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  • 1. Valuation in the Delaware Courts
    What Attorneys Need to Know about Recent Developments in Valuation, Appraisal and Fairness Opinions
    December 9, 2010
  • 2. The Panel
    Valuation in the Delaware Courts
    1
    Moderator: Jennifer Muller JMuller@HL.com
    Managing Director – Houlihan Lokey 415.273.3634
    Kevin R. Shannon kshannon@potteranderson.com
    Litigation Partner – Potter Anderson & Corroon LLP 302.984.6112
    Kevin Miller kevin.miller@alston.com
    Corporate Partner – Alston + Bird LLP 212.210.9520
    Richard De Rose RDeRose@HL.com
    Managing Director – Houlihan Lokey 212.497.7867
  • 3. Agenda
    Introduction
    Fiduciary Duty Litigation
    Appraisal Proceedings
    Valuation Methodologies
    Selected Cases
    Practical Aspects of Valuation Litigation
    Q&A
    Valuation in the Delaware Courts
    2
  • 4. Introduction
    Corporate directors often are called upon to make business decisions (e.g., evaluating a possible merger, liquidation, sale or divestiture) that involve valuation issues.
    Corporations often retain financial/valuation advisors to provide professional advice and opinions.
    Corporate directors generally are protected in relying in good faith upon their professional advisors.
    Retention of professional advisors is consistent with the directors’ fiduciary duty to act with care.
    Questions about values and valuation process often arise as critical issues in corporate litigation.
    Mergers and acquisitions (M&A) (fiduciary duty claims/appraisal suits);
    Bankruptcy and out-of-court restructurings (reorganization value, collateral value);
    Commercial disputes (expectancy damages, lost profits); and
    Taxation (determination and allocation of value).
    Valuation in the Delaware Courts
    4
  • 5. Introduction (cont.)
    Focus of today’s discussion is valuation issues in the context of M&A.
    Disputes over valuation typically arise in cases involving breaches of fiduciary duty or appraisal proceedings.
    Discussion confined to Delaware law.
    The appraisal decisions by the Delaware Chancery Court (the “Court”) offer valuable insights as to how the Court interprets and uses financial information and what valuation methodologies (e.g., discounted cash flow) and information (e.g., management projections) are deemed most reliable.
    Although the decisions are fact specific, they suggest the approach to valuation that Delaware courts will likely apply in other contexts, including in determining whether a transaction is entirely fair (e.g., the “fair price” prong of the “entire fairness” standard).
    Consistent with prior decisions, in the recent Hanover appraisal, the Court noted that “…fair value under a statutory appraisal is tantamount to fair price in an entire fairness action.”
    Valuation in the Delaware Courts
    5
  • 6. Fiduciary Duty Litigation
    Fiduciary Duty Litigation
    Stockholders often assert that the directors breached their fiduciary duties by: (i) failing to obtain the best price reasonably available in a change of control transaction; or (ii) employing defensive measures (e.g., a poison pill) to prevent a hostile acquisition.
    • Directors are subject to direct and derivative claims for alleged breaches of fiduciary duties.
    • 7. Lawsuits are usually filed shortly after the announcement of an agreed transaction or an unsolicited offer or proposal.
    Valuation issues arise in connection with: (i) determining liability and (ii) assessing damages.
    Fiduciary duties of directors under Delaware law.
    The duty of loyalty, which includes the obligation to act in good faith, requires that directors act in the best interests of the corporation and its stockholders, and that they not act to benefit themselves at the expense of the corporation.
    The duty of care requires that directors inform themselves of reasonably available information and deliberate upon their decisions.
    After Van Gorkom, corporations could adopt a charter provision exculpating directors for monetary damages for a breach of the duty of care.
    Under Revlon, directors have the duty to attempt to obtain the best price reasonably available in a change of control transaction.
    Collateral duty of disclosure generally requires that directors accurately disclose all material facts relevant to a stockholder vote (i.e., whether to approve a merger).
    Stockholders often allege that the disclosures relating to valuation, including the details of the financial advisors’ analyses, were misleading or deficient.
