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Valuation Methods in Fairness Opinions: An Empirical Study of Cash Transactions

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  • Sutter Securities Financial Services, San Francisco

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This study examined empirically which valuation methods are currently being used in fairness opinions in cash acquisitions and how they are applied. A search of the SEC's EDGAR database for two 12-month periods identified 315 cash acquisitions with 352 fairness opinions containing descriptions of their methods and analyses. The findings showed the discounted cash flow, comparable company, and comparable transaction methods in predominant use, with most opinions employing more than one method and almost half drawing on the much-disparaged “premiums paid” approach. In addition, a comparison of the fairness opinion approaches used in related party transactions with those in arm’s-length transactions found one disparity. We elaborate and provide commentary on these findings. The study then scrutinized specific variables in the income approach, focusing on discount rates and terminal values. Our commentary discusses the broad spreads of the DCF inputs which were found and the consequences thereof. For analyses using the market method, we looked at the multiples applied, finding, among other things, that P/E ratios were used more frequently in comparable company than in comparable transaction analyses. Additionally, we looked at how enterprise value was defined for use in the market method; it is clear that investment banking practice is to deduct cash in calculating enterprise value when enterprise value is the numerator in a multiple. Throughout the study, two other lines of inquiry were investigated: whether valuators applied different approaches when valuing financial institutions and whether there were material differences in practice among the various investment banks rendering opinions.
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Valuation Methods in Fairness Opinions: An Empirical
Study of Cash Transactions
Gilbert E. Matthews
This study examined empirically the valuation methods that are currently being used
in fairness opinions in cash acquisitions and the way in which they are applied. A
search of the SEC’s EDGAR database for two twelve-month periods identified 315
cash acquisitions with 352 fairness opinions containing descriptions of their methods
and analyses. The findings showed the discounted cash flow, comparable company,
and comparable transaction methods in predominant use, with most opinions
employing more than one method and almost half drawing on the much-disparaged
‘‘premiums paid’’ approach. In addition, a comparison of the fairness opinion
approaches used in related party transactions with those used in arm’s-length
transactions found one disparity.
The study then scrutinized specific variables in the income approach, focusing on
discount rates and terminal values. This commentary discusses the broad spreads of
the discounted cash flow inputs that were found and the consequences thereof. For
analyses using the market method, the study examines the multiples applied, finding,
among other things, that price/earnings ratios were used more frequently in
comparable company than in comparable transaction analyses. Additionally, the
study examines the way in which enterprise value was defined for use in the market
method; it is clear that investment banking practice is to deduct cash in calculating
enterprise value when enterprise value is the numerator in a multiple.
Throughout the study, two other lines of inquiry were investigated: whether valuators
applied different approaches when valuing financial institutions and whether there
were material differences in practice among the various investment banks rendering
opinions.
Introduction
Although most valuation analyses are not public, there
is one treasure trove of public information that is
available: descriptions of the valuation methodologies
used in fairness opinions for public companies. Docu-
ments filed with the Securities and Exchange Commis-
sion (SEC), such as proxy statements, contain fairness
opinions and describe the methodologies and analyses
utilized in corporate transactions.
This paper looks at the valuation methods employed in
352 fairness opinions in US cash transactions to
determine the methods that are actually employed and
the way in which they are applied. To do so, I searched
the SEC’s EDGAR database for fairness opinions
rendered in cash acquisitions of US companies during
two twelve-month periods.
1
I identified 315 cash
acquisitions containing 352 fairness opinions with descrip-
tions of methodologies. Of these opinions, 294 were in 271
arm’s-length transactions, while fifty-eight were in forty-
Gilbert E. Matthews, CFA, is with Sutter Securities
Incorporated, in San Francisco, California. He is also
on the editorial review board of Business Valuation
Review. Michelle Patterson, JD, PhD, assisted with
conceptualization, organization, and writing.
1
The study includes only transactions in which the consideration consisted
of a fixed amount of cash and excludes transactions in which any portion of
the cash consideration was contingent. A contingency adds an additional
factor to be weighed in a fairness opinion.
Business Valuation Review
Volume 31 NNumber 2/3
2012, American Society of Appraisers
Business Valuation Review — Summer/Fall 2012 Page 55
four related party transactions, which I assessed for
possible differences. I also provide commentary from an
investment banking point of view on selected aspects of the
findings. In these cases, my commentary follows the
relevant data presentation.
The study evidenced that the most common methods
used by investment banks and valuation firms were the
market approach (comparable companies and comparable
transactions)
2
and the income approach (discounted cash
flow [DCF] and discounted dividend model [DDM]).
Other findings were: virtually all of the fairness opinions
relied on more than one valuation approach;
3
almost half
of the fairness opinions employed the questionable
‘‘premiums paid’’ method;
4
and in related party transac-
tions with no change of control, there was one disparity
from the approaches utilized in other transactions. In
addition, alternative approaches such as analysts’ target
prices, asset value, and a leveraged buyout model were
applied in a small number of opinions.
I then scrutinized the inputs used in applying both the
income and market approaches. For the income approach,
I focused on the discount rates chosen and the methods
used to calculate terminal values. Next, I turned to the
market approach and examined the various multiples that
were applied, as well as the manner in which the opinion
givers defined enterprise value (EV).
In addition, this paper presents, in relevant sections,
data and comments concerning two other areas of interest.
The first relates to fairness factors employed by certain
investment banking firms to a materially greater extent
than the norm; the second addresses differences in the
valuation methods applied to financial institutions.
Data Sources
Under the SEC’s Rule 13e-3 disclosure requirements, a
summary of a financial advisor’s fairness opinion
analyses must be included in the proxy statement or
tender offer document for a going-private transaction.
This summary must include a discussion of each
methodology employed. In practice, the SEC has
extended this disclosure requirement to all published
fairness opinions. Data such as discount rates employed
in DCF analyses and multiples employed in comparable
company and comparable transaction analyses are usually
included.
The Delaware courts have enhanced the disclosure
requirements for fairness opinions. Vice Chancellor (now
Chancellor) Strine wrote in 2002:
[C]ourts must be candid in acknowledging that the
disclosure of the banker’s ‘‘fairness opinion’’ alone and
without more, provides stockholders with nothing other
than a conclusion, qualified by a gauze of protective
language designed to insulate the banker from liability.
The real informative value of the banker’s work is not in its
bottom-line conclusion, but in the valuation analysis that
buttresses that result… . [A] minority stockholder engaging
in the before-the-fact decision whether to tender would find
it material to know the basic valuation exercises that [the
investment banker] undertook, the key assumptions that
they used in performing them, and the range of values that
were thereby generated.
5
Similarly, a 2010 decision stated that ‘‘stockholders
are entitled to a fair summary of the substantive work
performed by the investment bankers upon whose
advice their board relied in reaching their recommen-
dation.’’
6
However, since ‘‘Delaware law does not
require stockholders be ‘given all the financial data they
would need if they were making an independent
determination of fair value,’’’
7
some documents re-
viewed in this study did not include complete
information, omitting, for example, information as to
the discount rates or multiples used.
To obtain descriptions of fairness opinion analyses, I
searched the EDGAR database using Morningstar
Document Researchfor proxy statements, information
statements, and Williams Act (tender offer) documents of
US companies that included the words ‘‘fairness
opinion.’’ I initially reviewed filings in the twelve-month
period that commenced September 2007 and ended in
August 2008, shortly before the severe market disruption
following the Lehman Brothers bankruptcy in September
2008. After the market partially recovered, I then
reviewed filings in the twelve months from September
2010 through August 2011.
8
2
Investment bankers customarily use the word ‘‘comparable’’ rather than
‘‘guideline.’’ None of the disclosures reviewed used the word ‘‘guideline’’;
some used ‘‘selected.’’ The Delaware courts also generally use ‘‘compa-
rable.’’ I therefore use ‘‘comparable’’ rather than ‘‘guideline’’ in this article.
3
Three opinions utilized only one approach: two (for financially troubled
companies) used a liquidation analysis, and one (for a company for which
the sole source of revenues was royalties) used DCF.
4
The reasoning in criticizing this approach is presented below under the
heading ‘‘Commentary: Why the premiums paid method is unsound.’’
5
In re Pure Resources, Inc., Shareholder Litigation, 808 A.2d 421, 449
(Del. Ch. 2002).
6
In re Cogent, Inc., Shareholder Litigation, 7 A.3d 487, 511 (Del. Ch.
2010).
7
Globis Partners, L.P. v. Plumtree Software, Inc., 2007 Del. Ch. LEXIS
169 (November 30, 2007) at *45, quoting Skeen v. Jo-Ann Stores, Inc., 750
A.2d 1170, 1174 (Del. 2000).
8
The search was based on filing dates, and thus it included some
transactions that were completed subsequent to August 2008 and August
2011, respectively, and some transactions that were never completed. It
excluded any transactions completed during the periods reviewed for which
no SEC filings were made during these periods.
Business Valuation Review
Page 56 2012, American Society of Appraisers
For the first period, I identified 156 applicable
transactions, which contained 175 published fairness
opinions. The second period yielded 160 transactions,
which contained 177 fairness opinions.
9
These 352
fairness opinions were reviewed to determine the
valuation methods applied by the investment bankers
and valuation firms rendering them.
Each description was reviewed to obtain the following
information:
NName of target company
NIndustry of target company
NDate of filed document
NFairness opinion provider
NFairness opinion date
NWhether the transaction was arm’s-length or with a
related party
NIf with a related party, whether there was a change
of control
NTransaction price
NShares outstanding
NPremium over latest closing price
NMethodologies used
10
NDiscount rates used in DCF calculations
NWhether WACC was expressly used
NTerminal value calculations to determine:
#whether multiples or growth rates were used
#what multiple or growth rate was used
#data point to which a multiple or growth rate was
applied
#width of range of multiples or growth rates
NData points used for comparable company and
comparable transaction calculations
NDefinition of enterprise value (EV)
In some cases, information such as the target company’s
industry or number of shares outstanding was not in the
document and was obtained from the target’s annual report
on Form 10-K or quarterly report on Form 10-Q.
