You cannot trust post-transaction expert valuations, but you can trust your own discounted cash flow analysis to arrive at fair value. That’s the conclusion the Delaware Court of Chancery drew in a recent statutory appraisal action.
The focal point was a successful privately held company that marketed a contractor database assisting users with record keeping and compliance. In January 2013, the company merged with its wholly owned subsidiary. The controlling shareholder offered certain minority shareholders $38,317 per share in cash. The two minority shareholders demanded a statutory appraisal. For trial, all parties offered expert valuation testimony. The three witnesses used a variety of valuation methods and weighted them “as they saw fit.”
Alarm bells: Once again, the court began its analysis by lamenting the huge divergence in value conclusions. An optimist, “a.k.a. someone other than a judge presiding over appraisal trials,” might assume that experts valuing the same company by analyzing the same set of financial data would reach a similar fair value result, the court said. Not so. Typically, the petitioner’s expert reaches a DCF value at least twice that of the respondent’s (company’s) expert. This case went much further. The gap in the experts’ value conclusions was “alarmingly” wide, the court found. It emphasized that the fair value of one petitioner expert was eight times that implied by the DCF the company’s expert provided.
As such, this case, “so far, takes the prize,” in terms of generating the greatest judicial skepticism regarding valuation, said Vice Chancellor Glasscock, who handled the case. The court rejected all valuation methods but the DCF. It said the guideline public companies analysis, which all experts used to some extent, was inappropriate because the subject had no “direct” public competitors. It found none of the reasons supporting the use of a direct capitalization of cash flow analysis applied. And it disapproved of the company expert’s analysis of two precedent transactions, remarking that these transactions lacked certain hallmarks of an arm’s-length deal.
The best way to a reliable indicator of value was the DCF, “a simple and powerful concept,” the court explained. It noted disagreements among the experts on many assumptions and inputs and decided to perform its own DCF analysis using the company expert’s DCF study as a framework. The company’s fair value was $98,783 per share, the court decided.
The case is In re ISN Software Corp. Appraisal Litig., 2016 Del. Ch. LEXIS 125 (Aug. 11, 2016). A case digest and the court’s opinion will be available in October at BVLaw.