    Valuation in the Delaware Courts
    7
  • 8. Fiduciary Duty Litigation (cont.)
    Fiduciary Duty Litigation
    Applicable standard of judicial review (i.e., business judgment rule or entire fairness) is often case determinative.
    Business judgment rule involves a presumption that the directors acted on an informed basis and in good faith.
    Entire fairness typically applies in controlling stockholder or interested transactions:
    Fair dealing focuses on the process resulting in the transaction; and
    Fair price focuses on the adequacy of the consideration.
    Remedy for breach of fiduciary duty.
    The Court has wide discretion to fashion the appropriate remedy, including injunctive relief and damages.
    Damages are often calculated based on a determination of the fair value of the company (quasi-appraisal).
    Valuation in the Delaware Courts
    8
  • 9. Appraisal Proceedings
    Appraisal Proceedings
    Statutory remedy available to stockholders who are cashed out in a transaction – entitled to judicial determination of “fair value.”
    Stockholders must perfect appraisal claim in accordance with the statute (including time limits), and they do not receive any consideration until the appraisal claim is resolved.
    “Fair value” does not mean “fair market value.”
    Fair value provides the equivalent of what has been taken away from the stockholder: proportionate interest in the going concern as of the date of the merger.
    No premiums/discounts at stockholder level.
    Fair value is determined exclusive of elements of value arising from consummation of the transaction, such as synergies.
    In determining fair value, the Court is required to take into account all relevant factors.
    Factors known or susceptible of proof and not product of speculation. Essentially, the Court can consider plans or projections that existed as of the transaction date, as long as they are not dependent on the consummation of the transaction.
    Valuation in the Delaware Courts
    10
  • 10. Appraisal Proceedings (cont.)
    Appraisal Proceedings
    For many years, fair value in an appraisal proceeding was determined pursuant to Delaware Block Method. Weinberger liberalized the valuation determination to include proof by “any techniques or methods which are generally considered acceptable in the financial community and otherwise admissible in court.”
    The Court is required to determine the fair value of the company as of the transaction date, which may be a significant period after the transaction was negotiated.
    Intervening factors can have a material impact on the valuation.
    Appraisal proceedings often involve a “battle of the experts,” but the Court is not required to accept or credit the valuations presented by either of the parties.
    Stockholders are entitled to interest from the date of the transaction.
    The default interest rate is equal to 5% over the Federal Reserve discount rate.
    Valuation in the Delaware Courts
    11
  • 11. Introduction
    “As one can glean by reading the recent Court of Chancery appraisal cases, there is much for bankers, M&A lawyers and corporate officials (including directors) to learn and apply in any major M&A transactions. It would be a wise step for the participants in such transactions to review and analyze some of the [appraisal] cases1.”
    The appraisal cases clearly demonstrate that the Delaware courts are financially sophisticated and that unsupported valuations will be quickly recognized and rejected.
    The judges will often use experts’ reports and testimony as a starting point for their own independent analysis.
    There is no explicit requirement that the valuation analyses underlying a fairness opinion need to conform to judicially approved valuation approaches to appraisal.
    The Court, however, is likely to look to the appraisal cases in assessing a fairness opinion in a fiduciary duty case.
    Since Weinberger, the discounted cash flow (DCF) method has become the Court’s favored valuation methodology.
    Where appropriate, however, the Court will also consider other methodologies.
    In a recent case (Hanover), the Court observed that, “Although there is no single preferred or accepted…methodology under Delaware law that establishes beyond question a company’s value, there are commonly accepted methodologies that a prudent expert should use in coordination with one another to demonstrate the reliability of its valuation. If a [DCF] analysis reveals a valuation similar to a comparable companies or comparable transaction analysis, I have more confidence that both analyses are accurately valuing a company.”
    Valuation Methodologies
    E. Norman Veasey & Christine T. Di Guglielmo, “What Happened in Delaware Corporation Law and Governance from 1992-2004?” A Retrospective on Some Key Developments, 153 U. Pa. L. Rev. 1399 (2005).
    13
  • 12. Market Indicia of Value
    Despite the statutory command to consider “all relevant factors,” the Court historically accorded a limited role to third-party sale value in the appraisal process.