Valuation Methods Used in the Opinions
Valuation methods frequently used
As would be expected, the primary valuation ap-
proaches used were the income approach (discounted
cash flow) and the market approach (comparable
companies and comparable transactions). Since the
discounted dividend method is effectively a form of
DCF, ‘‘DCF’’ discussions and statistics presented herein
will subsume the DDM numbers, except where DCF and
DDM are explicitly shown. The valuation approaches
most frequently used are presented in Table 1.
As shown in Table 1, the income method was employed
in 91% of the opinions, while 96% employed the market
method (86% of these used both comparable companies
and comparable transactions, and 10% used only one of the
two methods). Surprisingly, 48% of the opinions utilized a
9
Two published fairness opinions were issued in thirty-two of the
transactions and three in one 2007–2008 transaction. All of the published
opinions were to the seller other than two (one to the buyer, one to an
Employee Stock Ownership Plan) in 2007–2008. In one situation, seven
substantially identical opinions were issued to related limited partnerships;
these were treated as a single opinion for this study.
10
If a method was described as used ‘‘for informational purposes only,’’ it
was not counted as a method used by the opinion provider.
Table 1
Valuation Methods Frequently Used in Fairness Opinions
Valuation Method Used
September 2007 to August 2008 September 2010 to August 2011 Total
Opinions Percent Opinions Percent Opinions Percent
Total Number of Opinions 175 177 352
Income Approach 155 88.6 165*93.2 320*90.9
Discounted Cash Flow 148 84.6 158 89.3 306 86.9
Discounted Dividend Model 7 4.0 8 4.5 15 4.3
Market Approach 171 97.7 167 94.4 338 96.0
Comparable Companies 165 94.3 165 93.2 330 93.8
Comparable Transactions 158 90.3 154 87.0 312 88.6
Premiums Paid in Other
Transactions{86 50.0{81 46.6{167 48.3{
* One opinion used both DCF and DDM.
{This approach, the ‘‘premiums paid’’ method, is discussed and criticized later in this article.
{Three opinions in 2007–2008 and three opinions in 2010–2011 were for entities for which shares did not have an active market or
were not traded.
Valuation Methods in Fairness Opinions: An Empirical Study of Cash Transactions
Business Valuation Review — Summer/Fall 2012 Page 57
method—average premiums paid in other transactions
that is regarded by many experts as unsound.
11
Table 2 shows the number of fairness opinions using
all three primary methods, as well as those using only
two, one, or none of them.
At least one of the primary methods—comparable
companies, comparable transactions, and discounted cash
flow—was used in 99.1% of the fairness opinions, and all
three methods were used in 79.5%.
12
When the income approach was not used: No
adequate management projections
In all 307 situations where management disclosed that
it had made projections for three or more years,
discounted cash flow
13
was utilized. There were forty-
five opinions where the company either had not made
projections or had only made them for one or two years.
In thirteen of these cases, DCF calculations were
nonetheless performed utilizing projections extrapolated
by the valuator. For example:
Duff & Phelps [created] free cash flow projections for
fiscal years ending 2008 through 2017 [that] were
developed based on an analysis of ARG’s historical
performance, as well as discussions with and guidance
from the Company’s management regarding ARG’s
expected future performance.
14
FBR conducted discounted dividend analyses to calculate
ranges of implied per share values of the Company using
projections FBR had prepared and had reviewed and
discussed with the management of the Company, who
agreed that these projections were reasonable.
15
Morgan Stanley utilized publicly available estimates,
prepared by equity research analysts and available as of
August 17, 2010 (the Street Case). … Morgan Stanley
utilized Street Case projections for calendar years 2010 and
2011 and extrapolated these projections through 2015.
16
In the remaining thirty-two opinions that lacked
adequate projections (or any projections at all), DCF
was not applied. For twelve of these, the disclosure
explicitly stated that DCF was not used because adequate
projections were not available. For example:
Jefferies did not perform a discounted cash flow analysis
because the projections provided by the Company’s
management did not extend beyond fiscal year 2008.
17
11
See discussion under the heading ‘‘Commentary: Why the premiums paid
method is unsound.’’
Table 2
Combinations of Primary Valuation Methods Used in Fairness Opinions
Primary Valuation Methods Used
September 2007 to
August 2008
September 2010 to
August 2011 Total
Opinions Percent Opinions Percent Opinions Percent
DCF, Comparable Companies and
Comparable Transactions* 137 78.3 143 80.8 280 79.5
DCF and Comparable Companies
(but not Comparable Transactions){11 6.3 11 6.2 22 6.3
DCF and Comparable Transactions
(but not Comparable Companies) 5 2.9 2 1.1 7 2.0
Comparable Companies and Comparable
Transactions (but not DCF) 15 8.6 9 5.1 24 6.8
DCF Only 2 1.1 9 5.1 11 3.1
Comparable Companies Only 2 1.1 2 1.1 4 1.1
Comparable Transactions Only 1 0.6 0 0.0 1 0.3
None of the Three Primary Methods 2 1.1 1 0.6 3 0.9
Total 175 177 352
* Including in each period six opinions that used the discounted dividend model.
{Including in each period one opinion that used the discounted dividend model.
12
Recent Delaware decisions have expressed a preference for multimethod
valuations and have criticized the use of a single valuation approach. In re
Hanover Direct, Inc., Shareholders Litigation., 2010 Del. Ch. LEXIS 201
(September 24, 2010) at *5–6; S. Muoio & Co., LLC, v. Hallmark
Entertainment Investments Co., 2011 Del. Ch. LEXIS 43 (March 9, 2011) at
*71. (‘‘Although there certainly may be circumstances where using only
one valuation methodology is appropriate and reliable, this is not such a
circumstance. [The expert’s] failure to incorporate other valuation methods
into his analysis makes his valuation far less credible.’’)
13
As noted above, statistics for DCF in this study include the discounted
dividend model, except when DCF and DDM are explicitly shown
separately in Tables 1 and 11.
14
Allergy Research Group, Inc. Form 14D-9 dated August 12, 2008: 28.
15
MASSBANK Corp. proxy statement dated June 8, 2008: 38.
16
McAfee, Inc., proxy statement dated September 21, 2010: 41.
17
Claymont Steel Holdings, Inc., Form 14D-9 dated December 19, 2007: 24.
Business Valuation Review
Page 58 2012, American Society of Appraisers
The Company’s management advised Houlihan Lokey that
it did not have reliable long-term projections reflecting its
ability to continue to operate as a going concern.
18
As a consequence of the fact that management of
Answers.com did not believe it could forecast with
confidence the financial performance of Answers.com
beyond the fiscal year ending December 31, 2011, and
therefore did not provide any such forecasts to UBS, UBS
did not prepare a discounted cash flow analysis.
19
The other twenty opinions did not contain an explicit
explanation, but, since none of the disclosure documents
contained adequate projections, the omission of DCF
cannot be criticized.
When the market approach was not used
Table 1 shows that fourteen of the 352 opinions did not
use either form of the market approach. I found that the
omission of the market approach was explained in six
instances.
20
In the other eight, the omission was
unexplained.
Table 1 also shows that thirty-four opinions used only
one of the two market methods: Twenty-six used
comparable companies but not comparable transactions,
and eight used comparable transactions but not compa-
rable companies. In eleven of these thirty-four, the failure
to include the omitted method was explained. Examples
of the explanation are:
The comparable transaction multiples methodology was
not used because of the absence of recent transactions
involving similar businesses to that of Atari and in a similar
recovery situation.
21
Stone Key noted that … given the highly disparate nature
of the Company’s core businesses relative to the selected
companies in the precedent transactions analysis, it is
difficult to directly compare the company to other
companies.
22
Lazard also noted that there have been limited transactions
involving companies comparable to the Company and
given dramatic changes in market conditions and the
limited number of directly comparable mergers and
acquisitions transactions in the preceding 36 months, the
precedent transactions analysis is viewed as a less relevant
indication of value.
23
I reviewed the other twenty-three opinions and
determined that omitting the second method was clearly
unjustified in eight of them. First, in six of these where
two different firms rendered fairness opinions in the same
transaction, one omitted comparable companies and/or
transactions, but the other had identified relevant
transactions and used both methods. Second, in four
opinions (including two of the foregoing), the investment
bank had identified adequate industry transactions for its
premiums paid analysis, yet nonetheless it had omitted
the comparable transaction method, ignoring the multi-
ples paid in these transactions.
In the other fifteen fairness opinions in which one of
the two methods was not used, its absence was
unexplained and often questionable. Based on the
information in the documents I reviewed, I concluded
that adequate data were likely to have been available for
the opinion givers to have applied the omitted method in
many of those opinions.
Commentary: Why reasons for not using a primary
method should be disclosed
Disclosing summaries of investment bankers’ analyses
partially negates the extensive criticisms of fairness
opinions by supplying useful information to knowledge-
able shareholders. It is therefore important that when a
firm diverges from professionally accepted methods, its
reasoning for omission should be explained to sharehold-
ers—as it is likely to have explained to the board of
directors or special committee. The explanation is
important because, as the Delaware Court of Chancery
ruled, ‘‘stockholders are entitled to a fair summary of the
substantive work performed by the investment bankers
upon whose advice their board relied in reaching their
recommendation.’’
24
Premiums paid method: Use varies by firm
As noted earlier, the findings revealed that almost half
the opinions used the much-criticized premiums paid
method. Because this method is controversial, I decided to
look more closely at which firms used it, examining the
data on a firm-by-firm basis. I found that some firms relied
heavily on premiums paid method, some did not use it at
all, and some used it occasionally. Table 3 presents a firm-
by-firm breakdown for firms that rendered four or more
opinions in the periods reviewed (all of which were
investment banking firms) and for all other firms in
aggregate.
18
Cryocor, Inc., Form 14D-9 dated April 29, 2008: 26.
19
Answers Corporation proxy statement dated February 28, 2011: 36.
20
Three based their valuation of biotech companies on the value of future
royalties, while three others valued troubled companies at asset or
liquidation value.
21
Atari, Inc., preliminary proxy statement dated August 5, 2008: 44.
22
ICx Technologies, Inc., Form 14D-9 dated September 4, 2010: 25.
23
PRIMEDIA, Inc., information statement dated June 20, 2011: 33–34.
24
Cogent, 7 A.3d 487, 511.
Valuation Methods in Fairness Opinions: An Empirical Study of Cash Transactions
Business Valuation Review — Summer/Fall 2012 Page 59
In reviewing the data, I identified material differences as to
the use of the premiums paid method on a firm-by-firm basis.
