Fair Value v Fair Market   & Other Value Standards:   Considerations in Corporate and Shareholder Litigation   Boris J. St...
Overview  »      What is fair value?  »      Fair value, fair market value and other valuation standards  »      Methods t...
What is fair value?Page 3
Fair value is a legal standard of value defined by state statutes governing         dissenting shareholder actions and cor...
The framework for determining fair value in Delaware is provided by         statute and decisions by the Court of Chancery...
The legal definition of fair value in Delaware is given in Title 8, § 262(h) of         the Delaware General Corporation L...
Fair value, fair market value         and other valuation standardsPage 7
Fair value as defined for appraisal rights and minority oppression         purposes and fair market value are not equivale...
Fair value for appraisal rights and minority oppression cases also differs         from fair value in financial reporting,...
Fair value in appraisal rights may also differ from fair value in financial      reporting, fair market, intrinsic and inv...
Fair value in appraisal rights may also differ from fair value in financial      reporting, fair market, intrinsic and inv...
The greater the degree of control and liquidity of the shares, the higherthe level of value                  Strategic, in...
Methods to establish fair valuePage 13
The determination of fair value in Delaware is guided by the statutory      principle that the Court “shall take into acco...
Delaware courts typically use one or both of the income and market approaches to determine fair value                     ...
The income approach is used to derive an indication of fair value based on      the projected future income of the firm be...
Comparison of the DCF valuation method using Gordon Growth model      and exit multiple model terminal value calculations ...
The market approach is used to derive an indication of fair value based on      market multiples of publicly traded compar...
The market approach is used to derive an indication of fair value based on      market multiples of publicly traded compar...
Relationship between the capitalization rate, market multiple and      discount rate          Capitalization Rate = c = k ...
The transaction approach is used to derive an indication of fair value      based on market multiples of comparable merger...
The transaction approach is used to derive an indication of fair value      based on market multiples of comparable merger...
Liquidation value is an indication of the value shareholders would be      entitled to if the firm ceased operations and i...
The level of value resulting from a valuation method may differ based on      assumptions implicit to the method or impute...
Treatment of valuation discounts and premiumsPage 25
While not permitted at the shareholder level, valuation discounts and      premiums must be considered at the corporate le...
While not permitted at the shareholder level, valuation discounts andpremiums must be considered at the corporate level (c...
While not permitted at the shareholder level, valuation discounts and      premiums must be considered at the corporate le...
The IMD controversyPage 29
The Delaware courts adjust values derived from the guideline company      method by applying a control premium to eliminat...
The “implicit minority discount” was first adopted in Delaware not by      adversarial or judicial process, but by default...
Though now required by Delaware law, finance theory is not generally      supportive of the IMD  »       Consistent with t...
Though now required by Delaware law, market evidence is not generally      supportive of the IMD (continued)          No m...
Though now required by Delaware law, market evidence is not generally      supportive of the IMD (continued)  »       Firm...
That control shares trade at a premium to non-control shares does not      mean that non-control shares trade at an IMD  »...
Comparison of discounted cash flow, comparable company and      transaction approach valuations excluding IMD             ...
Comparison of discounted cash flow, comparable company and      transaction approach valuations including IMD             ...
SummaryPage 38
Summary  »       Fair value is a legal standard of value governing appraisal and fairness actions,          the framework ...
Summary (continued)  »       While not permitted at the shareholder level due to the principle that the firm          is t...
AppendixPage 41
Comparison of invested capital and equity cash flows          Invested Capital Cash Flow                 Equity Cash Flow ...
Relationship between enterprise value and market value of equity                      Calculation of Enterprise Value     ...
Expert profilePage 44
Boris J. Steffen, CPA, ASA, ABV, CDBV      (202) 538 – 5037      boris.steffen@naviganteconomics.com  »       Boris Steffe...
Fair Value v Fair Market   & Other Value Standards:   Considerations in Corporate and Shareholder Litigation   Boris J. St...
