Expert's discounted cash flow analysis fails Daubert test in Anheuser Busch case
Warren Distributing Co. v. InBev USA, LLC, 2010 WL 2179167 (D. N.J.) (May 28, 2010)
In 2006, New Jersey passed the Malt Alcohol Beverage Practices Act—a “watershed moment in the history of brewer-distributor relationships … that led to a new world of rights and inherent value,” according to the federal district court. In particular, the law precludes a successor brewing company from terminating its predecessor’s wholesale distribution agreements without paying fair market value to the wholesalers for any terminated brands.
The act came into play when Anheuser Busch purchased several domestic and European brands from a large national brewer (InBev U.S.A.), but decided to use its existing distribution network rather than its predecessor’s. Pursuant to the new law, and based on a market multiple formula, Anheuser Busch offered the former distributors 2.5 times gross margins for their domestic brands and 3.3 times gross margins for the European brands. Three distributors turned down the deal, and Anheuser Busch sent notice of termination along with checks totaling $25 million for the terminated distribution rights, based on multiples of 2.45 and 3.25, respectively, for domestic and foreign labels. Anheuser maintained that market multiples had been used for years in the local industry and that no transaction had ever topped a multiplier of 3.3.
Nevertheless, the three distributors sued for breach of contract and damages in federal court. Their expert witness not only “deconstructed” one of the largest payoffs to a cooperative distributor, claiming that Anheuser had in fact used a market multiple of 7.32, but he calculated total damages due the plaintiffs under a discounted cash flow analysis of over $45 million, or the equivalent of an 8.4 multiplier. Anheuser filed a Daubert motion to exclude the expert’s report, arguing his deconstruction was unreliable and his DCF was a poor analytical “fit” to this case.
May an expert engage in ‘mindreading’ market participants? Although the defendants raised the issue indirectly, the court initially considered the expert’s qualifications. Despite having valued beer distribution only once before in his 30-year accounting and consulting career, the court found the expert, a CPA/ABV, had sufficient credentials and experience to testify.
The bulk of the defendant’s Daubert challenge went to the expert’s dissection of their one transaction with the cooperative distributor. In particular, the expert claimed the deal occurred under duress, contrary to the fair market value standard. The defendants argued this was impermissible “mindreading,” and the court agreed. “An expert cannot testify about a person’s intent, motive, or state of mind,” it held, and struck any portions of his testimony regarding whether the deal involved a willing seller (a question of fact which the plaintiffs could establish through other witnesses). At the same time, the court admitted the expert’s ultimate conclusion that the deal involved a 7.32 multiplier (rather than a 3.3 multiplier), because it was not based on the parties’ states of mind, but on the value of two side transactions.
These side transactions took place on the same day that Anheuser closed the deal with the cooperative distributor and consisted of “inducements of … considerable value,” the plaintiff’s expert said. The first was a retention of distribution rights for an entire portfolio of current beer brands; it also received a “right of first offer” for new brands and a tax liability inducement. The defendants claimed that any value the expert attributed to these inducements was speculative and unreliable, but the court only agreed with respect to the first. Although the retention of distribution rights had “real value,” it said, what the expert “fails to appreciate” is that because of the enactment of the new law, the distributor was already entitled to retain the distribution rights to its former brands or receive fair market value reimbursement. Accordingly, the court excluded the expert’s testimony regarding these rights, but permitted his opinions regarding the value of the two remaining inducements, finding them based on his analysis of historical evidence and his expert judgment whether certain events would occur. “Any shortcomings … can be exposed during cross examination,” the court held.
Market approach is the only approach? The defendants also alleged that a DCF analysis was “per se inadmissible” for determining appropriate payments to wholesalers, simply because in these cases, the market multiple approach had been used “so many times, including … several times by the plaintiffs.”
But, “This is simply not so,” the court held. Provided a DCF is otherwise reliable, it can be used to calculate the value of distribution rights. “Moreover, DCF does not seem to be wildly different from the market multiples approach in that it, too, ultimately provides a multiplier, albeit one based on a number of different variables.”
The defendants also challenged the expert’s DCF for its use of a “flawed” discount rate and “unsupported data.” Specifically, he arrived at a 10.6% discount rate in part by relying on a consulting expert who had a stake in the outcome of the case. Plus, he “arbitrarily” assumed a 40/60 debt-to-income ratio when he should have used something closer to a 10/90, the defendants said. Finally, he used “highly speculative” long-term sales projections derived from the “say-so” of the plaintiffs.
The court dismissed all three arguments. The expert’s report gave sound, well-articulated reasons for how he arrived at the discount rate, after examining the plaintiff’s debt-to-income ratios as well as industry ratios. Likewise, his report “clearly spelled out” the six different sources (including the plaintiff’s internal projections) he relied on to reach his forecasted sales. Any allegations of bias or inappropriate assumptions could be better examined at trial through-cross examination, the court held, and admitted his DCF analysis under Daubert.