As seen in Table 3, a majority of the larger investment
banks, including JP Morgan, Credit Suisse, UBS, BofA
Merrill Lynch, Deutsche Bank, and Bear Stearns, seldom or
never employed this method. Houlihan Lokey, a leader in the
fairness opinion area, also rarely considered premiums paid.
Seven firms issued more than ten opinions during the periods
reviewed. Five of them collectively used premiums paid in
only 8% of their opinions. In contrast, Goldman Sachs and
Morgan Stanley applied the premiums paid approach in 60%
and 73%, respectively, of their opinions. No explanation for
their use or non-use of this approach was available in the
documents.
25
On an overall basis, smaller firms applied premiums
paid as a fairness standard more frequently than larger
firms (other than Goldman Sachs and Morgan Stanley).
Firms issuing less than four fairness opinions in the two
years reviewed used the method in 68% of their opinions,
while firms other than Goldman Sachs and Morgan
Stanley that issued four or more opinions used the
premiums paid method in 35% of their opinions.
26
Commentary: Why the premiums paid method
is unsound
The ‘‘premiums paid’’ method compares the premium
over market paid in the subject transaction with average
premiums over market paid in other transactions. The
Table 3
Opinions Using ‘‘Premiums Paid’’ as a Fairness Standard
Opinions Opinions Using Premiums Paid Percent Using Premiums Paid
Firms Issuing Four or More Fairness Opinions during the Periods Reviewed
UBS Securities 12 0 0
Bear Stearns 6 0 0
Qatalyst Partners 4 0 0
JP Morgan 28 1 4
Houlihan Lokey 11 1 9
Deutsche Bank 8 1 13
BofA Merrill Lynch* 15 2 13
Credit Suisse 11 2 18
Oppenheimer & Co. 5 1 20
Sandler O’Neill 5 1 20
Citigroup Global Markets 4 1 25
Keefe Bruyette & Woods 6 2 33
Moelis & Co. 7 3 43
Stifel Nicolaus 6 3 50
Allen & Co. 4 2 50
Lehman Brothers 4 2 50
Robert W. Baird 4 2 50
Barclays Capital 7 4 57
Lazard Fre`res 7 4 57
Goldman Sachs 40 24 60
Evercore 5 3 60
Cowen 6 4 67
RBC Capital Markets 7 5 71
Morgan Stanley 15 11 73
Weinberg Perella 4 3 75
Jefferies 9 7 78
Piper Jaffray 7 7 100
William Blair 5 5 100
Raymond James 4 4 100
Subtotal 256 104 40.6
Firms Issuing One to Three Opinions 90 61 67.8
Total 346{167 47.7
* Including Merrill Lynch in 2007–2008.
{Excludes six opinions for entities for which shares did not have an active market or were not traded.
26
Twenty-nine percent for firms issuing six or more opinions; 15% for firms
issuing eight or more.
25
A review of the data did not indicate a correlation between use of
premiums paid and the size of the premium, so that the decision as to
whether to apply the method was not selective.
Business Valuation Review
Page 60 2012, American Society of Appraisers
validity of using average premiums has been questioned
by numerous writers for more than two decades.
27
The
fact that many investment bankers rarely consider
premiums paid appears to indicate that they recognize
the method’s flaws. Nonetheless, as noted above,
numerous firms continue to use the premiums paid
method in determining the fairness of a transaction.
Since these premiums are based on the pre-announce-
ment market prices of acquired companies, the data
primarily include companies for which buyers are willing
to pay a premium. Thus, the universe of relevant
transactions forming the basis for the premiums paid
method includes only companies that the buyer deemed to
be undervalued and for which the buyer is willing to pay
a premium. This universe by definition excludes the great
majority of companies that buyers consider fairly priced
or overvalued, and which therefore were not attractive as
acquisition targets. Consequently, the data used when
calculating average premiums in transactions include a
substantial built-in upward bias and result in a distorted
basis for comparisons.
An acquiror does not first select a premium and apply
that premium to a target’s fluctuating market price. The
price premium is the difference between an acquiror’s
valuation of the target and the market’s valuation of the
target prior to the acquisition proposal. If the value of a
potential target to an acquiror is not greater than the
current market price, the buyer is unlikely to bid. The
premium offered is simply the difference at a point in
time between a company’s value to a buyer and that
company’s market price. A premium is the result, not the
cause, of a bid.
Premiums in prior transactions cannot provide a
fairness standard. Each company must be assessed on
its own fundamentals. If a transaction is not fair by other
approaches, a high premium over market price does not
make it fair. If a transaction is fair based on the income
approach and the market approach, a low premium alone
(or even the lack of a premium) does not make it unfair.
Alternative valuation methods used
Approaches other than the primary methods were
used in 140 (39.9%) of the fairness opinions.
28
No
single alternative method was applied in more than
18.2% of the 352 opinions, but forty opinions used two
or more. Alternative approaches were used 190 times.
Variants of the market approach were the most common,
comprising 26.5% of all opinions; however, 58% of
these were by three firms, Goldman Sachs, Morgan
Stanley, and BofA Merrill Lynch, which collectively
rendered less than 20% of the opinions. It is interesting
to note that some firms utilized ‘‘signature approaches,’’
i.e., they used a particular alternative method in a
majority of their fairness opinions that some other firms
did not use at all. The alternative methods used are listed
in Table 4.
Two of these approaches—the present value of the future
stock price and security analysts’ target prices—look at the
future value of publicly traded shares. Both methods are based
on multiples, and thus are variants of the market approach.
The present value of the future stock price is computed
by (a) multiplying projected earnings per share (EPS) or
projected earnings before interest, taxes, depreciation, and
amortization (EBITDA) by a price/earnings (P/E) ratio
27
See, e.g., Gilbert E. Matthews and M. Mark Lee, ‘‘Fairness Opinions and
Common Stock Valuations,’’ in The Library of Investment Banking, Vol. IV,
ed. R. Kuhn (Homewood, Illinois: Dow Jones Irwin), 407; Eric Nath,
‘‘Control Premiums and Minority Interest Discounts in Private Compa-
nies,’’ Business Valuation Review (June 1990), 41–43; Bradford Cornell,
Corporate Valuation (New York: McGraw Hill, 1993), 243; Shannon P.
Pratt, ‘‘Control Premiums? Maybe, Maybe Not—34% of 3rd Quarter
Buyouts at Discounts,’’ Business Valuation Update (January 1999), 1–2;
Richard A. Booth, ‘‘Minority Discounts and Control Premiums in Appraisal
Proceedings,’’ Business Lawyer 57 (2001):148–151; David Laro and Pratt,
Business Valuation and Taxes (Hoboken: Wiley, 2005), 314–315; Z.
Christopher Mercer and Travis W. Harms, Business Valuation: An
Integrated Theory, 2nd ed. (Hoboken: Wiley, 2007), 81; Lawrence A.
Hamermesh and Michael L. Wachter, ‘‘The Short and Puzzling Life of the
‘Implicit Minority Discount’ in Delaware Appraisal Law,’’ University of
Pennsylvania Law Review 156 (2007):23–24; Matthews, ‘‘Misuse of
Control Premiums in Delaware Appraisals,’’ Business Valuation Review 27
(Summer 2008): 118; Pratt, Business Valuation Discounts and Premiums,
2nd ed. (Hoboken: Wiley, 2009), 29–36.
28
As noted in Table 2, only three opinions used none of the primary
methods. In each of these situations, the company was valued based on its
assets because it had no meaningful current income or future prospects.
Table 4
Alternative Valuation Methods Used
Valuation Method Opinions Percent
Variant of Market Approach: 92 26.1
Present Value of Projected Future Price 64 18.2
Target Prices of Security Analysts 44 12.5
Variant of Income Approach: 50 14.2
Leveraged Buyout Model 48 13.6
Value Available in Recapitalization 5 1.4
Asset Approach: 28 8.0
Asset or Liquidation Value 22 6.3
Regression Model 8 2.3
Other: 2 0.6
Rule of Thumb (Value Per Ton of Steel) 1 0.3
Premium Over Corporate Repurchases 1 0.3
Total 140 39.8
Valuation Methods in Fairness Opinions: An Empirical Study of Cash Transactions
Business Valuation Review — Summer/Fall 2012 Page 61
based on the company’s historical P/E or EV
29
/EBITDA
ratio and on P/E or EV/EBITDA ratios of comparable
companies, and then (b) calculating the present value of the
estimated future price. Goldman Sachs is a major proponent
of this market-based method, using it in thirty-four of its
forty fairness opinions in this study. Morgan Stanley
applied it in eight of its fifteen opinions. In the other 296
opinions, this approach was applied only twenty-two times.
The comparison of the transaction price with security
analysts’ target prices can only be employed for
companies with good research coverage, primarily larger
companies for which shares are actively traded. Morgan
Stanley employed this method in ten of fifteen opinions,
BofA Merrill Lynch in eight of fifteen opinions, and
Barclays Capital in five of seven opinions. It was utilized
in only twenty-two of the other 314 opinions.
A leveraged buyout (LBO) analysis was used in forty-
eight opinions. This method values a company from a
financial investor’s perspective and excludes any syner-
gistic benefits. It is a variant of the income approach in
that it uses a company’s projections, is based on the
assumed return that a financial buyer would expect, and
assumes an exit price (usually after five years) based on
multiples of comparable companies. An LBO analysis
assumes that the buyer would pay a price based on
leveraging an acquisition with the maximum amount of
debt that would optimally be available at an acceptable
interest rate. LBO analyses were performed in more than
half the opinions issued by Evercore, Barclays Capital,
and William Blair (together, thirteen of eighteen opin-
ions), and in thirty-five of the other 333 opinions.
The consideration of the value available in recapitaliza-
tion (used in five opinions) is a related approach to the LBO
analysis. It is also based on hypothetical leverage, as it
considers the effect of a recapitalization on the value of the
shares. A recapitalization analysis assumes that the company
repurchases a substantial amount of its stock using a
company’s excess cash and/or by leveraging the company.
Asset value was used in twenty-two opinions.