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Boris J Steffen Fair Value In Corporate Shareholder Litigation Presentation (2)

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Considerations in Corporate and Shareholder Litigation

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Boris J Steffen Fair Value In Corporate Shareholder Litigation Presentation (2)

  1. 1. Fair Value v Fair Market & Other Value Standards: Considerations in Corporate and Shareholder Litigation Boris J. Steffen, CPA, ASA, ABV, CDBV Principal & DirectorPage 1
  2. 2. Overview » What is fair value? » Fair value, fair market value and other valuation standards » Methods to establish fair value » Treatment of valuation discounts and premiums » The IMD controversy » Summary » Appendix » Expert profilePage 2
  3. 3. What is fair value?Page 3
  4. 4. Fair value is a legal standard of value defined by state statutes governing dissenting shareholder actions and corporate dissolutions » The legal notion of fair value generally arises in statutory appraisal cases, in cases where a stockholder’s equity has been eliminated without consent, and in cases of self-dealing under the entire fairness test » Within these contexts, a majority of states follow the definition of fair value provided in the Model Business Corporation Act (“MBCA”), and in its revision (“RMBCA”) » In 1984, the MBCA defined fair value as › “The value of the shares immediately before the effectuation of the corporate action to which the shareholder objects, › excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable.” » Starting in 1999, the RMBCA definition of fair value was changed to › “The value of the shares immediately before the effectuation of the corporate action to which the shareholder objects › using customary and current valuation concepts and techniques generally employed for similar businesses in the context of the transaction requiring appraisal, › and without discounting for lack of marketability or minority status except, › if appropriate, for amendments to the certificate of incorporation pursuant to section 13.02(a)(5).Page 4
  5. 5. The framework for determining fair value in Delaware is provided by statute and decisions by the Court of Chancery and Supreme Court » Despite revisions to the MBCA, currently there is no clear consensus regarding the definition of fair value › Most states use the 1984 definition, › A few use the 1999 revision or a hybrid of the 1984 and 1999 revision, › While a minority use the 1984 definition with the phrase ‒ “unless exclusion would be inequitable” deleted, or with ‒ “unless exclusion would be inequitable” deleted, while adding that all relevant factors be considered » Many states look to Delaware case law for guidance in dissenting shareholder litigation, adopting all or some of the opinions of the Delaware Court of Chancery or Delaware Supreme Court › Delaware’s dissenting shareholder statute is modeled after the 1984 MBCA, though it omits the “unless exclusion would be inequitable” phrase, and requires that all relevant factors be considered » By comparison, Delaware does not have a minority oppression statute › Rather, wrongful conduct by the majority is addressed under the entire fairness test, which considers the ‒ Fairness of consideration ─ Absolute and relative ‒ Procedural fairness ─ Independence, competence and thoroughnessPage 5
  6. 6. The legal definition of fair value in Delaware is given in Title 8, § 262(h) of the Delaware General Corporation Law » As provided in the appraisal statute of the Delaware General Corporation Law, › “……the Court shall determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation, › …..In determining such fair value, the Court shall take into account all relevant factors.” » The details by which fair value is determined, however, are left to the parties and the Courts, with case law precedent providing guidance » As described by the Delaware Supreme Court, fair value is “that which has been taken from [the shareholder], viz. his proportionate interest in a going concern.” › And in the appraisal process, the corporation is to be valued as an entity, not as a collection of assets or by the sum of the market price of each share of stock outstanding, and › as a going concern, taking into account its market position and future prospects » Similarly, the corporation is to be valued….by means of traditional value factors, weighted as necessary, ignoring post-merger events or other potential business combinations. › The proportionate interest of the dissenting shareholder is determined only after the firm as an enterprise has been valued » In sum, fair value is the value of the shares on a pro rata enterprise basisPage 6
  7. 7. Fair value, fair market value and other valuation standardsPage 7
