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A Review of Valuations in Delaware Appraisal Cases, 2004–2005

Authors:
  • Sutter Securities Financial Services, San Francisco

Abstract and Figures

The Delaware Court of Chancery decided an unusually high number of appraisal cases during 2004 and 2005. In an appraisal, the Court looks at a company as it exists at the date of the transaction— the ‘‘operative reality.’’ Actions planned by a third-party acquiror before a change of control are normally excluded in a Delaware appraisal, but should be taken into account in second-stage mergers. The Court used discounted cash flow as its primary valuation methodology. This may reflect the fact that cases involving profitable companies with good comparable companies are easier to settle. In applying the comparable company method, the Chancery Court has been applying control premiums, even in a case in which no testimony supported a control premium. The appraisal valuations in 2004–5 did not display a tendency in favor of either petitioner or respondent.
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A Review of Valuations in Delaware Appraisal Cases, 2004–2005
by Gilbert E. Matthews, CFA
Abstract
The Delaware Court of Chancery decided an un-
usually high number of appraisal cases during 2004
and 2005. In an appraisal, the Court looks at a
company as it exists at the date of the transaction—
the ‘‘operative reality.’’ Actions planned by a third-
party acquiror before a change of control are nor-
mally excluded in a Delaware appraisal, but should be
taken into account in second-stage mergers. The Court
used discounted cash flow as its primary valuation
methodology. This may reflect the fact that cases
involving profitable companies with good comparable
companies are easier to settle. In applying the com-
parable company method, the Chancery Court has
been applying control premiums, even in a case in
which no testimony supported a control premium. The
appraisal valuations in 2004–5 did not display a
tendency in favor of either petitioner or respondent.
Introduction
Experience in the adversarial battle of the ex-
perts’ appraisal process under Delaware law
teaches one lesson very clearly: valuation deci-
sions are impossible to make with anything ap-
proaching complete confidence. Valuing an entity
is a difficult intellectual exercise, especially when
business and financial experts are able to organize
data in support of wildly divergent valuations for
the same entity. For a judge who is not an expert in
corporate finance, one can do little more than try
to detect gross distortions in the experts’ opinions.
This effort should, therefore, not be understood, as
a matter of intellectual honesty, as resulting in the
fair value of a corporation on a given date. The
value of a corporation is not a point on a line, but
a range of reasonable values, and the judge’s task
is to assign one particular value within this range
as the most reasonable value in light of all of the
relevant evidence and based on considerations of
fairness.
1
Chancellor Chandler made this statement on 31 De-
cember 2003, after five Delaware Supreme Court deci-
sions in the complex Technicolor
2
appraisal case, which
had begun in 1983. The Delaware Court of Chancery
had issued four opinions regarding valuation in statutory
appraisal cases in the four years prior to December
2003.
3
During 2004 and 2005, it issued fifteen valuation
opinions in appraisal cases. Four of these fifteen opinions
were appealed to the Supreme Court; three valuations
were affirmed and one (Technicolor) was increased.
This article focuses on 2004–2005 Delaware appraisal
decisions and addresses the Court of Chancery’s ap-
proaches to valuation. Several aspects of these valuations
are unique to statutory appraisals. The discussion in-
cludes the following areas of interest to valuation experts:
1. The valuation standards applicable in a statutory
appraisal in Delaware that differ from common
valuation practice;
2. The standard of ‘‘ operative reality’’ in Delaware
appraisals;
3. The Court’s use of control premiums;
4. The Court’s acceptance and rejection of various
valuation methodologies;
5. The relationships between the Court’s valuations,
the transaction prices, and the expert witnesses’
opinions;
6. The timeliness of the Court’s appraisal decisions;
7. The Court’s approach to interest on appraisal
awards; and
8. Commentaries on the fifteen individual cases, sum-
marizing the decisions and focusing on the experts’
valuation approaches and the methods and inputs
accepted or rejected by the Court.
Table 1, which displays summary data with respect to
the Court’s decisions, shows:
a. The Court’s conclusions in relation to the trans-
action prices and the experts’ valuations;
b. The methods used and rejected by the Court; and
c. Adjustments added by the Court to comparable
company valuations to offset minority discounts
on publicly traded shares or deducted from compa-
rable transaction valuations to eliminate premiums
for change of control.
Page 44 Business Valuation Review
1
Cede & Co. v. Technicolor, Inc., 2003 WL 23700218 (Del. Ch., 31
December 2003).
2
Decisions in 2004–2005 discussed in the following pages are de-
scribed using the name of the case used in the summaries later in this
article. The summaries include the citations.
3
The author searched http://courts.delaware.gov/opinions, the Dela-
ware State Courts’ Web site, which includes cases from 2000 to date,
for appraisal and valuation cases. The four decisions are: Gray v.
Cytokine Pharmasciences, Inc., 2002 WL 853549 (Del. Ch., 25 April
2002). Gonsalves v. Straight Arrow Publishers, Inc., 2002 WL
31057465 (Del. Ch., 10 September 2002); Gentile v. SinglePoint
Financial, Inc., 2003 WL 1240504 (Del. Ch., 5 March 2003); Tay lo r
v. American Specialty Retailing Group, Inc., 2003 WL 21753752 (Del.
Ch., 25 July 2003).
A Discussion of Valuation Standards Applicable
in a Statutory Appraisal in Delaware
Background
Appraisals in Delaware, as in most states, use a ‘‘fair
value’’ standard rather than a ‘‘fair market value’’ stan-
dard.
4
Therefore, there are numerous differences be-
tween how experts should conduct appraisal valuations
in contrast to valuations for fairness opinions, or for tax
and accounting purposes.
In Delaware, the objective is to provide the dissenting
shareholders with their proportionate share of fair value
in the going concern on the date of the transaction
triggering the right to an appraisal. In 1989, the Dela-
ware Supreme Court ruled that:
1. Neither minority discounts nor discounts for lack
of marketability are permitted when determining
the value of shares in appraisal actions; and
2. Dissenting shareholders are not entitled to benefit
from increases in value attributable to the trans-
action itself.