Although asset value is an accepted valuation approach,
it is not widely used for fairness opinions other than (a)
for companies with poor earnings and/or limited
prospects or (b) for financial institutions. When compa-
nies are facing liquidation, assets are adjusted to reflect
liquidation value. Asset value is relevant to valuations of
financial institutions, since their earning power is a direct
function of their asset value. It can also be appropriate for
regulated utilities, for which permitted returns are directly
related to book value.
All the regression analyses employed in the fairness
opinions in this study are based on book value. The
method was applied in eight opinions for financial
institutions. The regression analyses were used to
determine the correlation between price/book value ratios
and return on common equity.
Two other methods were each utilized only once in the
opinions reviewed. One method was an ‘‘industry rule of
thumb’’ measure. The ‘‘rule of thumb’’ approach is not a
generally accepted method; it can be used, however, as a
‘‘sanity check’’ on other methods (as was done in the one
instance found in this study). As such, it has been
accepted in a few court decisions.
30
The other singular
approach compared the premium offered in the proposed
transaction with premiums previously paid by the
company in its stock repurchases. The opinion giver
provided no foundation for this unique approach, which
appears to lack either an academic or logical foundation.
Methods Used in Arm’s-Length vs. Related
Party Transactions
Related party transactions in this study include all
transactions in which the principal shareholders and/or
management have interests that are adverse to those
of outside shareholders. They include transactions in
which:
(a) The minority shareholders are bought out by the
principal shareholder(s) and there is no change of
control, or
(b) a third party, such as a private equity firm, acquires
control, and the principal shareholders and/or
management have adverse interests because they
receive consideration different in whole or in part
from that offered to other shareholders.
Starting with the data in Table 1, I compared the
methods frequently used in arm’s-length transactions
(294 opinions) with those for related party transactions
(fifty-eight opinions). I also considered the data in
Table 4 regarding use of the asset approach.
31
I then
29
Enterprise value is generally defined by investment bankers as market
value of equity plus debt, preferred stock, and minority interests, minus cash
and cash equivalents, other than cash that is described as ‘‘restricted cash.’’
(See ‘‘Definition of enterprise value’’ section.) There are several other
alternative phrases with the same meaning, such as ‘‘market value of invested
capital,’’ ‘‘total value of invested capital,’’ ‘‘market capitalization,’’ ‘‘firm
value,’’ and ‘‘aggregate market value.’’ (‘‘Market capitalization’’ is
ambiguous; is also sometimes used as a synonym for market value of equity.)
30
See, e.g., Neal v. Alabama By-Products Corp., 1990 Del. Ch. LEXIS 127
(August 1, 1990), aff’d, Alabama By-Products Corp. v. Neal, 588 A.2d 255
(Del. 1991) (value per recoverable ton of coal reserves was accepted as a
valuation method); Yuspeh v. Klein, 840. So. 2d 41, 53 (La. App. 2003)
(alarm company valued at multiple of monthly revenues).
31
I observed no meaningful differences with respect to the other data points
in Table 4 and therefore did not include that data in Tables 5 and 6.
Business Valuation Review
Page 62 2012, American Society of Appraisers
divided the related party data between the thirty
transactions in which there was no change of control
and the twenty-eight with a change of control. The data
comparing arm’s-length transactions and related party
transaction are shown in Table 5. Related party transac-
tions with and without charge of control are compared in
Table 6.
There were substantive differences between the
methods used in arm’s-length transactions versus trans-
actions with no change of control, i.e., freeze-outs of
minority shareholders (going-private transactions). In
these, four differences were noted: (a) A lower percentage
used the income approach, (b) a higher percentage used
asset or liquidation value, (c) a lower percentage used
comparable transactions, and (d) a higher percentage used
the premiums paid method. After reviewing the data, I
concluded that two of these differences are not meaning-
ful: the lower proportion of opinions using the income
approach is attributable to absence of adequate projec-
tions, and the higher proportion using the asset approach
Table 5
Selected Valuation Methods Used: Arm’s-Length Compared to Related Party Transactions
Valuation Method Used
Arm’s-Length Transactions Related Party Transactions
Opinions Percent Opinions Percent
Total Number of Opinions 294 58
Income Approach: 268 91.2 53 91.4
Discounted Cash Flow 255 86.7 52 89.7
Discounted Dividend Model 14 4.8 1 1.7
Market Approach: 283 96.3 55 94.8
Comparable Companies 276 93.9 54 93.1
Comparable Transactions 267 90.8 45 77.6
Asset Approach: 20 6.8 9 15.5
Asset or Liquidation Value 14 4.8 9 15.5
Regression Model 8 2.7 0 0.0
Premiums Paid 137 47.4*30 52.6{
* Five opinions were for entities that were not publicly traded.
{One opinion was for an entity that was not publicly traded.
Table 6
Selected Valuation Methods Used: Related Party Transactions With and Without Change of Control
Valuation Method Used
Change of Control No Change of Control
Opinions Percent Opinions Percent
Total Number of Opinions 28 30
Income Approach: 28 100.0 25 83.3
Discounted Cash Flow 28 100.0 24 80.0
Discounted Dividend Model 0 0.0 1 3.3
Market Approach: 27 96.4 28 93.3
Comparable Companies 26 92.9 28 93.3
Comparable Transactions 25 89.3 20 66.7
Asset Approach: 3 10.7 6 20.0
Asset or Liquidation Value 3 10.7 6 20.0
Regression Model 0 0.0 0 0.0
Premiums Paid 10 35.7 20 69.0*
* One opinion was for an entity that was not publicly traded.
Valuation Methods in Fairness Opinions: An Empirical Study of Cash Transactions
Business Valuation Review — Summer/Fall 2012 Page 63
reflects the fact that four of the six opinions were for
troubled companies. The other two differences are
discussed next.
Only 67% of the opinions in non-change-of-control
transactions applied comparable transactions as a valua-
tion standard, in contrast to 89% for all other opinions.
32
Only one proxy statement for a related party transaction
offered an explanation of why comparable transactions
were not used:
[A]n analysis of multiples paid in change of control
transactions … [was] considered not relevant by Lehman
Brothers and Morgan Stanley as the transaction being
considered by the special committee did not involve a sale
by the Dolan Family Continuing Investors of their interest
in Cablevision.
33
Although the investment bankers in this situation
concluded that comparable transactions were inapplicable
when there was no change of control, their position is not
generally accepted. In the twenty-six other related party
opinions where there was no change of control and
comparable companies were used, comparable transac-
tions were considered in twenty (77%).
The premiums paid method was utilized in twenty
(69%) of the opinions in going-private transactions versus
47% for all other opinions. When the method was used, it
focused on premiums paid in other going-private
transactions; fifteen of the twenty opinions used this
comparison to buttress their conclusion.
Commentary: Are comparable transactions relevant
when there is no change of control?
Why would some firms omit a comparable transaction
analysis when opining on the fairness of a going-private
transaction? A possible explanation is that the remedy for
dissenting shareholders is appraisal, and most states,
including Delaware, exclude a control premium when
valuing dissenters’ shares. However, a majority of the
going-private opinions used premiums paid in other
acquisitions as a fairness standard, which is inconsistent
with ignoring imputed values based on comparable
transactions.
Dissenting shareholder cases reject control premiums
that reflect the benefits of synergies. Although acquisi-
tions by strategic buyers often include synergies, the
prices paid by these buyers may not include material
synergies except in situations where there may be
competitive strategic buyers. Acquisitions by financial
buyers often do not have synergistic benefits. Therefore,
the comparable transaction method should be considered
in most going-private transactions.
Inputs Used in DCF Analyses
I examined the discount rates used in DCF calculations,
looking at both the absolute values and at the width of the
ranges. I also looked at the approaches used to determine
terminal value, reviewing for each opinion:
NWhich basis—a multiples or a growth rate—was
used?
NIf a multiple was applied:
#To what data point was the multiple applied?
#If EV/EBITDA was used, what was the midpoint
of multiples applied?
#What was the spread of EBITDA multiples
applied?
NWhen a growth rate was used:
#To what data point was the growth rate applied?
#What was the midpoint of growth rates selected?
#What was the spread of growth rates selected?
I next comment on the impact of the wide spreads of
inputs found in the study on the utility of DCF as a
fairness standard.
Discount rates used in discounted cash
flow calculations
The discount rates employed in the 320 discounted cash
flow calculations varied from less than 10% to more than
25%. As would be expected, higher discount rates were
generally applied to smaller companies, while the lower
rates predominated for the largest companies. The average
discount rate used in transactions with equity values under
$100 million was 17%, while the average for transactions
over $1 billion was about 10%. However, there were
significant variations within each size range. The distribu-
tion of discount rates by size of transaction is shown in
Table 7.
Table 8 shows the number of opinions that specified
using WACC (weighted average cost of capital) and also
shows the spreads between the high and low discount
rates in the DCF calculations.
The majority of the disclosures explicitly state that the
discount rates were calculated using WACC: 82 of 155
(53%) in 2007–2008 and 105 of 165 (64%) in 2010–
2011, a material increase. (Further studies will be needed
to determine if WACC usage by investment banks is
actually increasing or whether it merely reflects fuller
32
This difference does not appear to be correlated with the fact that, on
average, the related party transactions were materially smaller than the
arms’-length transactions.
33
Cablevision Systems Corporation proxy statement dated September 14,
2007: 29. Cablevision’s minority shareholders voted down the proposed
transaction despite the two fairness opinions.
Business Valuation Review
Page 64 2012, American Society of Appraisers
disclosure.) There were twelve opinions that disclaimed
the use of WACC: one of these opted for the build-up
method, and eleven arbitrarily selected a discount rate,
stating that their selection was ‘‘appropriate’’ or was
based on the ‘‘judgment,’’ ‘‘experience,’’ or ‘‘expertise’’
of the investment bank rendering the opinion. The other
121 opinions did not explicitly discuss how the discount
rate was determined, but some of these may have utilized
WACC without specifically disclosing the fact. Seven
opinions gave no disclosure as to what discount rate was
utilized.
There was a spread between the high and low
discount rates of 2% or more in 73% of the opinions,
and a spread of 5% or more in 10% of them. When an
opinion specified WACC, theretendedtobeasmaller
spread: 80% with a spread of 1.5% or less used WACC,
but only 51% of the opinions with a spread of 2% or
more did so. The spread of discount rates as a
percentage of the ranges’ midpoints is shown in
Table 9.
