‘Fanciful’ projections make DCF unreliable valuation tool in Delaware appraisal case

In re PetSmart, Inc., 2017 Del. Ch. LEXIS 89 (May 26, 2017)

Management projections are the sine qua non of a discounted cash flow analysis, and, in a recent statutory appraisal action involving the pet product giant PetSmart, the Delaware Court of Chancery found they did not cut the mustard. The court called the projections, “at best, fanciful,” and concluded the most accurate measure of fair value was the merger consideration.

The parties knew the projections were all-important. Both sides hired projections experts as well as valuation experts. The petitioners’ projections expert was an expert in the retail industry who assessed the reliability of the management projections against his analysis of the pet retail industry and PetSmart’s future prospects. This expert saw no long-term problems for the company. He said it had hit a “speed bump” just before it started the auction process but would have rebounded. He declared the projections were created according to industry standards and reliably predicted the company’s future cash flows.

The company’s projections expert dismissed them as being “overly aggressive, optimistic and wholly unreliable.” He pointed out the projections were developed by a management team that was newly installed, had no experience creating long-term projections, and had no past examples it could use for guidance because the company in the ordinary course of business did not create long-term projections. The projections were sales-driven and were top-down projections. Bottom-up projections typically achieve more realistic and reliable results than top-down projections do, the company’s projections expert maintained.

The court noted the management projections were the “bedrock” of the petitioners’ DCF analysis. The petitioners’ valuation expert testified he had assumed the projections were reliable. He allowed that, if the court decided the projections were not reliable, the DCF analysis by extension was not reliable. In contrast, the company’s expert assumed the management projections were “entirely unreliable” and determined the sales price best indicated fair value.

The court concluded the management projections were “saddled with nearly all of [the] telltale indicators of unreliability.”

To read more about the Chancery’s analysis in this case, click here.