    Judicial concerns:
    Statutory exclusion of “value arising from the accomplishment or expectation of the merger.”
    Transaction price becoming a floor on fair value, thereby encouraging appraisal proceedings.
    Recent cases reflect increasing judicial acceptance of third-party sale and other market indicia of value.
    Union Illinois: The Court relied on the purchase price paid after a competitive auction in which the company was “marketed in an effective manner,…following the provision of full information to an array of logical buyers.”
    Highfields Capital: The Court relied on the arms-length price negotiated between MONY and AXA. With no material impediments to a topping bid, “the only logical explanation for why no bidder ever emerged was that MONY was not worth more than $31 per share.”
    In both cases, after backing out synergies, the dissenters received an appraised value that was less than the transaction price.
    The Court has disregarded third-party sale value when there was a basis for impugning the effectiveness of the sales process. See, e.g., eMachines and Golden Telecom.
    Valuation Methodologies
    14
  • 13. Discounted Cash Flow Analyses
    DCF is the theoretical approach to valuation most relied on by the Court.
    The Court is willing to rely exclusively on a DCF. See, e.g., JR Cigar andAndaloro.
    The basic premise of a DCF is that the value of a company is equal to the present value of its projected future cash flows.
    Three components:
    Cash flow projections;
    Terminal value; and
    Discount rate.
    DCF analyses are very sensitive to the inputs, and the Court will carefully scrutinize all underlying assumptions.
    Valuation Methodologies
    15
  • 14. DCF – Projections
    The starting point in a DCF is an estimate of free cash flow over a specified forecast period.
    The Court has consistently stressed its:
    Preference for contemporaneous management projections; and
    “Healthy skepticism” for adjustments to such projections, or the creation of new projections. See, e.g., Emerging Communications, JRC Acquisition, Medpointe and Travelocity.
    Management viewed as the most knowledgeable party about a company’s prospects. See, e.g.,Coleman.
    Management projections are especially credible when they have been provided to a financing source or regulator.
    Experts who ignore management projections risk having their entire analysis disregarded by the Court.
    Expert “opinions” regarding deviations from management projections are likely to carry little weight with the Court.
    However, specific factors may render a set of projections unreliable as a basis for a DCF:
    Erratic earnings history;
    Recent performance that is inconsistent with the projections;
    Past history of not achieving projected targets; and/or
    Management disavowal of the projections.
    In the absence of management projections, de novo projections need substantial evidential support. See, e.g., Montgomery Cellular.
    Valuation Methodologies
    16
  • 15. DCF – Terminal Value
    The second step in a DCF is to determine a terminal value, which represents the value of future free cash flows beginning at the end of the projection period.
    Generally calculated by one of two approaches.
    Perpetuity Growth Model (PGM); or
    Exit multiple approach.
    Should reflect long-term growth expectations beyond the projection period and should be applied to a normalized level of EBITDA or cash flow.
    Both approaches have been approved by the Court; however, there is a discernible judicial preference for the PGM.
    Two potential issues with exit multiple approach:
    Difficult to “back out” merger synergies (selected transactions). See, e.g., Highfields, Montgomery Cellular and Andaloro.
    Concern that a minority discount is implicit in the multiple chosen (selected companies). See PNB Holdings.
    The Court has rejected DCFs when the terminal value methodology was not adequately defended, or where a preponderance of the overall value depended on the terminal value. Compare JRC Acquisition with eMachines and Union Illinois.
    Valuation Methodologies
    17
  • 16. DCF – Weighted Average Cost of Capital
    The next step in a DCF is to calculate a discount rate which will determine the present value of (i) the free cash flows during the projection period and (ii) the terminal value.
    Typically, the discount rate is based on the company’s weighted average cost of capital (WACC).
    WACC is the after-tax weighted average of the debt and equity costs of capital.
    WACC is defined as:
    WACC = KE (E/V) + KD (1-T) (D/V) + KP (P/V)
    Where:
    Valuation Methodologies
    18
  • 17. DCF – Cost of Equity—Capital Asset Pricing Model
    The cost of equity is commonly determined using the capital asset pricing model (CAPM).