5
The ban on minority discounts and discounts for lack
of marketability distinguishes an appraisal valuation
from the fair market value standard that customarily
applies, for example, in Tax Court. Benefits resulting
from the transaction—cost savings, synergies, or benefits
of restructuring planned by the buyer (if the buyer is not
in control at the valuation date)—are excluded from an
appraisal valuation, although they would normally be
considered when arriving at a fairness opinion.
Although premiums and discounts may not be applied
at the stockholder level, in 1992 the Delaware Supreme
Court ruled that premiums may be applied at the com-
pany level in situations where the company has operating
subsidiaries.
6
In an appraisal of Rapid American Corpo-
ration, a conglomerate, it declared that the appraised
value should include a control premium at the parent
company level in order to compensate stockholders for
the parent’s 100% interest in three operating subsidiaries.
Value must be determined based on going-concern
value in a Delaware appraisal, not on a theoretical
liquidation basis.
7
Since Weinberger v. UOP, Inc.
(1983),
8
Delaware permits the use of any valuation
method (other than liquidation value) generally consid-
ered acceptable in the financial community. Discounted
cash flow (DCF) has been the most commonly used
approach, while comparable companies and comparable
acquisitions are sometimes used. Net asset value has
been accepted in a few cases. Methods based on widely
accepted ‘‘rules of thumb’’ are occasionally considered.
9
Operative reality
For a Delaware statutory appraisal, it is necessary to
look at a company as it exists at the date of the trans-
action—the ‘‘operative reality.’’ Although actions
planned by a third-party acquirer before a change of
control are normally excluded in a Delaware appraisal,
they should be taken into account in a second-stage
merger, i.e., a merger in which shareholders whose
shares are not acquired in an initial tender or exchange
offer are squeezed out in a subsequent merger. Dissent-
ing shareholders can benefit from changes made or
planned by a new management that has control prior to
the valuation date, provided that the plan is sufficiently
fixed at the valuation date. This principle was estab-
lished in Technicolor, where the company was valued
based on the acquirer’s business plan, which was in
place before the squeeze-out merger.
10
Under Delaware case law, no adjustments can be
made for such factors as excessive salaries being paid
to officers or other corporate waste,
11
or even for shares
improperly issued.
12
These factors can be challenged in
a derivative action (and would be relevant for a fairness
opinion), but an appraisal must value a company ‘‘as is.’’
The ‘‘as is’’ standard was applied in MedPointe. Car-
ter-Wallace, the subject of the appraisal, was simultane-
ously disposing of one business in an asset sale and
merging its other business into MedPointe. Each trans-
action was contingent on the other. The asset sale resulted
in substantial capital gains taxes and expenses. Petitioner
argued that the business being sold should be valued
without deducting the taxes and other costs resulting from
the asset sale since the asset sale had not occurred prior to
the merger transaction that triggered appraisal rights. The
Court rejected this argument and ruled that the asset sale
Summer 2006 Page 45
4
For a general discussion of valuations in statutory appraisals, see
Anne C. Singer and Jay E. Fishman, ‘‘Fair Value for Oppressed and
Dissenting Shareholders,’’ in The Handbook of Advanced Business
Valuation, Robert F. Reilly and Robert P. Schweihs, eds. (McGraw-
Hill, 2000).
5
Cavalier Oil v. Harnett, 564 A.2d 1137 (Del. 1989).
6
Rapid-American Corp. v. Harris, 603 A.2d 796 (Del. 1992). See also,
Hintmann v. Fred Weber, Inc., 1998 Del. Ch. LEXIS 26 (Del. Ch.
1998); M.G. Bancorporation v. LeBeau, 737 A.2d 513 (Del. 1999).
These decisions lead to the anomaly that a business conducted through
a subsidiary is entitled to a premium, but an identical business con-
ducted through a division is not.
7
Tri-Continental Corp. v. Battye, 74 A.2d 71 (Del. 1950); Bell v.
Kirby Lumber, 413 A.2d 137 (Del. 1980); Paskill Corp. v. Algoma
Corp., 747 A.2d 549 (Del. 2000).
8
457 A.2d 701 (Del. 1983).
9
E.g., Neal v. Alabama By-Products Corp., 1990 WL 109243 (Del.
Ch., 1 August 1990), affd., Alabama By-Products Corp. v. Neal, 588
A.2d 255 (Del. 1991), where the Court utilized value per recoverable
ton of coal reserves as a valuation method.
10
Cede & Co. v. Technicolor, Inc., 684 A.2d 289 (Del. 1996).
11
Gonsalves v. Straight Arrow Publishers, 701 A.2d 567 (Del. 1997).
12
Cavalier Oil v. Hartnett, 564 A.2d 1137 (Del. 1989); Gentile v.
SinglePoint Financial, 2003 WL 1240504 (Del. Ch., 5 March 2003).
was an ‘‘operating reality.’’ It therefore valued the Com-
pany based on the value of the business being merged
plus the net proceeds of the asset sale.
Consistent with the ‘‘as is’’ approach, benefits that
result from the transaction and benefits not obtainable
without the transaction are excluded from appraisal
valuations. Thus, the valuation in Heng Sang did not
include any tax benefits prospectively resulting from the
conversion of a C corporation to an S corporation.
Control premiums
Confusingly, the term ‘‘control premium’’ is used in
three different contexts in Delaware case law. It is used
to describe:
A. The difference between the acquisition value of a
company to an acquirer and the value of that
company as it is currently operated (‘‘as is’’ ),
represented as ‘‘A’’ ;
B. The difference between the value per share of
100% of a company ‘‘as is’’ and the market price
(‘‘B’’ ); and
C. The difference between the acquisition value per
share of a company and the market price of its
shares (‘‘C’’ ).
(A) þ(B) ¼(C).
