Columbia Pipeline ruling highlights terminal value flaw in expert’s DCF

BVWireIssue #204-3
September 25, 2019

dissenting shareholder
fair value, discounted cash flow (DCF), statutory appraisal, deal price, terminal value

In the Columbia Pipeline statutory appraisal action, the Delaware Court of Chancery recently rejected the petitioner expert’s discounted cash flow analysis to determine fair value and, in a short but noteworthy discussion, explained why the court has come to question the usefulness of the DCF in many instances.

This case featured a publicly traded company that owned and operated natural gas pipelines, storage, and other related assets. The Court of Chancery, after an exhaustive evaluation of the sale process, found the deal price was the best evidence of fair value despite flaws (some material) in the sale process. There were “objective indicia of deal price fairness,” the court said. The deal price was $25.50 per share.

Problematic ‘back-loading’: The court rejected the use of the trading price, finding that, under the facts, an analysis of the trading price was “comparatively unimportant.”

The petitioners, claiming the sale process was fatally flawed and undermined the deal price for appraisal purposes, advocated for the use of their expert’s discounted cash flow analysis. The DCF valuation arrived at a per-share price of $32.47. While the respondent’s expert critiqued the opposing expert’s DCF model, he did not do his own DCF valuation.

The court, referencing precedent Delaware Supreme Court decisions, declined to give the DCF here any weight. “Dell and DFC teach that a trial court should have greater confidence in market indicators and less confidence in a divergent expert determination.” The court noted the petitioners’ DCF valuation was out of sync with market indicators. It was 27% higher than the deal price and 64% higher than the unaffected trading price.

The court noted the experts disagreed over various inputs. The choice of inputs was a proper subject of debate and the outcome of the debates resulted in large swings in the valuation output, the court observed. Calling the DCF a “second-best method” in this case, the court declined “to call the balls and strikes of the valuation inputs.” At the same time, the court noted that, since Columbia’s business plan projected major capital expenditures between 2016 and 2021, leading to negative cash flow of nearly $4 billion during the five-year projection period, all of the positive value was generated in the terminal period in the petitioner expert’s DCF. The terminal value in that calculation represented 125% of the valuation of Columbia, the court observed. “This court has questioned the utility of a DCF in a case where the terminal value represented 97% of the result,” the court said. In a footnote, it cited other decisions that criticized DCF valuations where the terminal value accounted for over 75% of the total present value or where the terminal value derived from the use of the exit multiples method comprised 70% to 80% of present value. This “back-loading” showed the risks related to the use of the DCF and undermined its reliability, the court said. “This decision therefore does not use it.”

A digest of In re Appraisal of Columbia Pipeline Grp., Inc., 2019 Del. Ch. LEXIS 303 (Aug. 12, 2019), and the court’s opinion are at BVLaw. Digests of the various DFC Global and Dell rulings and the courts’ opinions also are available at BVLaw.

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