  8. 8. Fair value as defined for appraisal rights and minority oppression purposes and fair market value are not equivalent » While sometimes used interchangeably in other contexts, “The concept of fair value under Delaware law is not equivalent to the economic concept of fair market value.” » Under Delaware law, fair market value is “the price which would be agreed upon › by a willing seller and a willing buyer › under usual and ordinary circumstances, › after consideration of all available uses and purposes, › without any compulsion upon the seller to sell or upon the buy to buy.” » Examples of fair market value may include the price › at which a stock trades in an active and liquid public market › or determined in an active and competitive bidding process for privately held shares » Given these differences with the definition of fair value, the fair value of petitioners’ shares in an appraisal action can be adjudicated as higher or lower than that of their fair market valuePage 8
  9. 9. Fair value for appraisal rights and minority oppression cases also differs from fair value in financial reporting, intrinsic value and investment value the value of the shares immediately before the effectuation of the corporate action to which the Fair value (appraisal rights) dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action the price (exit) that would be received to sell an asset or paid to transfer a liability in an orderly transaction Fair value (financial reporting) between market participants at the measurement date the “true” value of an investment based on a Intrinsic value fundamental analysis of its inherent attributes, that will become the market value when other investors have the same insight and knowledge as the analyst the value to a specific owner based on that owner’s Investment value unique situation, abilities, knowledge, motivation and expectations, considering factors including available synergies, risk tolerance, required return and tax statusPage 9
  10. 10. Fair value in appraisal rights may also differ from fair value in financial reporting, fair market, intrinsic and investment values based on premise Valuation Premise Operational Premise Value in exchange Value to the holder Going concern Liquidation Value of a business or Value of a business or Value of a business in Orderly – value of interest in a real or interest maintained in continued use as an assets sold piecemeal hypothetical sale its current form by its assemblage of income with normal market present owner producing assets exposure Considers discounts Discounts and Accounts for value Forced – value of for lack of control and premiums are not added relationships assets sold piecemeal marketability and considered between tangible and with less than normal premiums for control intangible assets market exposure Typically applies to Typically applies to Assembled, in place Assemblage of assets fair market value fair value and and operational plant, - value of assets sold in investment value work force, licenses, place but not in systems and current use in the procedures production of income or as a going concernPage 10
  11. 11. Fair value in appraisal rights may also differ from fair value in financial reporting, fair market, intrinsic and investment values based on level » The level of value of an interest is a function of the degree of control and marketability of the underlying shares » Control refers to the ability to direct the management and policies of a business › The ability to appoint management, set operational and strategic policy, acquire and divest assets and declare and pay dividends, etc., etc. » Marketability refers to the ability to convert a property to cash quickly, with a minimum of transaction costs and a high level of certainty › By comparison, some analysts think of marketability as relating to the ability to make a sale, and liquidity as related to the timing and certainty of receiving the cash proceeds › The IRS defines lack of marketability as “the absence of a ready or existing market for the sale or purchase of the securities being valued.” » In practice, discounts for lack of control are taken before discounts for lack of marketabilityPage 11
  12. 12. The greater the degree of control and liquidity of the shares, the higherthe level of value Strategic, investment or acquisition value Strategic Synergies Premium Financial control value Minority interest ControlAgency Costs discount Premium Publicly Marketable, minority interest Traded Discount for lack Public, of marketability Restricted Privately Non-marketable, minority interest Held
  13. 13. Methods to establish fair valuePage 13
  14. 14. The determination of fair value in Delaware is guided by the statutory principle that the Court “shall take into account all relevant factors.” » Fair value may be determined by any technique or methodology generally considered acceptable in the financial community and admissible in court » Implicit to this interpretation is that no one particular method fits all facts and circumstances » Regardless of method, however, all relevant factors must be considered › Asset value, dividend record, earnings prospects, and any other factor affecting the firm’s financial stability or growth » Within this framework, the Court is free to adopt, adjust and or correct the opinions, frameworks and methods of the parties’ experts in reaching its own » The Court may not accept one party’s valuation in its entirety simply because it is more reasonable, however, as in a valuation proceeding it falls to the Court to determine the value of thePage 14