    Risk free rate of return;
    Equity risk premium; and
    Beta.
    The CAPM formula is as follows:
    KE= RF+  * (RM– RF)
    Where:
    KE = Cost of common equity capital;
    RF = Risk free rate of return;
     = Beta of the security;
    RM = Return on the market; and
    (RM– RF) = Equity risk premium.
    The Court has generally approved the CAPM for estimating the cost of equity in a DCF.
    The Court has also sanctioned the use of multi-factor models, such as the Fama-French Model (FFM). See, e.g., Andaloro, PNB Holdings and Union Illinois.
    Valuation Methodologies
    19
  • 18. DCF – Cost of Equity—Equity Risk Premium
    The equity risk premium (ERP) is the amount of “extra return” that investors demand in order to invest in equity securities rather than riskless U.S. treasury securities.
    The general practice has been to use an estimate based on historical returns from 1926 to the present.
    In Delaware Open MRI and MedPointe, the Court approved the use of the historical ERP data provided byMorningstar.
    Academics have argued that the ERP has decreased over time and that a more recent timeframe should be used.
    In PNB Holding, the Court appeared sympathetic to the use of a lower ERP (5.75%) than the 7.4% ERP suggested by the Morningstar data.
    More recently, in Golden Telecom, the Court selected an ERP of 6.0% based on the supply side ERP published by Morningstar, as opposed to the historical Morningstar ERP of 7.1%.
    The Court observed that the weight of published academic and professional opinion favors using the supply side ERP.
    Valuation Methodologies
    20
  • 19. DCF – Cost of Equity—Beta
    One of the major components of CAPM is “beta.”
    Represents systematic (nondiversifiable) risk of a security versus the systematic risk of the market as a whole.
    Published sources calculate betas differently in terms of, among other things, (i) length of time for observation of returns and (ii) the frequency of return measures.
    Time Period
    Betas are often calculated using pricing data over a two- or five-year period.
    Noting that “both methods find support in the literature as responsible methods, the Court in Andaloro observed that:
    “The longer five-year period might be thought to provide an estimate that includes price movements in both bull and bear markets and that smoothes out any short-term anomalies.”
    “The two-year period might be thought to provide information that is more current and that provides a better insight into the current beta, especially where some seismic market or industry shift is thought to have occurred.”
    Frequency
    Frequency rates include daily, weekly and monthly intervals.
    The frequency rate can impact the resulting beta.
    No strong judicial preference regarding frequency; however, the same considerations relevant to time period should apply.
    A shorter period with daily betas may be more appropriate for valuing companies in a volatile industry like technology.
    Valuation Methodologies
    21
  • 20. DCF – Cost of Equity—Adjustments
    Expert witnesses will often adjust the cost of equity to reflect company-specific risk factors.
    “The proponent of a company-specific premium bears the burden of convincing the Court of the premium’s appropriateness.” See Delaware Open MRI.
    Although company-specific premiums are not per se invalid under Delaware law, the Court has expressed skepticism towards them based on its observation of how litigants have manipulated such premiums.
    “To judges, the company-specific risk premium often seems like the device experts employ to bring their final results in line with their clients’ objectives, when other valuation inputs fail to do the trick.” See Delaware Open MRI.
    The Court will reject a company-specific premium without (i) a basis in valuation theory and (ii) fact-based evidence. See, e.g.,Emerging Communications and Gesoff.
    Small Company Premium
    One adjustment to a WACC calculation that has generally received judicial acceptance is the small company premium. See, e.g., Emerging Communications.
    Some academic studies have indicated that CAPM generally underestimates the required equity return of small companies.
    Other academics have questioned the existence of the phenomenon in recent periods and the Court is aware of the controversy.
    The use of size premium data from Morningstar has been generally approved by the Court.
    Valuation Methodologies
    22
  • 21. DCF – Cost of Debt
    The cost of debt may be based on the company’s actual after-tax cost of debt or that of industry comparables.
    Many practitioners calculate the cost of debt based on the weighted average cost of debt of selected comparable companies.
