptcy Code, the debtor had to show that the plan was “fair and equitable” to Class 6. If the debtor succeeded, the court could impose the plan (cram down the plan) on Class 6. Under the facts of the case, the unsecured creditors would only be entitled to a distribution if the total enterprise value (TEV) of the reorganized debtor exceeded the $317 million debt hurdle. If the committee could show the TEV exceeded the total outstanding obligations, the plan, as it was, was not confirmable.

Key value driver: The committee’s expert valued the debtor’s TEV between $335 million and $445 million. The midpoint was $390 million. The unsecured creditors would be in the money by $73 million. The debtor’s expert calculated TEV in the range between $180 million and $220 million, with a midpoint of $200 million. The court said it lacked market evidence as to the value. Therefore, the court’s decision “must rest on the battle of the parties’ valuation experts.” Both sides’ experts were highly qualified, used the same valuation methods (discounted cash flow analyses and comparable company analyses), and weighted the results similarly. “Yet despite these similarities, the experts reached vastly different value conclusions,” the court noted.

The court’s analysis focused on disagreements related to the experts’ comparable company analyses, specifically the selection of comparables. The set of comparable companies was a “key value driver,” the court said, because the companies “serve as a proxy for the subject company’s market and industry volatility and related future cash flow generating ability." The debtor’s expert considered five companies as possible comparables to the debtor, but, upon examination of their relative size, composition of assets, and the market they served, narrowed the set to two companies. The committee’s expert considered the same five companies and only excluded one company. The experts disagreed over the exclusion of the other two companies.

The court sided with the debtor’s expert, noting he had provided materials and testimony that showed the contested companies were not true comparables. Both had much more diversification of business lines, and both were bigger in size and scope of operation than the debtor. Diversification was a “not insignificant” characteristic and was unique among the comparable set, the court said. Relative to the other companies, diversification increased the contested companies’ revenue-generating ability and profitability and reduced their dependency on the fracking market. Arguing for inclusion, the committee’s expert said that all four companies were competitors of the debtor, which suggested they were similar. “Competitors and comparables are two completely different animals,” the court noted, citing the debtor’s expert. A company may be the debtor’s competitor but may not be a suitable comparable. The court noted that the committee expert’s larger set of comparables increased the debtor’s TEV by $78 million.

The court’s decision also notes several other disagreements over inputs for the valuation models but says the evidence was clear that the debtor’s TEV could never surpass the debt hurdle. The plan was confirmable but required modification as to an unrelated issue.

A digest of In re Emerge Energy Services LP, 2019 Bankr. LEXIS 3717 (Dec. 5, 2019), and the court’s opinion will be available soon at BVLaw.

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