  15. 15. Delaware courts typically use one or both of the income and market approaches to determine fair value Valuation Approaches Income Market Asset•Present value of future •Comparable firms and •Value of individual economic benefits transactions assets net of liabilities — Discounted cash flow — Guideline public — Net asset value company — Capitalized cash flow — Excess earnings — Guideline mergers and acquisitions
  16. 16. The income approach is used to derive an indication of fair value based on the projected future income of the firm being valued » While no one method is preferable per se, Delaware courts appear to favor the discounted cash flow (“DCF”) method in appraisal proceedings › First the appraiser calculates the cash flows for each period of the specific projection provided by the subject firm’s management ‒ Delaware law prefers valuations based on projections prepared by management given management’s first-hand knowledge of a firm’s operations › The value of the subject firm attributable to its cash flows in the post-projection period is then estimated to derive a terminal value ‒ Delaware courts have used both the perpetual growth rate model and the exit multiples model to estimate terminal value, expressing a preference for the former if it can be reliably used given the circumstances of the specific valuation › In turn, the cash flows over the specific projection period and the terminal value are discounted to the valuation date to calculate fair value » Notwithstanding, the Court of Chancery has noted that a DCF analysis is only as good as the model inputs, which are necessarily speculative › There are cases where the DCF method has been used exclusively, and others in which it has been rejected totallyPage 16
  17. 17. Comparison of the DCF valuation method using Gordon Growth model and exit multiple model terminal value calculations Present Value of Present Value of FCF Over Explicit Forecast Period Terminal Value FCF Gordon Growth Model FCFn x (1 + g) FCF1 + FCF2 + FCF3 + ….. FCFn + (k - g) 1 2 3 n n ( 1 + k) ( 1 + k) ( 1 + k) ( 1 + k) ( 1 + k) Present Value of Present Value of FCF Over Explicit Forecast Period Terminal Value FCF Exit Multiple Model FCF1 + FCF2 + FCF3 + ….. FCFn + FCFn x FCF multiple 1 2 3 n n ( 1 + k) ( 1 + k) ( 1 + k) ( 1 + k) ( 1 + k)Page 17
  18. 18. The market approach is used to derive an indication of fair value based on market multiples of publicly traded comparable firms » The market approach, also referred to in Delaware law as the “comparable,” “comparative” or “guideline” company approach, is thought of in the financial community as a valuation method › The first step is to identify publicly traded firms comparable to the subject firm, i.e., ‒ Size, product and geographic markets, growth, profitability, capital structure, maturity, ownership › Appropriate market-based pricing multiples are then calculated from the guideline public company trading prices and earnings measures, adjusting for differences with the subject firm ‒ No single multiple has been recognized as the most reliable, with the courts using multiples of EBIT, EBITDA, book value, net income and gross revenue › The market-based pricing multiples from the guideline public companies are then applied to the earnings measures of the subject firm to calculate fair value » Given the subjectivity inherent to the selection of comparable firms and appropriate multiples, reliance by the Delaware courts has been based on demonstrating that the › Comparable firms are in fact comparable to the subject firm › Earnings measures are relevant to the industryPage 18
  19. 19. The market approach is used to derive an indication of fair value based on market multiples of publicly traded comparable firms (continued) » In applying the market approach, the Delaware courts have considered it alternately as either › just one element among others in an integrated valuation analysis, or › as a check on the reliability of some other approach » And as with the income approach, the Delaware courts have also › relied on the market approach exclusively in certain cases, › while rejecting it as even one factor where material differences existed between the subject firm and the comparable companies » The Delaware courts have also found that the market approach results in an indication of value that includes an implicit minority discount that must be backed-out in determining fair value, in contrast to what is generally done in the financial community » In practice, the market approach relies on a one-year forward projection of future income Vt = 0 = FCFt = 1 x FCF market multiplePage 19
  20. 20. Relationship between the capitalization rate, market multiple and discount rate Capitalization Rate = c = k - g Market Multiple = 1 / c k = disount rate, whether cost of equity or weighted average cost of capital g = long-term sustainable growth rate in measure of income from subject asset Cost of Equity = re = rf + β (rm - rf) WACC = (re x WE) + (rp x WP ) + (rd [1 - Tc] WD) rf = rate of return on a risk-free security r e = cost of common equity β = beta, a measure of systematic risk WE = proportion of common equity in capital structure reflecting the correlation of the returns of a at market value stock and the market (rm - rf) = the market risk premium; difference r p = cost of preferrrd equity between the return on the market and risk-free security WP = proportion of preferred equity in capital structure at market value r d = cost of debt capital W D = proportion of debt in capital structure at market value Tc = marginal income tax ratePage 20