    In appraisal proceedings, however, the Court prefers using the company’s actual cost of debt. See Hintmann.
    The fact that a company “can obtain financing at special rates unavailable in the ordinary money markets does not alter the inquiry.” SeeHintmann.
    In Emerging Communications, in the absence of evidence that such financing would be unavailable in the future, the Court used the below-market rate that the company was able to secure from the Rural Telephone Finance Cooperative.
    Similarly, in U.S. Cellular, where a subsidiary’s sole source of financing was its corporate parent, the Court accepted the below-market rate of interest that the subsidiary paid to the parent as the subsidiary’s cost of debt.
    In some cases (e.g., Liberty Digital and Cancer Treatment Centers), the Court accepted a cost of debt based on an average of (i) the company’s actual cost of debt, (ii) the cost of debt of selected companies and (iii) an applicable bond index rate.
    Valuation Methodologies
    23
  • 22. DCF – Capital Structure
    Once the cost of debt and equity have been calculated, a weighted average is computed, based on either the company’s actual capital structure or a “target” capital structure.
    Practitioners often use a target capital structure for valuing a controlling interest and the company’s existing capital structure for valuing minority interests.
    In estimating a target capital structure, it is common to use a debt-to-equity ratio based on selected industry participants.
    In the appraisal context, however, the Court appears to favor the use of a company’s actual capital structure.
    In JRC Acquisition, the Court rejected a target debt-to-equity ratio, stating that the goal of the appraisal is to “value [JRC], not some theoretical company.”
    Use of the existing capital structure should be supported by evidence that management plans to maintain that structure.
    On occasion, the Court has sanctioned the use of a target capital structure. See, e.g., Andaloro, PNB, and Trilithic.
    Use of a target capital structure must be supported by evidence of the stated goal of management to seek a different capital structure over time or evidence that the current debt level cannot be sustained.
    Valuation Methodologies
    24
  • 23. Selected Company Analyses
    Selected company analyses are accepted by the Court as a valuation methodology.
    A selected company analysis estimates the value of a firm by examining the values that investors are currently ascribing to similar companies in the marketplace.
    The utility of the methodology depends on degree of similarity between the company being valued and the selected companies.
    Proposing party carries the burden of proving that the selected companies are, indeed, comparable, and the Court is critical of witnesses who lack familiarity with the details of the comparables. See, e.g., PNB Holdings and Golden Telecom.
    The Court is skeptical of broad arrays of “comparables,” only some of which may truly be comparable.
    Criteria for determining comparability may include, among other things:
    Develop financial metrics for the selected companies that can be used to value the subject company.
    Most common metrics are revenue, EBIT, EBITDA and EPS.
    May require adjustment for nonrecurring items.
    An enterprise value (EV) is then calculated for each selected company.
    Market value of equity, plus market value of debt, less cash.
    The EV of each selected company is then divided by the chosen financial metric to derive a ratio that indicates each company’s value as a multiple of the financial metric.
    Valuation Methodologies
    25
  • 24. Selected Company Analyses (cont.)
    Based on an analysis of the subject company’s operating and financial profile relative to the selected companies, a reference range of multiples for the company is chosen from the range derived from the selected companies and the subject company’s corresponding financial metric is then capitalized using the reference range of multiples to determine its EV.
    Selecting the mean or median of the reference range may not always be appropriate. See, e.g.,Sunbelt. However, a significant discount or premium to the mean or median can suggest lack of comparability. See, e.g., Andaloro.
    In the absence of reliable management projections, the Court has occasionally relied solely on a selected companies analysis.
    In Travelocity, the Court relied on a single company (viz., Expedia.com) where management felt that the future of the nascent online travel industry was too uncertain to permit accurate projections.
    Based on Travelocity.com’s lower growth rate, lesser cash flow and less attractive business model, the Court applied a 35% discount to Expedia.com’s EBITDA multiple in deriving a value for Travelocity.com.
    Even where reliable projections were available (see Andaloro), the Court gave the selected companies analysis a 25% weighting because “the insight on value provided by the comparable companies method should not be ignored, given the availability of a good array of solid comparables.”