The schematic diagram shown in Table 2 illustrates
the three different meanings of control premium used by
the Delaware Courts. The first, (A), is the premium that
results from the potential benefits of changes in oper-
ative reality. This premium might be described more
clearly as a ‘‘premium for change of control.’’ It includes
Table 1
Statutory Appraisal Decisions: Delaware Court of Chancery, 2004–2005
Company
Cancer
Treatment
Centers Coleman eMachines
Emerging
Communi-
cations
Heng
Sang
JRC
Acquisition
(800-JR
Cigar)
Liberty
Digital
MedPointe
(Carter-Wallace)
Industry Health
Care
Manufac-
turing
Computers Telecom-
munications
Real
Estate
Cigars Cable Health Care
Transaction price $260 $9.31 $1.06 $10.25 $93,500 $13.00 $3.31 $20.44
Petitioner’s expert* $16,400 $31.94 $2.48 $41.16 $217,000 $16.80 $9.82 $37.13
Defendant’s expert* $0 $5.83 $1.22 $10.38 $78,000 $12.67 $2.51 $19.40
Court $1,345 $32.35 $1.64 $38.05 $170,000 $13.58 $2.74 $24.45
As % of transaction price
Petitioner’s expert 6308% 343% 234% 402% 232% 129% 297% 182%
Defendant’s expert 0% 63% 115% 101% 83% 97% 76% 95%
Court’s value as % of:
Transaction price 517% 347% 155% 371% 182% 104% 83% 120%
Petitioner’s expert 8% 101% 66% 92% 78% 81% 28% 66%
Defendant’s expert 555% 134% 367% 218% 107% 109% 126%
Method used by Court
Discounted cash flow 85% Yes 100% 100% Yes 100% 100% 100%
Comparable companies 15% Yes Rejected Not used Not used
Comparable transactions Not used Yes Rejected
Net asset value Yes
Comparable companies:
Premium added to offset
minority discount
20% 15%
Comparable transactions:
Premium for change of
control deducted
–0% – – –
Independent opinion
before transaction
None None Fairness;
solvency
Fairness Appraisal;
valuation
Fairness None Fairness
*If the expert presented a range of values, the number used is the bottom of the range for petititioner and the top of the range for
defendant.
Page 46 Business Valuation Review
anticipated cost savings, synergies, or benefits of restruc-
turing planned by the buyer. This is the premium that
may not be added at the shareholder level in a Delaware
appraisal. The Court of Chancery often deducts a pre-
mium for change of control from valuations based on
comparable acquisitions. It should be noted that it is
possible for the ‘‘as is’’ value to be equal or close to the
acquisition value.
The second premium, (B), the difference between the
value of a company ‘‘as is’’ and market price, has also
been called a ‘‘control premium’’ in Delaware decisions.
This ‘‘control premium’’ is the inverse of the minority
discount. Publicly traded shares often trade at prices that
include a minority discount. Since minority discounts
are not permitted in Delaware appraisals, the Court,
Table 1 (extended)
Statutory Appraisal Decisions: Delaware Court of Chancery, 2004–2005
Technicolor United States Cellular
Montgomery
Cellular
PFPC
Worldwide Chancery Supreme Court Travelocity Trilithic
Union Illinois
(Union
Financial
Group) Janesville Sheboygan
Cellular Services Film
Processing
Film
Processing
E-Commerce Instruments Bank Cellular Cellular
$8,102 $34.26 $23.00 $23.00 $28.00 NA $10.20 $43.85 $21.45
$21,346 $60.76 $63.77 $63.77 $33.70 $2,564.84 .$16.00 $72.89 $41.39
$7,840 $19.86 $22.62 $22.62 $21.29 $74.14 $8.20 $45.11 $22.05
$19,622 $32.81 $21.98 $28.10 $30.43 $268.53 $8.74 $54.00 $30.13
263% 177% 277% 277% 120% NA .157% 166% 193%
97% 58% 98% 98% 76% NA 80% 103% 103%
242% 96% 96% 122% 109% NA 86% 123% 140%
92% 54% 34% 44% 90% 10% ,55% 74% 73%
250% 165% 97% 124% 143% 362% 107% 120% 137%
30% 75% 100% 100% Rejected 100% Rejected 70% 70%
5% 25% – 100%
65% Rejected Deal price 30% 30%
–– – – – –
Not stated 30% 30%
Not stated 13% 0% 0%
None Valuation Fairness Fairness Fairness None Fairness Valuations Valuations
* If the expert presented a range of values, the number used is the bottom of the range for petititioner and the top of the range for
defendant.
Table 2
Schematic Diagram Illustrating the Various Meanings
of the Term Control Premium
as Used by the Delaware Courts
Summer 2006 Page 47
when making a valuation based on comparable compa-
nies, endeavors to offset the minority discount by adding
a‘‘control premium.’’ To the extent, if any, that a
valuation based on comparable companies includes a
minority discount, the addition of a ‘‘control premium’’
to a comparable company valuation is required in a
Delaware appraisal. It is this premium that was an issue
in many 2004–2005 Delaware appraisal cases. For an
example, see the discussion in the PFPC Worldwide
commentary. The phrase ‘‘control premiums’’ in quota-
tion marks in the following discussions and commenta-
ries refers to (B), the inverse of the minority discount.
The third, (C), is the sum of (A), the premium for
change of control, and (B), the offset of a minority
discount. This premium over the publicly traded market
price is more accurately called an ‘‘acquisition premium.’’
Acquisition premiums are the data points for acquisitions
that are published in sources such as Mergerstat.
Current Developments
Control premiums in 2004–2005
Discounted cash flow
In conformity to accepted valuation standards, the
Court rejected the ‘‘control premiums’’ applied by two
experts to their DCF valuations. Because DCF values an
entire business, a valuation based on DCF cannot in-
clude a minority discount.
Comparable transactions
In considering comparable acquisitions, the portion of
the acquisition premiums derived from offsetting minor-
ity discounts may be used, but not the portion attribut-
able to change of control. The Court, when relying on
comparable transactions, found a premium for change of
control in only one case in 2004–2005. In Union Illi-
nois, the Court specifically applied a 13% deduction for
synergies.
Comparable companies
The Court continues to apply ‘‘control premiums’’
mechanically to comparable company valuations in the
mistaken view that a publicly traded market price neces-
sarily includes an embedded minority discount. In Trav-
elocity, the Court added a 30% premium to a comparable
company valuation even though there was no testimony
that a ‘‘control premium’’ should be applied! The Court
stated that it applied a premium because other Chancery
Court decisions had added a similar premium to valu-
ations based on comparable companies.
