Yet another bankruptcy decision discredits the DCF—and the expert who ‘forced’ its value

Adding to what seems to be an unfortunate trend in current case law—first appearing in an article on the future of valuation litigation and continuing as a “cautionary tale” for BV experts—a new bankruptcy decision considers how to value a subsidiary during its 2006 spinoff from Verizon. At the time, the subsidiary’s public trading price produced an implied enterprise value of $12.8 billion.

To support claims that Verizon loaded the business with debt prior to the spinoff and drove it into bankruptcy, the trustee’s expert gave no weight to its trading price because she believed Verizon withheld “material information from the market.” But even after her market multiple and comparable transactions approaches produced values ranging from $11.7 billion to $15.8 billion, she declined to assign them much weight. Instead, she applied a DCF analysis—including a discount rate of nearly 10% and a 2% company-specific risk premium (CSRP)—to yield a value of $5.85 billion. After assigning this a 70% weight, she ultimately valued the subsidiary at $8.15 billion—or more than $4 billion under its publicly traded value—enough, after including its spinoff debt, to render it insolvent.

Rebuttal experts sharply critiqued the cash flow projections, terminal value assumptions, discount rate, and CSRP that went into the expert’s DCF. Simply correcting for these errors would have boosted her DCF value by $4.8 billion, they said—and the federal district court agreed:

At nearly every step in the DCF analysis, [the expert] selected inputs that forced [the subsidiary’s] value lower. From her selection of only the most pessimistic projections of [the subsidiary’s] future performance, to her reliance on a “commercially unreasonable” terminal value projection …, to her selection of a remarkably high discount rate, the method produced a valuation that is low in the extreme and that implied an incredibly low trading multiple for [the subsidiary].
After rejecting all three of the expert’s approaches as unreliable, the court ultimately found the subsidiary was worth “no less than” $12 billion on the spinoff date, based on its publicly traded price. Read the complete digest of U.S. Bank, N.A. v. Verizon Communications, Inc.,2013 U.S. Dist. LEXIS 8521 (Jan. 22, 2013) in the April Business Valuation Update; the court’s decision will be posted soon at BVLaw.