    The Court believes that selected company analyses include an inherent built-in minority discount because individual shares of publicly traded stocks represent minority positions.
    The Court routinely supports the addition of a premium to compensate for the minority discount. See, e.g., Travelocity.
    May not be applicable in a fiduciary case involving a controlling stockholder.
    Valuation Methodologies
    26
  • 25. Selected Transactions Analyses
    Selected transactions analyses are accepted by the Court.
    The selected transactions methodology is a market-based approach that utilizes values observed in past change of control transactions involving companies that are comparable to the subject company.
    The analytical steps in the approach are largely the same as those in the selected companies approach.
    An added complexity is the need to assess whether a precedent transaction has become too old to provide a meaningful comparison. See, e.g., Highfields.
    As with selected companies analyses, the testifying expert carries the burden of persuasion, and the Court will carefully evaluate if that burden has been met.
    In the appraisal setting, the Court has expressed concern regarding selected transaction analyses because, “The merger and acquisition data undoubtedly contains post-merger value, such as synergies… that must be excluded from appraisal value.” See, e.g.,KleinwortBenson.
    However, in the absence of reliable projections upon which to base a DCF, or as an additional confirmatory valuation technique, the Court will consider selected transactions if they are sufficiently comparable. See, e.g., Montgomery Cellular.
    Valuation Methodologies
    27
  • 26. In re Sunbelt Beverage Corp. Shareholders Litigation
    In re Sunbelt Beverage Corp. S’holdersLitig. (“Sunbelt”)
    Breach of fiduciary duty and appraisal claims arising from a squeeze-out merger.
    Defendants argued that the merger was entirely fair and that the fair value of Sunbelt shares was $45.83 per share.
    The Court applied entire fairness test:
    Found the fair value of Sunbelt shares was $114.04 per share; and
    Awarded pre- and post-judgment interest, compounded monthly, court costs and expert’s fees, but not attorney’s fees.
    Analysis
    Standard applied: the Court addressed the fiduciary duty/entire fairness claim and appraisal claim as one.
    Fair value of the Sunbelt shares was common issue to both claims.
    Relevance of fairness opinion: “Highly suspect”
    Produced in approximately one week;
    Lead appraiser was busy working on at least one other matter that included a cross-country site visit; and
    Lead appraiser was unable to work extensively and meaningfully with Sunbelt representatives.
    Selected Cases
    29
  • 27. In re Sunbelt Beverage Corp. Shareholders Litigation (cont.)
    Analysis (cont.)
    Usefulness of formula price generated pursuant to 1994 stock purchase agreement:
    The Court was unpersuaded that valuation formula struck three years previously was relevant to fair value at time of merger.
    Usefulness of the selected transactions analysis:
    The Court expressed doubts about the comparability of the companies included in the selected transactions analysis:
    Differences in size;
    Differences across product lines and geography;
    All were privately held in a tightly controlled market; and
    Even if the companies were comparable, expert did not account for differences likely affecting accuracy of calculations.
    Inclusions of real-estate payments; and
    Post-closing price adjustments.
    Usefulness of median multiple approach (to compensate for differences among specific companies or transactions):
    The Court was unwilling to rely on median multiples where there are known variations or errors in an already small sample size.
    Selected Cases
    30
  • 28. In re Sunbelt Beverage Corp. Shareholders Litigation (cont.)
    Analysis (cont.)
    Small-firm risk premium
    Plaintiff’s expert selected a premium of 3.47%, the value Ibbotson indicated for micro-cap companies in the ninth and 10th deciles of equity capitalization.
    Defendant’s expert selected a premium of 5.78%, the value Ibbotson indicated for companies in the 10thdecile of equity capitalization.
    The Court preferred approach of plaintiff’s expert because it followed the strict language Ibbotson used to describe how it adjusted for small-firm premiums in its own publication.
    The Court noted circularity of needing to select a discount rate to determine market value and needing to know market value to determine appropriate discount rate.
    Company specific risk premium
    The proponent of a company specific premium bears the burden of convincing the Court of the premium’s appropriateness.