A‘‘control premium’’ should not be added unless the
Court receives evidence demonstrating that a ‘‘control
premium’’ should be applicable to the subject company,
and, if so, in what amount. Relying on average premi-
ums in other transactions is not a reasonable or sufficient
basis. The fact that ‘‘control premiums’’ should not be
automatic has been recognized in valuation literature at
least as far back as 1993:
The fact that most companies do not receive take-
over bids at premiums above market price indicates
investors believe that the shares of those companies
are not worth significantly more than market price
[emphasis in original].
13
It should be noted that it is possible for the publicly
traded market value of a company to exceed its acquis-
ition value. For example, in 1999 most ‘‘dot-com’’
companies sold at market prices well in excess of cash
acquisition values.
The Chancery Court’s practice of automatically ap-
plying average control premiums derived from unrelated
transactions is in marked contrast to the U.S. Tax
Court’s developing position with respect to marketability
discounts. The Tax Court no longer accepts generic
marketability discounts, but is requiring case-specific
analyses.
14
The Court of Chancery should consider
applying a ‘‘control premium’’ in a comparable company
analysis based on evidence as to the minority discounts,
if any, in the relevant industry and in the relevant time
period.
Valuation methods
Table 3 summarizes the methods adopted by the
Court of Chancery in 2004–2005.
Discounted cash flow
The Court of Chancery continues to rely on dis-
counted cash flow as its primary method of valuation.
One reason for its reliance is that in all of the 2004–
2005 cases, both experts used DCF, while in seven of
Page 48 Business Valuation Review
13
Bradford Cornell, Corporate Valuation (McGraw Hill, 1993). p. 243.
See also, e.g.: Shannon P. Pratt, ‘‘Control Premiums? Maybe, Maybe
Not – 34% of 3
rd
Quarter Buyouts at Discounts,’’ in Business Valuation
Update, January 1999, 1–2, cited in Shannon P. Pratt, Robert F. Reilly
and Robert P. Schweihs, Valuing a Business: The Analysis and Ap-
praisal of Closely Held Companies, Fourth Edition (McGraw Hill,
2000), 357; M. Mark Lee and Gilbert E. Matthews, ‘‘Fairness Opin-
ions,’’ in The Handbook of Advanced Business Valuation, Robert F.
Reilly and Robert P. Schweihs, eds. (McGraw Hill, 2000), 327; Richard
A. Booth, ‘‘Minority Discounts and Control Premiums in Appraisal
Proceedings,’’ Business Lawyer, Nov. 2001, 127; and Gilbert E. Mat-
thews, ‘‘Fairness Opinions: Common Errors and Omissions,’’ in The
Handbook of Business Valuation and Intellectual Property Analysis,
Robert F. Reilly and Robert P. Schweihs, eds. (McGraw Hill, 2004),
214–6; and Philip J. Clements and Philip W. Wisler, The Standard &
Poor’s Guide to Fairness Opinions (McGraw Hill, 2005),94.
14
Shannon P. Pratt, Robert F. Reilly and Robert P. Schweihs, Val u in g
a Business: The Analysis and Appraisal of Closely Held Companies,
Fourth Edition (McGraw Hill, 2000), 419; Michael A. Paschall, ‘‘The
35% ‘Standard’ Marketability Discount: R.I.P,’’ CCH Business Valua-
tion Alert, February 2005, 3.
the fifteen cases neither comparable companies nor com-
parable transactions were used by either expert. None-
theless, the Court rejected DCF in two cases and used it
‘‘reluctantly’’ in two others. DCF was rejected in Trave-
locity because of the lack of reliable projections, and in
Union Illinois, where the Court did not accept either the
petitioner’s optimistic adjustments to management’s pro-
jections or his weighted average cost of capital
(WACC).
The Court applied DCF reluctantly in eMachines,
where only a one-year projection was available and the
operating history was limited, but where the experts
presented no other acceptable methodology. It expressed
similar reservations in using DCF in Cancer Treatment
Centers, which had only a two-year earnings history and
no management forecast. When employing DCF, the
Court showed a distinct preference for management-
prepared projections when they were available.
The Court’s approach to determining terminal value
varied depending on the testimony. Although it accepted
terminal value calculated by applying an EBITDA multi-
ple in United States Cellular, the Court rejected the use
of a multiple in Coleman as being ‘‘a comparable
companies analysis packaged in a different form.’’ In
situations where either of the two experts used a three-
stage growth model, the Court did likewise.
Comparable companies
The Court used comparable companies in six of the
nine cases in which either of the experts used this
approach. The Court did not use comparable companies
in MedPointe, where petitioner’s expert had used com-
parable companies solely as a check on his DCF valu-
ation, nor in Emerging Communications, where the
Court pointed out that neither side had focused on
comparable companies in their briefs. In two cases, the
expert used only one comparable company: in eMa-
chines, the Court rejected the approach for this reason,
but in Travelocity, the Court permitted the single com-
parable company to serve as the sole basis for its
valuation. When the Court concluded that the selected
comparable companies were dissimilar to the company
being valued, it employed the approach but gave it a low
weight.
The fact that the comparable company method was
not applied in several cases may not reflect the impor-
tance of this approach in Delaware appraisal litigation.
The cases that go to trial are not a random sample.
When there are no useful comparable companies or if
comparable companies cannot be used because of a lack
of earnings, there is often a wide gap between the
parties’ valuations, making settlement difficult. On the
other hand, in situations where both sides agree on the
appropriate comparable companies, the difference be-
tween the two sides should be smaller, and the oppor-
tunity for settlement is greater.
Comparable transactions
The Court used comparable acquisitions in four of
the seven cases in which either of the experts used this
approach. The Court in JRC Acquisition explicitly
rejected the comparable transaction method because
the comparable transactions were acquisitions of man-
ufacturers, while the subject company was a distrib-
utor. In Trilithic, the method was rejected because the
expert relied on a single transaction that had occurred
four years earlier. In Cancer Treatment Centers,the
Court did not discuss why it decided to ignore peti-
tioner’s comparable transactions approach. The method
was accepted in Coleman, which did not specify the
weights given to the three approaches; however, the
Court’s concluded value was equal to the gross value
contemporaneously paid to buy out management’s op-
tions.
