In valuing distressed companies, DE Chancery warns against comparing ‘good’ apples to ‘bad’

BVWireIssue #127-1
April 3, 2013

After trying to integrate several businesses, with disastrous results, a private equity firm finally “quit” and sold off most of its senior debt. For two months, the purchaser tried but failed to secure a single bid for the company’s assets, and ended up selling them to an affiliate—at an open auction—for just under $92 million. 

Without having made a bid, the PE firm sued the debt purchaser and affiliate in the Delaware Court of Chancery, claiming the sale process and price was not “commercially reasonable” (under the UCC). To show the company was worth more than the $92 million paid at foreclosure, the PE firm's expert applied a DCF analysis as well as the guideline public company method, selecting three public comparables in the same industry but with stable, if not profitable, financials. After a rebuttal expert criticized his failure to use distressed companies as comparables—and accused him of overstating the EBITDA multiple for one company by 100%—the PE firm’s expert revised his report but didn’t change his overall conclusion that the company was worth $110 million at auction.

That final value “makes no sense,” the Court of Chancery said. First, his market approach failed to compare the company to other distressed firms. Second, his DCF was based on “stale, unrealistic” projections, formulated during the turnaround phase. Finally—even when confronted with “glaring mistakes” in his report—the expert failed to revise his original opinion. Read the complete digest of Edgewater Growth Capital Partners LP v. H.I.G. Capital, Inc., 2013 Del. Ch. LEXIS 54 (Feb. 28, 2013) in the May Business Valuation Update; the court’s opinion will be posted soon at BVLaw.

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