34
In only 18% of the DCF analyses were the spreads less
than 10% of the midpoint: 22% of the spreads were
between 10% and 14.9%, and 37% were between 15%
and 24.9%, while 23% were 25% or more. WACC was
specified in 77% of the opinions with spreads under 10%,
67% with spreads between 10% and 14.9%, and 51%
with spreads of 15% or more.
Terminal value: Multiples used more often than
growth rates
Although academic sources generally agree that
terminal value in DCF valuations should be calculated
Table 8
Difference Between High and Low Discount Rates Used in DCF Calculations
Difference
September 2007 to August 2008 September 2010 to August 2011 Total
WACC Used Other WACC Used Other WACC Used Other
0% 6 2 12 2 18 4
0.5% 5 0 0 0 5 0
1% to 1.5% 23 8 22 5 45 13
2% to 2.5% 21 28 38 32 59 60
3% to 3.5% 2 11 10 5 12 16
4% to 4.5% 14 11 15 9* 29 20*
5% 5 2 54106
6% 1 4 0 1 1 5
7% to 9% 2 2 1 1 3 3
10% 2 0 1 1 3 1
Subtotal 81 68 104 60 185 128
Discount Rate Not Disclosed 1 5 1 0 2 5
Total 82 73 105 60*187 133*
* Includes one opinion using the build-up method.
Table 7
Midpoints of Discount Rates Used in Discounted Cash Flow Valuations
Equity Value of Transaction
Average
Discount Rate
Less than
10%
10% to
11.9%
12% to
13.9%
14% to
16.9%
17% to
20%
More than
20%
Less than $25 Million 17.0% — 1 5 4 1 5
$25 to $50 Million 17.3% 1 3 7 6 3
$50 to $100 Million 17.7% 4 9 11 6
$100 to $250 Million 15.6% 3 3 15 17 7 7
$250 to $500 Million 13.4% 5 15 17 15 9 1
$500 Million to $1 Billion 12.0% 5 11 13 7 2 —
$1 to $3 Billion 11.1% 7 27 14 2
$3 to $10 Billion 9.8% 18 13 6 — — —
More than $10 Billion 8.5% 6 2 ————
34
For example, if the range was 7.0% to 9.0%, the spread is 2.0%, the
midpoint is 8.0%, and the range is 25% (2.0%48.0%) of the midpoint.
Valuation Methods in Fairness Opinions: An Empirical Study of Cash Transactions
Business Valuation Review — Summer/Fall 2012 Page 65
using models that capitalize expected increases (growth
rates) in cash flows in the terminal period, the data shows
investment banking practice favors the use of multiples,
primarily EV/EBITDA ratios derived from comparable
companies and/or comparable transactions. Table 10
shows the number of opinions that used a multiple to
determine terminal value and the number using growth
rates.
Of the 320 opinions that used DCF, 309 described the
methodology employed to determine terminal value:
65.5% used multiples, and 41.0% used growth rates;
6.5% used both. The portion that used a growth model,
either alone or in addition to a multiple, increased from
37.6% in 2007–2008 to 44.1% in 2010–2011. (Studies
over time would be needed to confirm whether this
modest increase indicates a trend.)
Table 11 shows that more than 90% of terminal
value calculations for nonfinancial companies used
EBITDA multiples, while 6% used multiples of revenues
(primarily for companies with negative or minimal
current operating income). It also shows that that all
growth-rate-based terminal value calculations for nonfi-
nancial institutions were based on free cash flow (FCF).
Table 11 shows that terminal value calculations for
financial institutions used significantly different ap-
proaches. Terminal values of financial institutions based
on multiples all utilized net income and/or book value,
and those based on growth rates generally utilized
projected dividend growth.
35
In contrast, the predominant
methods for nonfinancial companies were either multiples
of EBITDA or growth of free cash flow. EBITDA is not a
meaningful data point for valuing financial institutions
because interest income and interest expense are
components of their operating income.
Table 9
Spread of Discount Rates in DCF Calculations as Percent of Midpoint
Spread as Percent of
Midpoint
September 2007 to August 2008 September 2010 to August 2011 Total
WACC Used Other WACC Used Other WACC Used Other
0% 6 2 12 2 18 4
3.9% to 9.9% 13 4 13 5 26 9
10% to 14.9% 20 13 27 10 47 23
15% to 19.9% 13 15 20 17 33 32
20% to 24.9% 14 15 10 11 24 26
25% to 29.9% 5 9 11 7* 16 16*
30% to 39.9% 9 4 6 5 15 9
40% to 50% 1 6 5 3 6 9
Total 81 68 104 60 185 128
* Includes one opinion using the build-up method.
Table 10
Approaches Used to Calculate Terminal Value
Basis of Calculation
September 2007 to August 2008 September 2010 to August 2011 Total
Opinions Percent Opinions Percent Opinions Percent
Multiples Only 93 62.4 90 57.5 183 59.0
Growth Model Only 48 32.2 59 36.6 107 34.5
Both Multiples and Growth Model 8 5.4 12 7.5 20 6.5
Subtotal 149 161 310
Product Life—No Terminal Value* 3 3 6
Basis Not Disclosed 3 1 4
DCF Not Used 20 12 32
Total 175 177 352
* Five of these were developmental pharmaceutical/bioscience companies; one was a loan portfolio.
35
Except for one utility opinion, all calculations that employed the
discounted dividend model were for financial institutions.
Business Valuation Review
Page 66 2012, American Society of Appraisers
Terminal value: EBITDA multiples used
in calculations
I examined the EBITDA multiples selected by the
opinion providers for computing terminal value. The
range of the midpoints of EBITDA multiples utilized is
shown in Table 12.
A company’s EBITDA multiple is a function of market
conditions as well as the growth prospects of the
company and its industry. When the EBITDA multiples
chosen in the 2010–2011 period were compared with
those in 2007–2008, the median was observed to have
dropped 6% from 8.03to 7.53, and the harmonic mean
fell 10% from 7.93to 7.13.
36
These lower multiples
reflect the adverse change in market conditions—the
mean S&P 500 closing price in the 2010–2011 period
was 9% lower than in the 2007–2008 period.
37
I then looked at the width of the ranges of EBITDA
multiples
38
and assembled the data in Table 13. Many
ranges were quite wide: The mean range of the spreads
was 24.9%, and the median was 23.5%. There was no
material difference between the two periods.
Terminal value: Growth rates used
in calculations
As would be expected, a review of growth rates
similarly shows the impact of depressed market and
economic conditions on analysts’ assumptions; overall,
lower growth rates were applied in the later period. The
mean growth rate declined from 3.4% in the 2007–2008
period to 2.5% in 2010–2011; the median fell from 3.0%
to 2.5%.
39
This decline reflects lowered expectations for
the economy in the later period. Although the most
commonly employed growth rate in both periods was
3%, in 2010–2011 only 21% used growth rates above
3%, while 55% used lower. In contrast, in 2007–2008,
the number of growth rates higher than 3% (38%)
equaled the number lower than 3%. Table 14 shows the
midpoints of the growth rates employed in the two
periods.
Table 15 shows widths of the ranges of growth rates
used in terminal value calculations. More than half of the
spreads in growth rates were 2% or more.
Table 11
Terminal Value: Basis of Calculations
All Opinions
Opinions for Financial Companies Opinions for All Other Companies
Using DCF Using DDM Using DCF Using DDM
Multiples of:
Revenues 11 — 11 —
EBITDA 155 — — 155 —
EBITDA & Revenues 1 — 1 —
EBITDA & Free Cash Flow 1 — 1 —
EBITDA & Net Income 1 — 1 —
Free Cash Flow 3 — 3 —
Net Operating Profit 2 — 2 —
Net Income 11 5 2 4
Book Value 541—
Book Value & Net Income 15 10 5
Multiples Total 205 19 8 178 0
Growth of:
Free Cash Flow 119 1 118
Net Income 1 1
Dividends 6 — 5 1*
Growth Model Total 126 0 7 118 1
Total{310
* This opinion also used DCF with an EBITDA multiple.
{Twenty opinions (including two financial companies) calculated terminal value using both multiples and a growth model.
36
Based on this review of the data for the two periods, the decline in average
EBITDA multiples is not attributable to a difference in the mix of industries
in which the various companies participated.
37
The impact on terminal value of a lower EBITDA multiple is linear; i.e., a
10% change in the multiple changes terminal value by 10%.
38
For example, if the range was 7.03to 9.03, the range is 2.03, the
midpoint is 8.03, and the range is 25% (2.0348.03).
39
The impact on terminal value of a lower growth rate is a function of the
discount rate. Lowering the growth rate from 3.0% to 2.5% reduces terminal
value by 10% at an 8% discount rate, by 5.6% at a 12% discount rate, by
3.8% at a 16% discount rate, and by 2.9% at a 20% discount rate.
Valuation Methods in Fairness Opinions: An Empirical Study of Cash Transactions
Business Valuation Review — Summer/Fall 2012 Page 67
Commentary: Wide spreads of inputs limit the utility
of DCF as a fairness standard
The Delaware Court of Chancery favors discounted cash
flow as a valuation methodology for fairness opinions,
both because it appears to be precise and because it is
forward-looking. It has long been recognized that one
weakness of DCF is the unreliability of projections.
40
In
addition, however, DCF remains highly subject to the
inputs discussed above—discount rates,
41
terminal value
multiples, and terminal value growth rates—and this study
provides further evidence for the thesis that the precision in
DCF is illusory.
First, I examined the impact of discount rate spreads on
DCF valuations. The wide discount rate spreads shown in
Table 9 demonstrate that investment bankers’ discount
rates are imprecise, even when their determinations were
based on WACC. The fact that the high and low ends of
the discount rate spreads were rounded to an integer or to
a number ending in .5 in all but sixteen of the 291 ranges
serves to highlight the lack of precision. Based on the
data in Tables 7 and 9, I used as an example the
difference between using a 13% discount rate and a 17%
discount rate; the spread between 13% and 17% is 27% of
the midpoint. I calculated the difference in value for a
hypothetical company for which free cash flow is
projected to grow at 10% per year for five years. The
calculated value at a 13% discount rate range was 17%
higher than at a 17% discount rate. This demonstrates that
DCF values are materially sensitive to the width of
discount rates ranges.