Net asset value
Under Delaware case law, liquidation value may not
be used as a valuation standard in an appraisal. How-
ever, in Heng Sang, the Court accepted petitioner’s net
asset value approach, distinguishing it from a ‘‘theoret-
ical liquidation value’’ because the calculated net asset
value was based on future revenues and expenses.
The Court of Chancery’s Valuations Compared
with the Transaction Price and the Experts’
Valuations
Did petitioners benefit from seeking appraisal? Table
4 shows the appraisal award as a percentage of the
amount that would have been received if the petitioner
had accepted the original transaction.
In five of the fourteen relevant opinions (Trilithic
dealt with an unpriced recapitalization), there was only
a small difference between the transaction price and the
Court of Chancery’s appraisal. On the other hand, four of
the appraisal awards were more than double the trans-
action price. Interestingly, three of those four transac-
Table 3
Methods Used or Rejected by the Court
Cases* Used Rejected
Discounted cash flow 13 2
Comparable companies 5 3
Comparable transactions 4 3
Net asset value 1 0
* Total of 15 cases.
Summer 2006 Page 49
tions had been undertaken without fairness opinions or
valuations,
15
while nine of the other ten transactions had
the benefit of an independent fairness opinion or valu-
ation. It clearly appears to be beneficial for petitioners to
challenge transactions that were not supported by inde-
pendent reports.
The petitioners had to bear their own legal and expert
witness fees in all but one of the cases. In Montgomery
Cellular, the Supreme Court ruled that defendants should
reimburse the petitioner’s reasonable legal and expert
fees because defendants had acted in bad faith, destroyed
evidence, and lied under oath.
In a majority of the cases, the Court’s award was
materially lower than the petitioner’s valuation. Table 5
shows the appraisal award as a percentage of the value
claimed by the petitioner’s expert. Table 6 looks at the
inverse, the petitioner’s valuation as a percentage of the
Court’s decision.
On balance, the Court of Chancery showed no ten-
dency to lean toward either side. The record of the
defendant’s experts is quite similar to the petitioner’s
experts. Table 7 shows the appraisal award as a percent-
age of the value claimed by the defendant’s expert.
My review of the Court’s valuations in comparison to
the values claimed by the experts does not indicate that
there is a tactical advantage for either expert to submit an
aggressive valuation. In most of the cases, the Court
clearly was closer to one side’s valuation than to the
other’s. There was no tendency to ‘‘split the baby.’’
The Court often calculated its own valuation, using
selected inputs from the expert witnesses. It dismissed
several of the expert valuations in full. Experts would be
well advised to be familiar with Delaware appraisal law
and its applications before preparing a valuation report.
The expert should understand the relevant valuation
standards and appreciate what approaches are likely to
be acceptable to the Court.
Timeliness
A criticism of the Delaware appraisal process has
been the slowness of the process. Several cases have
taken more than a decade for a final decision. Unlike
some states, Delaware does not require any escrow or
partial payment, so the petitioner not only is deprived of
any proceeds for years, but also bears the risk of being
an unsecured creditor.
The recently decided cases show a modest improve-
ment in the speed of the process. Eleven of the fifteen
cases decided by the Court of Chancery in 2004 and
2005 were concluded less than four years after the
transaction. Emerging Communications was tried three
years after the transaction, but the decision was not
rendered until 2 1/2 years after trial. Cancer Treatment
Centers and Trilithic were twelve to thirteen years old,
but the decisions indicate that the length of time was due
mainly to delays by the petitioner. Technicolor’s lengthy
history was a function of the numerous successful ap-
Table 5
Court’s Valuation as % of Petitioner’s Valuation
Percentage Valuation
8%–10% 2
20%–50% 2
50%–70% 4
70%–85% 3
90%–105% 4
Table 6
Petitioner’s Valuation as % of Court’s Valuation
Percentage Valuation
,115% 4
115%–160% 5
160%–300% 3
.300% 3
Table 4
Court’s Valuation as % of Transaction Price
Percentage Valuation
80%–90% 2
95%–110% 3
120%–140% 3
150%–200% 2
.200% 4
Table 7
Court’s Valuation as % of Defendant’s Valuation
Percentage Valuation
,115% 4*
115%–160% 4
160%–300% 3
.300% 4
* The Supreme Court raised the appraised value of
Technicolor from 97% to 124% of the defendant’s valuation.
Page 50 Business Valuation Review
15
The one case in which the Court materially disagreed with a fairness
opinion was Emerging Communications. As noted below in the dis-
cussion of this case, this decision was based on a highly questionable
valuation.
peals to the Supreme Court that served to clarify the
applicable Delaware standards.
What is the reason for this trend toward faster adju-
dication? Perhaps because the Delaware Supreme Court
has clarified many of the ground rules, the Court of
Chancery is better able to focus on the facts of each
specific case. It also may well be that as the case law is
being more fully developed and relevant valuation
standards are becoming clearer, it has become easier for
counsel and experts to prepare for trial.
A shift to compound interest on
appraisal awards
An interesting change in Delaware appraisal cases has
been a change in the form of interest on an appraisal
judgment. Most cases until 1997 adopted the practice of
awarding simple interest, although Chancellor Allen
awarded compound interest in his 1990 Technicolor
decision.
16
In a 1997 decision, Vice Chancellor Jacobs
(who since has been elevated to the Delaware Supreme
Court) stated:
Certainly respondent has earned compound inter-
est on its investments during the pendency of this
proceeding and certainly petitioner would have
had to pay compound interest to borrow funds
during the pendency of this proceeding. Accord-
ingly, I am unable to conclude that an award of
simple interest will adequately compensate the
petitioners for the loss of the use of their funds or
prevent the company from retaining unjust benefits
from the use of petitioners’ funds.
17
Since Grimes, compound interest has become the
general practice. All of the decisions in 2004 and 2005
granted compound interest.
Commentaries on Delaware Appraisal Cases in
2004 and 2005
Cancer Treatment Centers of America
Lane v. Cancer Treatment Centers of America, Inc.
2004 WL 1752847
Court of Chancery, Del. (Vice Chancellor Noble)
30 July 2004
Transaction date: 20 March 1991
Petitioner’s expert: Robert Cimasi, Health Capital
Consultants
Respondent’s expert: Richard Baehr, Richard A.