    “[T]o judges, the company specific risk premium often seems like the device experts employ to bring their final results in line with their clients’ objectives, when other valuation inputs fail to do the trick.”
    Selected Cases
    31
  • 29. In re Sunbelt Beverage Corp. Shareholders Litigation (cont.)
    Analysis (cont.)
    Subchapter S conversion
    The stockholder is only entitled to be paid for that which has been taken from him or her.
    That value does not include speculative elements of value that may arise from the accomplishment of the merger.
    Key Takeaways:
    A fairness opinion will carry little weight absent a record that demonstrates the financial advisor devoted adequate time and effort in its preparation.
    Courts often view a discounted cash flow as the most reliable valuation methodology.
    The prevailing party in an appraisal proceeding is often the party that sticks closest to the valuation approach advocated by the valuation literature (e.g., Ibbotson), only advocating variation when it has quantitative analytic support.
    Company specific risk premiums are often suspect.
    Selected Cases
    32
  • 30. Global GT LP v. Golden Telecom, Inc.
    Global GT LP v. Golden Telecom, Inc. (“Golden Telecom”)
    Analysis
    The Court considered appropriate discount rate for use in a discounted cash flow analysis:
    Equity risk premium (ERP) based on historical data vs. ERP based on supply-side data.
    Despite prior judicial use of and reliance on ERP based on historical data, the Court used ERP based in part on supply-side as supported by most current views of the relevant professional community.
    Historical beta vs. forward looking Barra beta.
    The Court declined to use a Barra beta because of the absence of empirical evidence that it is superior.
    No neutral academic support for the predictive power of the Barra beta.
    Expert advocating use of Barra beta had, in another recent case, used historical beta.
    Lack of visibility as to how proprietary Barra model works.
    Selected Cases
    33
  • 31. Global GT LP v. Golden Telecom, Inc. (cont.)
    Selected Cases
    Key Takeaways:
    Courts more likely to use valuation approaches and assumptions that reflect historical consensus of professional community.
    Courts may be willing to adopt new approaches if:
    Sufficient evidence that consensus of relevant professional community has changed.
    Peer reviewed studies and other evidence allow the Court to conclude new approach is more reliable.
    Objective record indicates how new approach works and why it is superior.
    34
  • 32. Berger v. Pubco Corp.
    Berger v. Pubco Corp. (“Berger II”)
    Analysis
    Addition of a control premium in an appraisal action under Delaware law is not appropriate where the appraisers did not rely upon a comparable company valuation methodology.
    Key Takeaway:
    In appraisal actions, a control premium should not be applied to valuations based on a DCF analysis.
    Selected Cases
    35
  • 33. In re 3Com Shareholders Litigation
    In re 3Com S’holdersLitig. (“3Com”)
    Analysis
    Court denied plaintiffs’ motion for expedited discovery.
    Standard of review: So long as the proxy statement, viewed in its entirety, sufficiently discloses and explains the matter to be voted on, the omission or inclusion of a particular fact is generally left to management’s business judgment.
    Plaintiffs must establish a sufficiently colorable claim.
    A sufficient possibility of a threatened irreparable injury to justify imposing the extra costs of an expedited preliminary injunction proceeding.
    A material disclosure violation typically creates a per se irreparable harm because it cannot be adequately remedied by an award of damages.
    Claims: Plaintiffs alleged five material disclosure violations including that the financial advisor deviated from accepted practices in its valuation methodology.
    Court denied plaintiffs’ motion for expedited discovery.
    Valuing a company as a going concern is a subjective and uncertain enterprise.
    “Quibbles with a financial advisor’s work simply cannot be the basis of a disclosure claim.”
    Selected Cases
    36
  • 34. Maric Capital Master Fund v. Plato Learning, Inc.
    Maric Capital Master Fund v. Plato Learning, Inc. (“Maric”)
    Analysis
    The Court concluded that the valuation methodology used by a financial advisor to render a fairness opinion was not appropriate.
    In Maric, the financial advisor used a discount rate determined by adding illiquidity and micro cap premiums to the WACC.
    The materials provided to the Board and the proxy disclosed the range of discount rates used but not that premiums had been added to WACC.