I then examined the impact of spreads on terminal
value and concluded that terminal values are also very
41
See Nath, ‘‘The Biggest Valuation Myth,’’ Business Valuation Review 30
(Fall 2011), 88.
40
See, e.g., Richard A. Breaky and Stewart C. Myers, Principals of
Corporate Finance, 5th ed. (New York: McGraw Hill, 1996), 798; Pratt,
Robert F. Reilly, and Robert P. Schweihs, Valuing a Business, 3rd ed.
(Chicago: Irwin, 1995), 191; Matthews and Lee, ‘‘Fairness Opinions and
Common Stock Valuations’’ (1990), 411.
Table 13
Terminal Value: Width of Spreads of EBITDA
Multiples as Percent of Midpoint
Spread as
Percent of
Midpoint
September 2007
to August 2008
September 2010
to August 2011 Total
0% to 9.9% 4 4 8
10% to 19.9% 17 24 41
20% to 29.9% 32 33 65
30% to 39.9% 9 14 23
40% to 49.9% 7 7 14
50% or more 4 3 7
Total 73 85 158
Table 15
Terminal Value: Spreads of Growth Rates
Width of
Spread
September 2007
to August 2008
September 2010
to August 2011 Total
0% 3 6 9
0.5% 4 3 7
1% 17 20 37
1.5% 0 1 1
2% 23 30 53
3% 2 3 5
4% or More 2 3 5
Total 51 66 117
Table 14
Terminal Value: Midpoints of Growth Rates Used in
Growth Models
Growth Rate
September 2007
to August 2008
September 2010
to August 2011 Total
0% 0 5 5
1% 1 4 5
.1% and ,2% 2 3 5
2% 7 13 20
.2% and ,3% 9 11 20
3% 12 16 28
.3% and ,4% 4 5 9
4% 4 5 9
.4% and ,5% 3 1 4
5% 6 2 8
.5% 3 1 4
Subtotal 51 66 117
Minus 30%* 0 1 1
Not Disclosed 4 4 8
Total 55 71 126
* Excluded from mean and median.
Table 12
Terminal Value: EBITDA Multiples Used
EBITDA
Multiple
September 2007
to August 2008
September 2010
to August 2011 Total
3.53to 4.43022
4.53to 5.437815
5.53to 6.4361117
6.53to 7.4392029
7.53to 8.4320 22 42
8.53to 9.4310 11 21
9.53to 10.437512
10.53to 11.43516
11.53to 12.43336
12.53and Up 6 2 8
Total 73 85 158
Business Valuation Review
Page 68 2012, American Society of Appraisers
sensitive to wide spreads of DCF multiples and growth
rates. This is true both for terminal values based on
EBITDA multiples and those based on growth rates. As
the driving factor in most DCF valuations, terminal value
often represents 70% to 80% (and sometimes more) of the
calculated value.
The average difference between high and low EBITDA
multiples was approximately 25% (see Table 13), and the
calculated terminal value based on multiples has the same
range. Similarly, Table 15 shows that approximately half
of the terminal values based on growth rates used spreads
of 2% or more. If a 15% discount rate is applied, a 4%
growth rate results in a terminal value 20% higher than a
2% growth rate; if a 10% discount rate is applied, the
difference becomes 36%.
The widths of the spreads of discount rates, EBITDA
multiples, and growth rates create wide valuation ranges
at the EV level. When a company is leveraged, the range
widens at the equity level. For example, if the EV range is
$85 million to $115 million (a 30% range compared to
the midpoint), and the company has net debt of $50
million, the equity value is $35 million to $65 million (a
60% range compared to the midpoint). The ranges in
inputs drive the valuation and inexorably lead to wide
valuation ranges. The faith in, and the reliance on, the
DCF method is thus misleading and unfortunate. This
study has shown that DCF valuations more closely
resemble sausages, which have similar appearances, but
which, in fact, require further inspection to determine the
quality of the ingredients therein.
The wide valuation ranges that are used in fairness
opinions are of limited utility in assessing fairness. If the
price offered to shareholders is near the low end of a wide
range, how is that fact an indicium of fairness? Are wide
ranges used to make it easier to fit a transaction price
within a range? The credibility of fairness opinions is
deleteriously affected by wide valuation ranges.
Multiples Used in the Market Approach
Primary multiples used
The various multiples applied in comparable company
and comparable transaction analyses are shown in
Tables 16 and 17, respectively.
The principal multiples used in the 296 comparable
company analyses for nonfinancial companies were EV/
EBITDA (85%), EV/Revenues (41%), P/E (56%). For the
278 comparable transaction analyses for nonfinancial
companies, EV/EBITDA was used in 83% and EV/
Revenues was used in 50%, while P/E ratios were used in
merely 12%. Fairness opinions for financial institutions
predominantly used P/E ratios and multiples of book
value (BV) and/or tangible book value (TBV). In
contrast, multiples of book value and tangible book value
were seldom used for nonfinancial companies.
Unless the valuator can demonstrate that there is a
strong correlation between revenues and profit margins,
revenue multiples are less reliable for valuing businesses
than EBITDA multiples and P/E ratios.
42
Multiples of
revenues can be applied when an entity (usually an
unseasoned or troubled company) has little or no
EBITDA and the comparison is with similar companies.
They are often used by analysts with respect to immature
high-tech companies in such industries as biotech and
software. In twenty-three (9%) of the fairness opinions for
nonfinancial companies that used both comparable
companies and comparable transactions, the companies
had minimal or no earnings, so no other data point was
Table 16
Data Points Used in Comparable Company Analyses
Data Point
September 2007 to August 2008 September 2010 to August 2011 Percent
Opinions for Banks
and Insurance
Companies
Opinions for
All Other
Companies
Opinions for Banks
and Insurance
Companies
Opinions for
All Other
Companies
Opinions for Banks
and Insurance
Companies
Opinions for
All Other
Companies
EV/Revenues 0 73 0 49 0 41
EV/EBITDA 0 110 0 142 0 85
EV/EBIT 0 20 0 2 0 7
P/E 22 77 10 90 94 56
P/BV and/or TBV 21 5 11 5 94 3
Total*23 142 11 154
* Many opinions used more than one multiple.
42
‘‘[W]hen considering using a multiple of sales, it is useful to first see
whether the guideline company multiples of revenue are well correlated
with return on sales.’’ Pratt, Valuing a Business, 5th ed. (New York:
McGraw Hill, 2008), 294.
Valuation Methods in Fairness Opinions: An Empirical Study of Cash Transactions
Business Valuation Review — Summer/Fall 2012 Page 69
meaningful. However, I observed that revenue multiples
also were frequently used in opinions where meaningful
EV/EBITDA ratios were also available.
Comparisons of EV/EBITDA ratios are widely accept-
ed for valuing businesses. EV/EBITDA ratios were the
predominant multiple for the market approach used in
fairness opinions for companies other than financial
institutions. (As discussed previously herein, EBITDA is
not applicable for valuing banks and insurance compa-
nies.) The method is useful for comparing companies
with different capital structures because it is considered to
be more capital structure neutral than P/E ratios.
Although it does not take into account differences in
capital expenditures, these differences are often small
within an industry.
EBIT multiples can be useful as an additional data
point, but they were used far less often than EBITDA
multiples or P/E ratios. EBIT multiples were used in more
than 10% of the 2007–2008 opinions but only in 2% in
2010–2011.
For banks and insurance companies, P/E ratios were
used in 94% of the thirty-four comparable company
analyses and 88% of the thirty-two comparable transac-
tion analyses. For companies other than financial
institutions, P/E ratios were used in 57% of the 294
comparable company studies but, surprisingly, in only
11% of the 277 comparable transaction studies. The
failure to use P/E ratios for such a large portion of
comparable transaction analyses, which cannot be
attributed to lack of publicly available information, is
discussed in the following commentary section.
Multiples of net worth and tangible net worth are
commonly used for banks and insurance companies and
are occasionally used for regulated utilities. They are
relevant in situations where earning power is directly
related to net worth. Banks’ earnings are a function of
their assets, and the earnings of insurance companies and
regulated utilities are a function of the returns on
investment permitted by regulators.
As discussed earlier, the three primary multiples used
by fairness opinion providers for nonfinancial companies
were EV/EBITDA, EV/Revenues, and P/E. Table 18
shows the principal combinations of these three multiples
used in the periods reviewed.
Some valuations applied only one of these three
multiples, some applied two, and some applied all three.
It is noteworthy that although there were 130 opinions in
which EBITDA multiples were considered for both
comparable companies and comparable transactions, P/E
ratios were used for comparable transactions in merely
eighteen of them.
Commentary: Most comparable transaction
analyses unreasonably ignored P/E
There were eight opinions using both comparable
transactions and comparable companies in which the
comparable company analyses used either EV/EBITDA
or P/E, but their comparable transaction analyses failed to
do so, relying upon EV/Revenues alone. In each of these
situations, the selected comparable transactions included
several publicly traded companies for which income
account data were available. Thus, there was no apparent
reason not to have calculated EV/EBITDA multiples and,
in most cases, P/E ratios for the selected comparable
transactions.
As pointed out already, there were 112 opinions where
the fairness opinion analyses used EV/EBITDA and P/E
ratios for the comparable companies but only EBITDA
multiples were used for the comparable transactions. I
reviewed the selected comparable transactions in these
112 analyses and found that, in about 90% of them,
adequate data were publicly available to have enabled P/E
ratios to be used for the comparable transactions. The
Table 17
Data Points Used in Comparable Transaction Analyses
Data Point
September 2007 to August 2008 September 2010 to August 2011 Percent
Opinions for Banks
and Insurance
Companies
Opinions for
All Other
Companies
Opinions for Banks
and Insurance
Companies
Opinions for
All Other
Companies
Opinions for Banks
and Insurance
Companies
Opinions for
All Other
Companies
EV/Revenues 0 78 0 61 0 50
EV/EBITDA 0 102 0 127 0 83
EV/EBIT 0 17 0 3 0 7
P/E 20 20 8 12 88 12
P/BV and/or TBV 21 1 10 2 97 1
Total*21 136 11 142
* Many opinions used more than one multiple.
Business Valuation Review
Page 70 2012, American Society of Appraisers
failure to use available P/E ratios reduced the information
available from these comparable transaction analyses.