Baehr & Associates
Valuation opinion: None
Deal price: $260 per share
Petitioner’s valuation: $16,400 per share
Respondent’s valuation: Zero
Appraised value: $1,345 per share
Petitioner owned 10% of this small private company,
which merged with RSJ, Inc., in 1991. RSJ was owned
by the control shareholders of Cancer Treatment Centers
of America (CTCA) and the merger was accomplished
by written consent without a meeting of CTCA’s Board.
Cimasi used DCF, comparable transactions, and com-
parable companies, giving these measures weights of
50%, 20%, and 30%, respectively. Cimasi created his
own projections for his DCF analysis. He used a WACC
of 27.43%, three equity risk premiums (health care
industry premium of 2.01%, small size premium of 5%,
and company-specific premium of 7%), and a 25%:75%
debt/equity ratio. Terminal value was calculated using
5% growth in his growth model. His DCF value was
$17,920. He testified that he included a 20% ‘‘control
premium’’ because he had based his WACC on market
prices. Appropriately, the Court rejected this improper
application of a ‘‘control premium’’ to a DCF valuation.
Cimasi, in his comparable transaction analysis, uti-
lized multiples of revenues, EBIT, and net income to
derive a value of $9,836 per share. In his comparable
company analysis, he used multiples of revenues and
EBITDA. He assumed that the valuation based on his
comparable companies should be adjusted to include a
20% ‘‘control premium.’’ His value based on comparable
companies was $18,259 per share.
Baehr relied on DCF, using a comparable company
analysis only as a check on his DCF valuation. His
WACC was 27.9%, based on a small company premium
of 6.34% and a company-specific premium of 10%. He
assumed 0% growth in his growth model and derived a
negative equity value in three of his four scenarios.
The Court used discounted cash flow reluctantly in
this situation.
One can reasonably have doubts about the ability of a DCF
analysis to capture accurately the fair value of an emerging
company with an earnings history of only two years. Yet, both
experts advocated a DCF analysis as the optimal method of
determining the enterprise value of CTCA.
The Court prepared its own DCF calculation based on
the Court’s interpretation of the record, making substan-
tial changes to Baehr’s model. It calculated a value of
$1,009 per share.
The Court noted that none of public companies used
as comparables ‘‘can comfortably be considered compa-
rable to CTCA.’’ However, because of ‘‘the Court’s
discomfort in relying solely upon...DCF,’’ it also consid-
ered the comparable company approach. Noting that the
Court of Chancery has tended to apply a ‘‘control
Summer 2006 Page 51
16
Cede & Co. v. Technicolor, Inc., 1990 WL161084 (Del Ch., 19
October 1990)
17
Grimes v. Vitalink Communications Corp., 1997 WL 538676 (Del.
Ch., 26 August 1997).
premium’’ on the order of 30%, the Court accepted
Cimasi’s 20%. The Court derived a value of $3,256 per
share, but gave its own comparable company valuation
only a 15% weight.
Although the Court’s $1,345 per share valuation was
more than five times the deal price, it was only about
8% of petitioner’s claim.
Coleman
Prescott Group Small Cap, L.P. v. The Coleman Co.
2004 WL 2059515
Court of Chancery, Del. (Vice Chancellor Jacobs)
8 September 2004
Transaction date: 6 January 2000
Petitioner’s expert: Dr. Samuel J. Kursh, LEGC
Respondent’s expert: John Garvey, Chicago
Partners
Fairness opinion: None
Deal price: $9.31 per share
Petitioner’s valuation: $31.94 per share
Respondent’s valuation: $5.83 per share
Appraised value: $32.35 per share
Sunbeam Corporation bought 79% of Coleman from
MacAndrews & Forbes in March 1998 for approxi-
mately $32 per share in a package of cash (including
assumption of debt) and stock. The second stage merger,
exchanging $6.44 in cash and 0.5677 shares of Sunbeam
for each Coleman share, was intended to close promptly,
but Sunbeam’s financial problems materially delayed the
SEC’s clearance of the required registration statement.
When the squeeze-out took place twenty-two months
later, the terms were materially unchanged,
18
despite
the severe deterioration in Sunbeam’s performance and
market value. When the squeeze-out merger closed,
shareholders received consideration that had a value of
only $9.31 per share.
Sunbeam claimed that the value of Coleman had
declined sharply from March 1998 to January 2000.
Based on the record, the Court strongly disagreed.
Sunbeam had made optimistic presentations about Cole-
man to analysts before the merger on 9 November 1999,
and after the merger on 8 March 2000. The Court
focused on a favorable three-year Coleman forecast that
Sunbeam had provided to its banks on 31 January 2000,
shortly after the merger. The Court stated that ‘‘most of
the work [on the forecast] had been completed before or
at the time of the merger.’’
Kursh used four approaches in valuing Coleman:
transactions in Coleman’s own stock ($32.35–$46.82);
DCF ($25.41–$31.94); comparable acquisitions ($29.56–
$34.92); and comparable companies ($24.94–$27.29).
The $32.35 number was based on the $27.50 price at
which Coleman management’s stock options had been
cashed out on the merger date, grossed up by Kursh to
eliminate a 15% marketability discount.
Kursh’s DCF analysis used discount rates of 11%–
13% and a three-stage growth model with declining
growth in years four to six. The Court accepted his
three-stage model.
Kursh stated that five of the comparable acquisitions
he relied upon were of companies similar to Coleman.
On the other hand, he concluded that comparable com-
panies were not an accurate indicator because there were
no good publicly traded comparables, and he gave no
weight to his comparable company valuation (which was
his lowest number). Kursh gave greatest weight to the
Coleman transactions, somewhat less weight to compa-
rable acquisitions, and the least weight to DCF in arriv-
ing at his $31.94 conclusion.
Garvey used only comparable companies and DCF.
In his comparable company analysis, he used lower
Coleman projections than had been furnished to Sun-
beam’s lenders and assumed that the 1999 results in-
cluded a non-recurring Y2K benefit. In his DCF
analysis, he used materially lower EBITDA margins
than were used in Sunbeam’s projections. He used an
11% WACC and a 5.83terminal value multiple applied
to his own estimate of EBITDA.