    The proxy statement said discount rate based on WACC.
    Rather than just requiring disclosure of the additional premiums, the court required the disclosure in the proxy statement of the valuation ranges that would have resulted from using discount rates equal to the calculated WACC.
    Key Takeaway:
    There appears to be a disconnect between the Court’s view in Maric and the Court’s view in 3Com.
    Maric: The Court can determine whether the valuation methodology used by a financial advisor in connection with preparing a fairness opinion is appropriate
    3Com - limits the Court’s ability to assess a financial advisor’s chosen valuation approach.
    See, also, Globis Partners, L.P. v. Plumtree Software, Inc.
    Selected Cases
    37
  • 35. Practical Aspects of Valuation Litigation
    Retention of Experts
    Although expert witnesses are retained by the parties, the expert’s goal should be to assist the Court and not simply to advocate a parties’ position.
    The Court often gives no weight to expert testimony that it deems not credible.
    An expert must be qualified to offer an expert opinion.
    In addition to academic and professional credentials, it is important to consider actual valuation expertise, including “real world” industry experience.
    The ability of an expert to clearly present and explain his opinions in Court is critical.
    Prior to identifying any expert, it is necessary to consider whether the expert suffers from any actual or potential conflicts or other issues that could undermine the expert’s credibility and/or opinions.
    Examples of potential conflicts/issues include prior engagements for one of the parties; contingent compensation; inconsistent/contrary positions taken in prior testimony; and/or published materials that may be inconsistent with opinion.
    For example, in Golden Telecom, an expert witness was criticized by the Court for failing to explain his shift from reliance on Ibbotson data in an earlier appraisal proceeding to reliance on Barra in the pending proceeding.
    Daubert/Kumho Tire challenges seeking to exclude expert testimony.
    Experts should avoid novel or untested theories or inappropriate application of recognized theories.
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  • 36. Practical Aspects of Valuation Litigation (cont.)
    Pre-Trial
    It is beneficial to retain experts early to avoid unsupportable positions at the pleading stage, and also to ensure that information is obtained during discovery to support the expert’s opinions.
    Issues often arise as to whether an expert should be retained as a consultant or a testifying witness.
    The nature of the engagement will impact whether communications with the expert are protected work product versus discoverable facts and opinions.
    A party may initially retain an expert as a consultant with subsequent retention as a testifying witness if deemed beneficial.
    The parties often enter into agreements as to scope of expert production, including drafts of reports.
    It is important to clearly define the scope of expert opinion.
    Evidence
    When faced with conflicting expert opinions, the Court may look to market indicia of value for the company.
    The Court may consider auction results, arm’s-length negotiations, pre-announcement trading price, and prior valuation opinions.
    The greater the amount and the higher the quality of data that was not prepared in connection with the litigation, the easier it will be to defend an expert opinion.
    The Court generally favors reliance on management forecasts that were prepared in the ordinary course of business.
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  • 37. Practical Aspects of Valuation Litigation (cont.)
    Evidence (cont.)
    Experts should have quantitative and qualitative explanations for the selection of valuation variables, such as comps and discount rates.
    Important to consider consistency with information that was presented to the Board in connection with the challenged transaction.
    Subjective “professional judgments” often carry little weight unless supported by specific evidence.
    Experts should be familiar with academic treatises and other authorities that support the expert’s conclusion or rebut the opposing witness.
    Do not include references and citations that have not been fully researched and relied on.
    “Cherry picking” quotes from a text that otherwise contains contrary statements can be embarrassing (if not worse).
    Experts should understand the other potential methodologies and variables that arguably could have been employed, and have a well-articulated rationale for eschewing them.
    Understand the Court’s view of such methodologies and variables as reflected in prior decisions.
    Understand the valuation implications of such alternative methodologies and variables, including sensitivity analyses.
    Experts should review and consider all of the relevant facts.
    Expert analyses should address all relevant facts, even facts that do not support the opinions.
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  • 38. Q&A
  • 39. Valuation in the Delaware Courts
    What Attorneys Need to Know about Recent Developments in Valuation, Appraisal and Fairness Opinions
    December 9, 2010