Commentary on nonstandard multiples used
Nonstandard multiples were used on twenty-four
occasions in the 336 opinions that used the market
approach. In describing these methods, I discuss why
some are useful in certain situations and why others are
either of little value or invalid for analytical purposes.
Price/earnings/growth (P/E/G) ratios were used in seven
opinions. Although this ratio is not often used in valuation
practice, security analysts who follow high-growth indus-
tries sometimes employ it. A P/E/G ratio is calculated by
dividing the P/E ratio by the expected medium-term
growth rate. It is based on the questionable premise
expressed by Peter Lynch, a well-known investment
manager, that the P/E ratio of a fairly priced stock should
equal its EPS growth rate (P/E 5G). One critic explained:
According to Lynch, a company that’s fairly priced will have
a P/E ratio equal to its growth rate. In other words, a stock
with a PEG ratio of 1.0 is fairly valued, while a stock with a
PEG ratio of less than 1.0 is undervalued, and a stock with a
PEG ratio greater than 1.0 would be overvalued.
While this seems incredibly simple and intuitive, remember
it is only a rule of thumb. The assertion that a P/E ratio should
equal earnings growth is somewhat arbitrary and certainly
does not apply to all companies.
43
[Emphasis in original]
A P/E/G ratio is statistically flawed because it
compares a number (e.g., 10.03) with a percentage
(e.g., 10%). Moreover, this formula breaks down at low
growth rates: A stock with 2% earnings growth is surely
worth more than a 2.03P/E ratio.
EV/EBITDAR ratios were utilized in two fairness
opinions for airlines. EBITDAR is EBITDA plus rental
payments. EBITDAR multiples are used to compare
companies that rely primarily on leased assets to
companies that own most of their assets. The intent of an
EBITDAR multiple is to neutralize the impact on a
valuation analysis of an airline’s decision as to whether to
rent or buy. The concept of EBITDAR is useful, but the
way in which EBITDAR multiples are customarily
calculated is flawed. Analysts usually calculate the EV/
EBITDAR multiple by adding rent expense to EBITDA,
but without a corresponding adjustment to EV, rendering
this procedure conceptually unsound. Rental expense for
aircraft is similar to capitalized lease payments: Rental
payments effectively include an interest component and a
primary payment component. The denominator—EBIT-
DAR—should include only the portion of the annual rent
expense payments that is substantively equivalent to
interest, not the entire rental payment. The numerator—
EV—should be increased by the present value of the
portion of future rent expense payments that are substan-
tively equivalent to the principal payments.
44
If this
procedure is followed, the ratio can be useful.
One opinion for a power generation company used a
ratio of rent-adjusted EV to rent-adjusted EBITDA in its
comparable company comparisons
45
and described the
method as follows:
Table 18
Principal Combinations of Primary Multiples Used in Opinions (Other Than Financial Institutions)*
Same Multiples Used for Both Comparable Companies and Comparable Transfers: Opinions
Both Used EV/Revenues Only 23
Both Used EV/EBITDA; Neither Used P/E 86
Both Used EV/EBITDA and P/E 18
Both Used P/E; Neither Used EV/EBITDA 6
Total 133
Different Multiples Used for Comparable Transactions:
Comparable Companies Used EV/EBITDA and/or P/E but Comparable Transactions Used EV/Revenues Only 8
Comparable Companies Used EV/EBITDA and P/E but Comparable Transactions Used EV/EBITDA Only 112
Comparable Companies Used P/E Only but Comparable Transactions Used EV/EBITDA Only 2
Total 122
* Many analyses that used EV/EBITDA and/or P/E also used EV/Revenues. This table includes EV/Revenues only if it was the sole
multiple used.
43
Todd Bunton, ‘‘Beware the PEG Ratio,’’ Zack’s Investment Research,
November 1, 2011, accessed at http://www.zacks.com/commentary/19287/
Beware+the+PEG+Ratio, April 4, 2012.
44
For a method of determining the value of scheduled future principal and
interest payments embedded in rentals, see S. Cottle, R. F. Murray, and
F. E. Block, Graham & Dodd’s Security Analysis, 5th ed. (New York:
McGraw-Hill, 1988), 305–310.
45
This opinion was classified in tables above as a form of EV/EBITDA.
Valuation Methods in Fairness Opinions: An Empirical Study of Cash Transactions
Business Valuation Review — Summer/Fall 2012 Page 71
Rent-Adjusted EV … is defined as the market value of
common equity plus the book value of debt and preferred
stock, plus an estimate of the present value of
anticipated rent expense, plus minority interest, less
cash. … [E]stimated earnings plus rent expense, before
interest, taxes, depreciation and amortization, referred to as
Rent-Adjusted EBITDA.
46
[emphasis added]
This hybrid approach reduces the numerator in the
ratio, but it does not address the issue of separating the
interest and principal components of rental payments.
Ratios of price to operating income per share were used
in three opinions for insurance companies, an approach
occasionally utilized by security analysts following the
insurance and bank sectors. Because interest is a
component of income and of expense for financial
institutions, this useful ratio is the functional equivalent
of an EBIT ratio in other businesses.
An EV/FCF ratio was also utilized in four of the 228
opinions that used the standard EV/EBITDA ratio. The
primary difference between EBITDA and free cash flow
is that capital expenditures are deducted in calculating
FCF. This seldom-used method values companies with
lower capital expenditures higher than those with higher
capital expenditures.
Six opinions used rules of thumb: Multiples of proved
reserves and of daily production were applied to value
two oil and gas entities; a cable television (TV) company
was valued using multiples of the number of subscribers;
a water utility was valued based on multiples of the
number of customers; multiples of assets under manage-
ment (AUM) were utilized in two opinions. Market-based
rules of thumb that are not earnings based, such as
multiples of oil and gas reserves, number of customers, or
AUM, are of limited value.
47
For example, the value of
AUM to a company depends on the earnings derived
from it, which in turn is a function of the fee structure.
Rules of thumb should not be used as primary methods
but can sometimes be used as secondary ‘‘sanity checks’’
on other valuation conclusions.
One opinion calculated an EV/gross profit ratio. This
multiple is rarely seen in valuations or analyst reports,
and it does not appear to be a useful valuation method.
The price/cash flow (P/CF) ratio was used in only one
fairness opinion. This ratio is no longer an accepted
valuation method. It was widely used in the 1960s and
early 1970s, but this practice changed after the SEC
prohibited companies from including ‘‘cash flow per
share’’ in their financial statements or in any other public
documents. In July 1973, the SEC issued ASR 142,
48
which stated that ‘‘per share data other than that relating
to net income, net assets and dividends should be avoided
in reporting financial results.’’ It appropriately did so
because the cash flow from depreciation is relevant to the
value of a company as a whole—hence the relevance of
an EV/EBITDA ratio—but depreciation per share is not a
meaningful statistic due to differences in capital structure.
Opinion givers may elect to apply nonstandard
multiples when they provide an alternative approach for
determining fairness. However, those who choose to
apply an infrequently used multiple should understand
whether there are any potential flaws in the approach and
explain what its advantages are and why it is valid.
Definition of enterprise value in the
market approach
The valuation community currently uses two different
approaches to calculate enterprise value (EV) as the
numerator for multiples in the market approach. The
valuation literature continues to reflect this disorder: Some
writers define EV as debt plus equity,
49
while others define
EV as debt plus equity minus cash.
50
Pratt writes that either
alternative is acceptable.
51
I reviewed the fairness opinion
disclosures to ascertain how investment bankers and other
opinion givers defined EV and, particularly, how they treated
cash. This review discerned that the overwhelming practice
of investment bankers is to deduct cash and cash equivalents.
Of the 336 opinions that used the market approach, 282
used ratios with EV in the numerator. The phrase ‘‘enterprise
value’’ was used in 88% of them. The phrases used are
shown in Table 19.
Of these 282 opinions, 210 described how EV (by any
name) was defined, while seventy-two did not. Only one
definition (not by an investment banker) did not deduct
cash. One definition deducted only ‘‘excess cash.’’
52
A
total of 208 (99%) of the definitions deducted all cash on
46
Dynergy, Inc., proxy statement dated October 4, 2010: 46; fairness
opinion by Greenhill & Co.
47
‘‘Rules of thumb … fail to differentiate either operating characteristics or
assets from one company to another. … Consequently, rules of thumb
rarely, if ever, should be used without reference to other, more reliable
valuation methods.’’ Pratt, Valuing a Business, 319.
48
US Securities and Exchange Commission. Accounting Series Release
No. 142, Reporting Cash Flow and Other Related Data (Washington, D.C.:
Government Printing Office, 1973).
49
For example, James R. Hitchner, Financial Valuation, 2nd ed. (Hoboken:
Wiley, 2006), 241; Philip J. Clements and Philip W. Wisler, The Standard
& Poor’s Guide to Fairness Opinions (New York: McGraw Hill, 2005), 40.
50
For example, Patrick A. Gaughan, Mergers, Acquisitions, and Corporate
Restructuring, 4th ed. (New York: Wiley, 2007), 12; Gilbert E. Matthews,
‘‘Fairness Opinions: Common Errors and Omissions,’’ in The Handbook of
Business Valuation and Intellectual Property Analysis, ed. Robert F. Reilly and
Robert P. Schweihs (New York: McGraw Hill, 2004), 212. (Some practitioners
prefer to deduct only ‘‘excess cash,’’ but this concept is difficult in practice.)
51
Pratt, Valuing a Business, 265.
52
‘‘Excess cash’’ was not defined. The same investment bank deducted all
cash in twenty other opinions.
Business Valuation Review
Page 72 2012, American Society of Appraisers
the balance sheet.
53
The definitions called for deducting
cash from the sum of debt and equity regardless of
whether cash exceeded the amount of debt.
The investment bankers in this study sometimes explained
why they adjusted for additional balance sheet items when
calculating EV. For instance, the inclusion of minority
interests and preferred stock is customary whenever these
items are on the balance sheet. Marketable securities are
commonly considered to be cash equivalents and are
therefore deducted. Depending on facts and circumstances,
other items may appropriately be considered, e.g., capital
leases may be added, and nonoperating assets and the
present value of loss carryforwards may be deducted.
Examples of definitions are:
[E]nterprise value … is the market value of common equity
plus the book value of debt and minority interest less cash
and the value of unconsolidated assets.