Garvey determined that Sunbeam’s low Moody’s debt
rating implied a 48.4% risk of bankruptcy. He arrived at
the conclusion that Coleman would lose 25% of its value
in a bankruptcy of its parent. He then imaginatively but
questionably lowered his enterprise value by 12.1%,
thereby reducing his equity value by 20.9%. The Court
called this approach ‘‘contrary to the facts’’ and ‘‘ a trans-
parent contrivance for litigation purposes.’’
The Court rejected Garvey’s valuation in full. It said,
‘‘The comparable company analysis...in this particular
case is inherently less reliable than the company-specific
transaction and DCF approaches.’’ It further criticized
Garvey’s projections and the extraordinarily low EBIT-
DA multiple that he derived, stating that his compara-
bles were not ‘‘truly comparable to Coleman in any
meaningful sense.... The only attributes that [Garvey’s]
comparables’ had in common was that their stock was
significantly undervalued in the market, with resulting
low EBITDA multiples.’’ The Court also faulted Garvey
for not adding a ‘‘control premium’’ to his comparable
company valuation.
The Court rejected Garvey’s DCF analysis, concluding
that he used projections that were too low. It also criticized
Page 52 Business Valuation Review
18
Shareholders received, in addition, 0.381 warrants per Coleman
share pursuant to a litigation settlement. Each warrant entitled the
holder to purchase one Sunbeam share at $7.00 per share until 24
August 2003. Sunbeam Form S4/A, 6 December 1999.
Garvey’s DCF analysis because his terminal value, which
was about 75% of his DCF value, was based on a multiple
derived from the comparable company analysis, so that
the DCF valuation was ‘‘in reality a comparable compa-
nies analysis packaged in a different form.’’
Coleman challenged all of Kursh’s valuations other
than DCF as being ‘‘sale value’’ rather than going-con-
cern value, and challenged his comparable transaction
analysis as improperly including a premium for change
of control. The Court rejected this argument, stating, ‘‘In
point of fact, every major valuation technique uses one
or more of these ‘sale values,’ but the only ‘sale value’
that Section 262 and the case law proscribe are valuation
techniques that improperly include synergistic elements
of value and minority and illiquidity discounts [empha-
sis in original].’’
At trial, petitioners asked Garvey to recalculate his
valuation (a) without the 12.1% discount, (b) using Cole-
man’s actual 1999 EBITDA, (c) applying 75% of Cole-
man’s 1998 multiple, and (d) applying a 35% ‘‘control
premium.’’ The resulting valuation was $32.90 per share.
The Court’s valuation of $32.35 was slightly higher
than Kursh’s value of $31.94 and slightly less than
Garvey’s $32.90 calculation using the adjustments that
the petitioner’s counsel proposed at trial. The Court’s
conclusion was precisely the price at which Kursh
valued the cash-out of Coleman management’s stock
options on the merger date.
eMachines
Gholl v. eMachines, Inc.
2004 WL 2847865
Court of Chancery, Del. (Vice Chancellor Jacobs)
3 May 2004
(Affirmed by Supreme Court, Del., 14 June 2005)
Transaction date: 31 December 2001
Petitioners’ expert: Daniel Larson, EaglePoint
Group
Respondent’s expert: Gregg Jarrell, University of
Rochester
Fairness opinion: Credit Suisse First Boston
(CSFB)
Solvency opinion: Houlihan Lokey Howard &
Zukin
Deal price: $1.06 per share
Petitioners’ valuation: $2.48 per share
Respondent’s valuation: $0.93–$1.22 per share
Appraised value: $1.64 per share
eMachines was a marginal PC manufacturer that out-
sourced its production. The merger was a leveraged
going-private transaction led by eMachines’ president,
who owned only 1% of the shares. It consisted of a cash
tender offer followed by a short-form squeeze-out merger.
In preparing its fairness opinion, CSFB calculated a
DCF value of $1.41–$2.22 per share using the Manage-
ment Case and $0.91-$1.20 using its own ‘‘Sensitivity
Case.’’ Since the Company’s balance sheet showed that it
had $1.19 per share in cash, it is not difficult to under-
stand why the petitioner sought a statutory appraisal.
Larson valued eMachines using DCF, but the Court’s
decision did not give his number. Larson also did a
comparable company analysis based only on Gateway,
discounting Gateway’s multiples by 25%. The Court
rejected his comparable company valuation because it
used only one company and because that one company
yielded a wide range of values. Jarrell used DCF to
value eMachines at $0.93–$1.03 using management case
projections and at $1.00–$1.22 using the 2002 budget.
The Court reluctantly used DCF. ‘‘The Court has
reservations about applying a DCF model . . . where
projections for only one year are available and the
relevant operating history is equally limited. Both par-
ties, however, have relied on DCF valuations . . .’’
Although the merger closed on 31 December 2001,
and the 2002 Budget was not finalized until February
2002, the Court determined that the underlying informa-
tion was known or knowable at the merger date. At trial,
the Company claimed that the projection was a long
shot, but the Court rejected its argument, noting that
eMachines’ management had based the company’s Bo-
nus Plan on it.
The Court pointed out that the experts disagreed on
‘‘operating margins, the method for determining terminal
value, the discount rate, and the treatment of excess cash.’’
In calculating the discount rate, the Court tax-effected the
cost of debt, even though eMachines had large tax-loss
carry-forwards. It reasoned that ‘‘ deductions for interest
payments would allow the Company to save its NOLs [net
operating losses] for subsequent years.’’
The Court used a growth model for terminal value,
stating that ‘‘a multiples approach . . . depends on being
able to identify comparable companies.’’
Defendant claimed that it needed $50–$75 million in
cash to operate the business. However, since the buyer
planned to use all but about $15 million ($0.10 per
share) of the Company’s cash to finance the transaction,
the Court rejected this argument. The Court cited the
Houlihan Lokey solvency opinion as a ‘‘careful analy-
sis’’ that was ‘‘highly probative’’ of the $15 million
number.