  21. 21. The transaction approach is used to derive an indication of fair value based on market multiples of comparable mergers and acquisitions The transaction approach, also referred to in Delaware law as the “comparable transaction” or “comparable acquisition” approach, is thought of in the financial community as a valuation method As compared to the market approach, which uses prices from the trading of marketable minority interests in the stock market, the transaction approach use prices from the sale of controlling interests in the merger market, which can include the entire capital structure, and reflect publicly traded as well as privately held firms •The first step is to identify comparable guideline mergers and acquisitions i.e., •Size, industry, date, type, approach, consideration, completion •Appropriate market-based pricing multiples are then calculated from the guideline merger and acquisition transaction prices and earnings measures, adjusting for differences with the subject firm, and for economic and industry conditions between the date of the transaction and valuation i.e., •Multiples of EBIT, EBITDA, book value, net income and gross revenue •The market-based pricing multiples from the guideline mergers and acquisitions are then applied to the earnings measures of the subject firm to calculate fair valuePage 21
  22. 22. The transaction approach is used to derive an indication of fair value based on market multiples of comparable mergers and acquisitions (continued) » Judicial decisions concerning the appropriate use of the transaction approach indicate that the results of the approach must be adjusted, with Delaware courts finding that › Fair value is not equal to the pro rata value of the highest price available in a sale to a third party › A control premium derived from merger and acquisition data includes post-merger value arising from potential synergies or better management that cannot be included in fair value › The results of the transaction approach must be adjusted to eliminate any portion of shared synergies implicit to the comparable transactions » As with the income and market approaches, the use of the transaction approach by the Delaware courts has varied › Certain courts have treated the approach as one indication among others in an integrated valuation, or as a check on the reasonableness of another approach › Others have relied on it totally, or excluded it completely due to reliability and transaction comparability concernsPage 22
  23. 23. Liquidation value is an indication of the value shareholders would be entitled to if the firm ceased operations and its assets were sold piecemeal Neither a valuation approach nor method in the financial community, liquidation value assumes a firm’s assets will be sold in a mass assemblage, or in an orderly or forced liquidation •As liquidation value is not reflective of a going concern, it is not interchangeable with, or a substitute for, fair value •Notwithstanding, liquidation value is regarded as an acceptable measure and relevant factor to consider with others in the adjudication of fair value, particularly for a firm whose value derives from its underlying assets Also referred to as net asset value, liquidation value is equal to the market value of a firm’s assets, including cash, minus its outstanding liabilities, debentures and preferred stock •The first step in the net asset value method under the asset approach is to obtain a GAAP-based balance sheet dated as close as possible to the valuation date •Next, actual or contingent off-balance sheet assets and liabilities are identified •Each asset and liability is then analyzed and revalued or valued as necessary, recognizing a deferred tax liability for the built-in gain on appreciated assets •A market-value based balance sheet is then constructed using the restated values, with the net of the assets and liabilities equal to the market value of the equityPage 23
  24. 24. The level of value resulting from a valuation method may differ based on assumptions implicit to the method or imputed to the cash flows Relationship between Valuation Methodology Affects the Resulting Value Method Assumption Level of Value Discounted Cash Flow Control cash flows Controla Minority cash flows Marketable, minority Guideline Merger & Acquisition Control transaction Controla Guideline Company Control cash flows Controla Minority cash flows Marketable, minority Net Asset Value Control over assets Control Excess Earnings Control over assets Control a If synergies involved, could be investment valuePage 24
  25. 25. Treatment of valuation discounts and premiumsPage 25