54
Firm Value of a particular company was calculated as
market value of that company’s common stock based on
fully diluted shares using the treasury method … plus the
value of that company’s indebtedness, minority interest and
preferred stock, minus that company’s cash and cash
equivalents and marketable securities.
55
Enterprise Value of a particular company was calculated as
market value of the company’s equity … plus the value of
the company’s indebtedness, capital leases, minority
interest and preferred stock minus the company’s cash
and cash equivalents, and marketable securities.
56
[F]irm value] … [is] equity value … plus straight debt,
minority interest, straight preferred stock and out-of-the-
money convertibles, less cash and long term equity
investments valued at the current market price where available,
and at book value where market price is not available.
57
The enterprise value of each company was obtained by
adding its short- and long-term debt to the sum of the
market value of its common equity, the value of any
preferred stock (at liquidation value), and the book value of
any minority interest, and subtracting its cash and cash
equivalents and the present value of the net operating loss
carryforwards, if any.
58
Commentary on defining enterprise value
The investment banking practice of using net debt
(interest-bearing debt minus cash) rather than gross
interest-bearing debt reflects economic reality. A com-
pany’s value is not reduced by using cash to retire debt
nor is its value increased by borrowing. Since cash is, in
effect, negative debt, the logical and accurate method is to
deduct cash when computing EV.
Some valuators posit that only excess cash should be
deducted rather than all cash. In a comparable company
analysis, which necessarily depends on publicly available
data, this approach is impossible to apply in practice.
While it may be possible for management to inform the
valuator as to the subject company’s excess cash,
59
that
information is not publicly available for the comparable
companies. If the valuator were to make an arbitrary
assumption for each comparable company as to its excess
cash, that would increase the subjectivity of the valuation.
60
Conclusions
Based on this review of 352 fairness opinions in cash
transactions, I have arrived at the following conclusions:
1. Most fairness opinions rely on the primary ap-
proaches: discounted cash flow, comparable com-
panies, and comparable transactions. The use of
multiple methods, rather than a single approach, is
in alignment with the opinion recently expressed by
the Delaware Court of Chancery:
[I]t is preferable to take a more robust approach involving
multiple techniques—such as a DCF analysis, a comparable
transactions analysis … and a comparable companies analysis
…, to triangulate a value range, as all three methodologies
individually have their own limitations.
61
[emphasis added]
53
Most expressly deducted cash, while some used the phrase ‘‘net debt,’’
which in industry practice means debt minus cash.
54
California Pizza Kitchen, Inc., Form 14D-9 dated June 8, 2011: 31;
fairness opinion by Moelis & Co.
55
EnergySouth, Inc., proxy statement dated August 20, 2008: 22; fairness
opinion by JP Morgan.
56
United Retail Group, Inc., Form 14D-9 dated September 25, 2007: 25–26;
fairness opinion by Bear Stearns.
59
An adjustment for excess cash can be appropriate in a DCF valuation.
60
In any event, even if the data were available, using all cash rather than
excess cash would likely be no more than a rounding error in a comparable
company valuation.
Table 19
Terms Used to Describe Enterprise Value
Description Opinions
Enterprise Value 244
Total Enterprise Value 4
Firm Value 21
Company Value 1
Aggregate Value 9
Market Capitalization 1
Total Market Capitalization 1
Market Value of Invested Capital 1
Total 282
57
Anheuser-Busch Companies, Inc., preliminary proxy statement dated
August 15, 2008: 39; fairness opinion by Citigroup Global Markets.
58
Mediacom Communications Corporation proxy statement, p. 21; fairness
opinion by Barclays Capital.
61
S Muoio & Co., 2011 Del. Ch. LEXIS 43 at *84.
Valuation Methods in Fairness Opinions: An Empirical Study of Cash Transactions
Business Valuation Review — Summer/Fall 2012 Page 73
2. Generally, when any one of the approaches,
discounted cash flow, comparable companies, or
comparable transactions. is not used in an opinion,
it is because the opinion provider believes that
adequate data are not available.
3. Although the ‘‘premiums paid’’ method is seriously
flawed, it was used as a valuation standard in almost
half of the opinions reviewed and in 69% of going-
private transactions.
4. The analyses in related party transactions do not
differ materially from those used in arm’s-length
transactions, except that a lower percentage of
opinions uses comparable transactions when there is
no change of control.
5. Other approaches used in approximately 15% of the
opinions reviewed are (a) the present value of
projected future price, (b) a leveraged buyout
model, and (c) a comparison with target prices of
security analysts.
6. A majority of the discounted cash flow valuations in
fairness opinions based the discount rate on WACC.
7. DCF valuations in fairness opinions calculate
terminal values with multiples (usually of
EBITDA) more often than by using a growth
model.
8. The common practice of utilizing a wide range of
multiples and of growth rates creates wide ranges of
DCF values, which illustrate the imprecision of the
DCF methodology.
9. EV/EBITDA is the primary multiple used for
comparable company and comparable transaction
analyses (other than for financial institutions, where
it is inapplicable).
10. The ratio of price to book value or net asset value is
commonly used for financial institutions.
11. P/E ratios are commonly used for comparable
companies but, inexplicably, are used far less often
for comparable transactions.
12. Despite the well-known limitations of the EV/
Revenues ratio, this approach is often used.
13. Investment bankers’ definition of enterprise value
deducts cash.
Business Valuation Review
Page 74 2012, American Society of Appraisers
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in a merger, a stockholder often has a statutory right of dissent and appraisal under which the stockholder may demand to be paid fair value exclusive of any gain or loss that may arise from the merger itself. Most courts and commentators agree that a dissenting stockholder should ordinarily receive a pro rata share of the fair value of the corporation without any discount simply because minority shares lack control. In several recent cases, the courts have indicated that a minority stockholder is thus entitled to a share of the control value of the corporation even though the merger does not constitute a sale of control (as in a going private transaction) and even though control of the subject corporation is not contestable (as where a single stockholder owns an outright majority of shares). In a similar vein, several courts have ruled that reliance on market prices for purposes of appraisal results in an inherent minority discount, thus requiring that a premium for control be added. In short, the emerging rule appears to be that fair value is the price at which a controlling stockholder could sell control because failure to do so amounts to imposition of a minority discount. It is the thesis here that the routine addition of a control premium is inconsistent with settled corporation law and good policy because (among other reasons) it is based on the unwarranted assumption that the source of a control premium must be a minority discount. To be sure, the courts should adjust for a minority discount if one is found. But the routine addition of a control premium as part of fair value creates a windfall for dissenting stockholders and infringes the legitimate rights of majority stockholders.
2010: 46; fairness opinion by Greenhill & Co. 47 ''Rules of thumb … fail to differentiate either operating characteristics or assets from one company to another. … Consequently, rules of thumb rarely, if ever, should be used without reference to other, more reliable valuation methods
  • Inc Dynergy
Dynergy, Inc., proxy statement dated October 4, 2010: 46; fairness opinion by Greenhill & Co. 47 ''Rules of thumb … fail to differentiate either operating characteristics or assets from one company to another. … Consequently, rules of thumb rarely, if ever, should be used without reference to other, more reliable valuation methods.'' Pratt, Valuing a Business, 319. 48 US Securities and Exchange Commission. Accounting Series Release No. 142, Reporting Cash Flow and Other Related Data (Washington, D.C.: Government Printing Office, 1973).
Valuing a Business, 265. 52 ''Excess cash'' was not defined. The same investment bank deducted all cash in twenty other opinions
  • Pratt
Pratt, Valuing a Business, 265. 52 ''Excess cash'' was not defined. The same investment bank deducted all cash in twenty other opinions. Business Valuation Review
The Standard & Poor's Guide to Fairness OpinionsFairness Opinions: Common Errors and Omissions,'' in The Handbook of Business Valuation and Intellectual Property Analysis
  • James R For Example
  • Hitchner
  • J Financial Valuation Philip
  • Philip W Clements
  • Patrick A Wisler
  • E Gaughan Gilbert
  • Matthews
For example, James R. Hitchner, Financial Valuation, 2nd ed. (Hoboken: Wiley, 2006), 241; Philip J. Clements and Philip W. Wisler, The Standard & Poor's Guide to Fairness Opinions (New York: McGraw Hill, 2005), 40. 50 For example, Patrick A. Gaughan, Mergers, Acquisitions, and Corporate Restructuring, 4th ed. (New York: Wiley, 2007), 12; Gilbert E. Matthews, ''Fairness Opinions: Common Errors and Omissions,'' in The Handbook of Business Valuation and Intellectual Property Analysis, ed. Robert F. Reilly and Robert P. Schweihs (New York: McGraw Hill, 2004), 212. (Some practitioners prefer to deduct only ''excess cash,'' but this concept is difficult in practice.)
Rules of thumb … fail to differentiate either operating characteristics or assets from one company to another. … Consequently, rules of thumb rarely, if ever, should be used without reference to other, more reliable valuation methods
''Rules of thumb … fail to differentiate either operating characteristics or assets from one company to another. … Consequently, rules of thumb rarely, if ever, should be used without reference to other, more reliable valuation methods.'' Pratt, Valuing a Business, 319. 48 US Securities and Exchange Commission. Accounting Series Release No. 142, Reporting Cash Flow and Other Related Data (Washington, D.C.: Government Printing Office, 1973).
Fairness Opinions: Common Errors and Omissions,'' in The Handbook of Business Valuation and Intellectual Property Analysis
  • James R For Example
  • Hitchner
  • J Philip
  • Philip W Clements
  • Wisler
  • E Gilbert
  • Matthews
For example, James R. Hitchner, Financial Valuation, 2nd ed. (Hoboken: Wiley, 2006), 241; Philip J. Clements and Philip W. Wisler, The Standard & Poor's Guide to Fairness Opinions (New York: McGraw Hill, 2005), 40. 50 For example, Patrick A. Gaughan, Mergers, Acquisitions, and Corporate Restructuring, 4th ed. (New York: Wiley, 2007), 12; Gilbert E. Matthews, ''Fairness Opinions: Common Errors and Omissions,'' in The Handbook of Business Valuation and Intellectual Property Analysis, ed. Robert F. Reilly and Robert P. Schweihs (New York: McGraw Hill, 2004), 212. (Some practitioners prefer to deduct only ''excess cash,'' but this concept is difficult in practice.) 51