Unusual circumstances require measures of the same order. The Delaware Court of Chancery regularly uses the discounted cash flow (DCF) method in statutory appraisal actions, but in a recent case that was not feasible.
‘Daunting task’: The case involved a group of related companies that operated in the flood barrier industry. The plaintiff had a 10% interest in the target company, which was lost when it merged with an affiliate. Under a shareholder agreement, she could force the company to repurchase her stake. In January 2012, she received an offer of $207.50 per share but declined and petitioned for a fair value determination from the Chancery.
There were multiple reasons, said the court (J. Glasscock), why the request “should be a daunting task for a law-trained judge.” For example, since this was a short-term merger, there was no reliable market price. Also, management produced no projections in the ordinary course of business. And revenue was unpredictable since sales depended on natural disasters and similar weather-related events. The target sold proprietary “Concertainer units”: rapidly deployable barriers that function as giant sandbags to protect against storms or floods. Three past events drove demand for the products during the relevant years, 2009, 2010, and 2011: an unusual dam project in the state of Washington; the BP oil spill; and the “500-year flood,” a disaster that affected three states. Their significance became a flashpoint between the parties; they argued over whether and how revenues resulting from them prefigured future revenues.
Both experts agreed that, absent cash flow projections, a DCF was not an option and performed the less common direct capitalization of cash flow (DCCF) analysis. The court said it was “unfamiliar with the methodology typically employed in a DCCF analysis” but adopted it. Because both experts agreed as to the necessary inputs and calculations, it focused on resolving disputes over values for each.
When it came to the appropriate cash flows for the analysis, the petitioner’s expert weighted the target’s actual revenues in 2010 and 2011 at 40% and 60% respectively. He then multiplied the resulting figure by a projected 55% profit margin and subtracted $1.5 million in estimated overhead expenses. The respondent’s expert weighted actual and “normalized” EBITDA figures for 2009, 2010, and 2011; the “normalized” figures backed out revenues earned from the three disasters, which the respondent took pains to characterize as “nonrecurring” events. This claim had no traction with the court, but it also questioned the petitioner expert’s unsubstantiated decision to weight the highest grossing year in the company’s history at 60%. The best predictor of future cash flows was the past cash flows for the three years, weighted equally, said the Chancery. In the final analysis, its DCCF analysis yielded a fair value of $364.24 per share.
Find an extended discussion of Laidler v. Hesco Bastion Environmental, Inc., 2014 Del. Ch. LEXIS 75 (May 12, 2014), in the July edition of Business Valuation Update; the court opinion will be available soon at BVLaw.