  26. 26. While not permitted at the shareholder level, valuation discounts and premiums must be considered at the corporate level » The objective of a Delaware appraisal is to determine the fair value of 100 percent of the company, and to give the dissenting shareholder his or her proportionate share of that amount › A shareholder of a large block of stock is therefore not entitled to a premium, while a dissenting minority shareholder may not be penalized by a discount » Applying a discount to a minority interest is also contrary to the requirement that the firm be valued as a going concern rather than in a sale › The appraisal process assumes that the shareholder would have held his or her interest regardless of size but for the merger › Discounting a minority shareholder’s proportionate interest also imposes a penalty for lack of control, potentially enriching the majority unfairly » In contrast to the treatment of shareholders, discounts and premiums must be considered at the corporate level › A discount may be required to derive a going concern value, but once determined, it should not be discounted based on the minority interest of the shareholder › The fair value of a holding company includes a premium to reflect the value of control over its majority- or wholly-owned subsidiariesPage 26
  27. 27. While not permitted at the shareholder level, valuation discounts andpremiums must be considered at the corporate level (continued) Minority Discount Not permitted at the shareholder level in either a statutory appraisal or entire fairness proceeding, though allowed to value securities held by a firm that was itself being valued Marketability Discount Not permitted at the shareholder level in a statutory appraisal proceeding, despite approval of the small stock premium in the discount rate of the DCF method given that small firms have higher rates of return than large firms Private Company or Liquidity Discount Not permitted at the corporate level given perception that a private company or liquidity discount is in substance a marketability discount applied to all shares
  28. 28. While not permitted at the shareholder level, valuation discounts and premiums must be considered at the corporate level (continued) Company-Specific Risk Premium Control and Synergy Premiums » Appraisers sometimes add a risk » The Court may consider a transaction premium to the discount rate used in a price in determining fair value DCF valuation in an effort to reflect » At the shareholder level, however, the company-specific risk they believe is value of the control and or synergy not reflected by the company’s beta premiums must be eliminated and small size premium » In contrast, the fair value of a holding » The Court of Chancery, however, will company includes a premium for not adopt a company-specific risk control premium unless supported by fact- » Factors affecting the size of the control based evidence premium include the character of non- operating assets, discretionary costs, existing management, available but unexploited opportunities and the ability to integrate the acquired firmPage 28
  29. 29. The IMD controversyPage 29
  30. 30. The Delaware courts adjust values derived from the guideline company method by applying a control premium to eliminate what is known as the “implicit minority discount” “The comparable companies analysis …..includes an inherent minority Concurrently, and inconsistently, the trading discount, because the method Delaware courts continue to accept and depends on comparisons to market adopt DCF valuations that incorporate multiples derived from…..minority terminal values calculated using exit blocks of the comparable multiples derived from market companies…..the court must correct multiples of comparable companies this minority trading discount by adding back a premium…”Page 30
  31. 31. The “implicit minority discount” was first adopted in Delaware not by adversarial or judicial process, but by default The implicit minority discount (“IMD”) first appeared in Delaware in the matter of In re Radiology Associates (1991) •Plaintiff’s expert submitted valuations based on DCF and comparable company analyses (“CCA”), the latter of which was rejected •The expert’s opinion that it was necessary to add a 30 % premium to the value derived from the DCF analysis as it included an IMD due to the use of returns from minority interests to derive a discount rate was also rejected Following in 1992, the Court rejected a 15 % premium added to a CCA to correct for an IMD argued in Salomon Brothers Inc. v. Interstate Bakeries Corp. That same year, the vice chancellor that rejected the IMD in Salomon approved it in Hodas v. Spectrum Technology, Inc., and not because of further analysis •The defendant’s expert in Hodas was the plaintiff’s expert in Radiology •As in Radiology, the expert, this time advocating a lower valuation, opined that it was necessary to add a 30 % premium to adjust for the IMD , albeit in the CCA •This adjustment met no opposition from the respondent, who stood to benefit from it, and the IMD ended up being adopted by the vice chancellor absent any comment or evaluationPage 31
  32. 32. Though now required by Delaware law, finance theory is not generally supportive of the IMD » Consistent with the DCF method, finance theory holds that the value of a firm as a going concern equals the net present value of its expected free cash flows, discounted at a risk-adjusted cost of capital » No adjustments are taken in a DCF analysis for premiums or discounts › The premium paid by a third-party acquirer reflects the value of synergies, the benefits of control or both › Agency costs arising from the separation of ownership and control are embedded in the free cash flows » For an all-equity financed firm, the result of a DCF analysis is the value of its equity › The pro rata value of the enterprise as a going concern is derived simply by dividing by the number of shares » Given that a CCA is in essence a short-form DCF analysis with expected future cash flows the same in each year, but with growth and discount rates estimated using rates implicit to the market multiples of comparable firms, adjusting a CCA valuation for the IMD is theoretically and procedurally inconsistentPage 32
  33. 33. Though now required by Delaware law, market evidence is not generally supportive of the IMD (continued) No matter how liquid or efficient, the IMD assumes implicitly that publicly traded shares trade at a discount to their proportionate share of the value of the firm Strong: security prices reflect all information; historical, public and private Semi-strong: security prices reflect all historical and public information Weak: security prices reflect all historical informationPage 33
  34. 34. Though now required by Delaware law, market evidence is not generally supportive of the IMD (continued) » Firms are acquired at a premium to their going concern value as opportunities not available to or pursued by the firms independently make them more valuable to bidders » In an arms-length transaction with a third-party, the premium reflects the value of expected synergies and or benefits of control; not an IMD » In a going-private transaction, the premium represents the benefits of control, whether the ability to reduce agency costs and or improve management; not an IMD › In an efficient market, agency costs are factored into the prices at which shares trade and are purchased by minority shareholders › The opportunity to improve management and reduce agency costs would not be available but-for a change in control » That the majority of publicly-owned and traded firms are not acquired also indicates that their stock does not trade at an IMDPage 34
  35. 35. That control shares trade at a premium to non-control shares does not mean that non-control shares trade at an IMD » The value of a share of stock to a shareholder depends on the specific attributes of the ownership interest » With respect to control rights, the most valuable is at the level of strategic control, followed by financial control, marketable minority (stock price equivalent) and nonmarketable minority levels » While identical in dollar-value, the difference between a financial control interest and marketable minority interest is viewed as a › control premium from the marketable minority interest perspective › minority discount from the financial control interest perspective » The difference between the value of a financial control interest and marketable minority interest then equals the difference between a valuation that assumes control, and one that assumes the firm continues as is as a going concern » It follows that the effect of the minority discount is to eliminate the value of control, and that there is no need to adjust a marketable minority value for an IMD as it represents the value of the firm as a going concernPage 35
  36. 36. Comparison of discounted cash flow, comparable company and transaction approach valuations excluding IMD XYZ, Inc. Valuation Summary Valuation as of September X, 2009 Low High Mid-point Value of XYZ Class A Shares1 $55.06 $73.78 $64.42 Value of XYZ Class A Shares from Discounted Cash Flow Analysis $59.85 $77.93 $68.89 Value of XYZ Class A Shares from Comparable Public Companies Analysis2 $47.52 $67.36 $57.44 Value of XYZ Class A Shares from Precedent Transaction Analysis $57.83 $76.04 $66.93 Note: [1] Value of XYZ Class A Shares is calculated by weighting equally the Value of XYZ Class A Shares from Discounted Cash Flow Analysis, the Value of XYZ Class A Shares from Comparable Public Companies Analysis and the Value of XYZ Class A Shares from Precedent Transaction Analysis. [2] Exclusive of control premium of 30%.Page 36
  37. 37. Comparison of discounted cash flow, comparable company and transaction approach valuations including IMD XYZ, Inc. Valuation Summary Valuation as of September X, 2009 Low High Mid-point Value of XYZ Class A Shares1 $56.64 $76.01 $66.33 Value of XYZ Class A Shares from Discounted Cash Flow Analysis $59.85 $77.93 $68.89 Value of XYZ Class A Shares from Comparable Public Companies Analysis2 $61.77 $87.57 $74.67 Value of XYZ Class A Shares from Precedent Transaction Analysis $57.83 $76.04 $66.93 Note: [1] Value of XYZ Class A Shares is calculated by weighting equally the Value of XYZ Class A Shares from Discounted Cash Flow Analysis, the Value of XYZ Class A Shares from Comparable Public Companies Analysis and the Value of XYZ Class A Shares from Precedent Transaction Analysis. [2] Inclusive of control premium of 30%.Page 37
  38. 38. SummaryPage 38
  39. 39. Summary » Fair value is a legal standard of value governing appraisal and fairness actions, the framework for which is provided by state statutes and case law » Under Delaware law, fair value is equal to the value of a holder’s shares in a firm, valued on a pro rata, going concern, enterprise basis, considering all relevant factors, but excluding any element of value attributable to the merger » The legal standard of fair value differs from the standards of fair value for financial reporting, fair market value, intrinsic and investment value » Fair value may also differ from other standards based on premise, whether in exchange, to a holder, as a going concern or in liquidation, and based on level, strategic, financial, marketable minority or non-marketable minority » Delaware courts typically use one or both of the income and market approaches to determine fair value » The income approach relies on the projected future income of the firm being valued to derive an indication of value, while the market approach uses market multiples derived from publicly traded comparable firms or comparable mergers and acquisitionsPage 39
  40. 40. Summary (continued) » While not permitted at the shareholder level due to the principle that the firm is to be valued as a going concern, valuation discounts and premiums must be considered at the corporate level » A company-specific risk premium to account for risk not reflected by firm’s equity beta and small size premium may not be added to the cost of capital unless factually supported » At the shareholder level, the value of synergies and control must be eliminated, while the fair value of a holding company includes a premium for control » Delaware courts apply a control premium to values derived from comparable company analyses to eliminate the “implicit minority discount” thought to arise from the use of market multiples based on minority interests » The IMD is generally at odds with finance theory, market evidence and practice in the financial community. That control shares are more valuable than minority shares reflects the value of control and not an IMD to the value of the enterprise as a going concern.Page 40
  41. 41. AppendixPage 41
  42. 42. Comparison of invested capital and equity cash flows Invested Capital Cash Flow Equity Cash Flow Revenue Revenue ─ Cost of Sales ─ Cost of Sales ─ Operating Expenses ─ Operating Expenses = Operating Income (EBIT) = Operating Income (EBIT) ─ Interest Expense = Pretax Income ─ Taxes on EBIT ─ Income Taxes = Net Operating Profit After Tax = Net Income + Depreciation & Amortization + Depreciation & Amortization = Gross Cash Flow = Gross Cash Flow ─ Change in Working Capital ─ Change in Working Capital ─ Capital Expenditures ─ Capital Expenditures +/- Change in Debt Principal = Invested Capital Cash Flow = Equity Cash FlowPage 42
  43. 43. Relationship between enterprise value and market value of equity Calculation of Enterprise Value = Market value of common equity + Market value of interest bearing debt + Preferred stock + Minority interest ─ Cash and cash equivalents = Enterprise value ─ Market value of interest bearing debt = Market value of equityPage 43
  44. 44. Expert profilePage 44
  45. 45. Boris J. Steffen, CPA, ASA, ABV, CDBV (202) 538 – 5037 boris.steffen@naviganteconomics.com » Boris Steffen is an expert in financial and managerial accounting, corporate finance and valuation with significant multi-industry, multi-company and cross-border experience in operations, finance, strategy and litigation. As an advisor in financing, investment and restructuring transactions and claims, matters in which he has consulted or testified include antitrust and competition policy, bankruptcy, restructuring and solvency, contracts, intellectual property, international trade and arbitration, mergers and acquisitions, business valuation, pricing, costs and profitability, securities and taxes. » As a corporate development executive and consultant, Mr. Steffen has advised in transactions and claims valued in excess of $100 billion. Sectors in which he has consulted include the aerospace, automotive, beef processing, biotechnology, business services, cable network, chemical, consumer product, defense, document management, electronic imaging, financial services & banking, food & beverage, healthcare, independent power, information technology, insurance, internet, newspaper, magazine, pharmaceutical, oil & gas, printing, pumps & controls, retail, semiconductor, software, steel, telecom, tobacco and electric utility industries. » Mr. Steffen has held positions in finance, public policy, corporate development and consulting with Inland Steel Industries, the FTC, Bureau of Competition, U.S. Generating, and LECG. He holds a Master of Management degree with specializations in accounting and finance from the Kellogg School of Management of Northwestern University, and a Bachelor of Science degree in Finance and Bachelor of Music degree in Applied Music from DePaul University. He is an Accredited Senior Appraiser, Certified Public Accountant, Accredited in Business Valuation, Certified Distressed Business Valuation Analyst, and member of the AICPA, ABA, ABI, Insol International, AIRA, ASA and American Finance Association.Page 45
  46. 46. Fair Value v Fair Market & Other Value Standards: Considerations in Corporate and Shareholder Litigation Boris J. Steffen, CPA, ASA, ABV, CDBV Principal & DirectorPage 46

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