The Court gave little weight to the fact that the
transaction price represented a 96% premium over mar-
ket, appropriately stating that a ‘‘premium of this size
[was] more indicative of the inefficiencies in the [Pink
Sheet] market for the Company’s stock than reflective of
its value as a going concern.’’ It also rejected a brief
Summer 2006 Page 53
seven-day auction as ‘‘inconclusive as to the fair value
of eMachines.’’
The Court’s decision in this case was not far below
the middle of the range of the two sides’ valuations. The
Court’s valuation of $1.64 per share effectively valued
the operating business (including the $15 million of cash
required for operations) at $0.55 per share and the
excess cash at $1.09 per share.
Emerging Communications
In re Emerging Communications, Inc. Shareholders
Litigation
2004 WL 13045745
Court of Chancery, Del. (Vice Chancellor Jacobs)
3 May 2004 (revised 4 June 2004)
Transaction date: 18 October 1998
Plaintiffs’ expert: Mark Zmijewski, Univ. of
Chicago
Defendants’ expert: Daniel Bayston, Duff &
Phelps
Defendants’ rebuttal expert: Gilbert Matthews,
19
Sutter Securities
Fairness opinion: Houlihan Lokey Howard
& Zukin
Deal price: $10.25 per share
Plaintiffs’ valuation: $41.16 per share
Defendants’ valuation: $10.38 per share
Appraised value: $38.05 per share
Emerging Communications was taken private in a
cash merger. The principal business of Emerging Com-
munications was its U.S. Virgin Islands telephone com-
pany. This case involved both a statutory appraisal and a
breach of fiduciary claim.
The trial transcript shows that (a) Bayston testified
that he performed a comparable company analysis to
which he gave a 50% weight, and (b) Zmijewski testi-
fied that he did not do a comparable company analysis,
but that he had considered comparable company analy-
ses that had been performed by other firms at earlier
dates. The Court’s opinion, however, does not use com-
parable companies. It pointed out that neither side fo-
cused on comparable companies in its briefs, and stated
that it therefore did not address comparable companies
in its decision.
Zmijewski and Bayston both performed a DCF anal-
ysis. Matthews testified as a rebuttal witness with respect
to Zmijewski’s DCF assumptions and calculations. Zmi-
jewski calculated his WACC with no adjustments for
size or company-specific factors. Bayston calculated his
WACC using a discount for a very small company and
added a ‘‘weather risk’’ factor, reflecting the hurricane
risk in the Virgin Islands. Zmijewski used a manage-
ment projection in which depreciation materially ex-
ceeded capital expenditures during the forecast period;
he extrapolated these figures without adjustment in his
growth model.
There were several areas in which the two sides
disagreed. These issues included:
1. the projections that should be used for the valua-
tion;
2. the appropriate relationship between capital expen-
ditures and depreciation in a growth model; and
3. the appropriate discount rate to be applied in a
DCF model.
A substantive issue in the case was whether the
appropriate projections for the appraisal were the March
1998 projections, which had been used for Houlihan
Lokey’s fairness opinion, or the June 1998 projections
that had been given to the Company’s lender. The June
projections included a forecast for a business acquired
after the March projections and also reflected benefits
from cost savings stemming from the going-private
transaction. The June projections were never shown to
Houlihan Lokey or to the Special Committee. The Court
used the June projections.
While the going-private transaction was in progress,
the Company acquired a cellular telephone business in
St. Maarten for $27 million in an arm’s length trans-
action. Management presented its lenders with June
projections based on annualizing the St. Maarten results
for January and February 1998 and assuming a 10%
growth rate. Although the St. Maarten projection had
been made by management, it was questionable on its
face. The growth rate was unsupported. Moreover, it
was patently illogical to annualize the January–Febru-
ary results of a business in a seasonal winter resort.
However, the Court uncritically adopted the June pro-
jections without questioning either the 10% growth
projection or the logic of annualizing peak-season
months. The Court’s DCF valuation effectively valued
the St. Maarten business at about $130 million, almost
five times the contemporaneous acquisition price,
which had been negotiated at arm’s length with sophis-
ticated sellers.
A smaller issue related to the projections was the
impact of cost savings from the going-private trans-
action on the expenses in the June projections. Be-
cause of inadequate data on these cost savings, the
Court did not permit any adjustments to the June
projections reflecting the cost reductions related to
going private.
The Court accepted a discounted cash flow analysis
that included a material assumption that was unrealistic.
Page 54 Business Valuation Review
19
The author of this article.
The terminal value calculation was based on a growth
model applied to a forecast in which capital expenditures
were $9.4 million and depreciation was $22.5 million
(with both figures increasing 2.9% annually). Obviously,
this is impossible. In a growing company, capital ex-
penditures must exceed depreciation over the medium
term. The Court dismissed the criticism of this important
error in a footnote.
20
The Court also used a discount rate that was extra-
ordinarily low. Bayston used a discount rate of 11.5%,
which was consistent with discount rates used in other
fairness opinions regarding telecom companies and was
equal to the rate of return permitted by the Virgin
Islands’ Public Service Commission. Zmijewski used
8.8% for the period when the Company would benefit
from a tax abatement and 8.5% thereafter. The Court
used 8.69%. It accepted a small stock premium of 1.7%,
but denied Bayston’s ‘‘super-small’’ company premium
plus a hurricane risk premium of 2.4%. It decided that
the debt/equity ratio should be based on the current
capital structure rather than the lower target ratio, and
that the cost of debt should be the low rate that the
Company was getting from the Rural Telephone Finance
Cooperative.
The Court’s conclusion was close to the petitioners’
valuation and almost four times the transaction price.
Plaintiffs alleged that officers and directors had
breached their fiduciary duties to shareholders. The
Chairman of the Special Committee, former Kennedy
speechwriter Richard Goodwin, was centrally involved
in the process and negotiated on behalf of the Special
Committee. The Court noted that ‘‘all Committee initia-
tives and decisions were made by Goodwin, subject to
concurrence by Ramphal and Vondras [the other mem-
bers], who on all relevant issues willingly deferred to
Goodwin.’’ Nonetheless, Goodwin, who was not knowl-
edgeable in the telecom industry, was not deemed liable
by the Court, which stated that ‘‘there is no persuasive
evidence that Goodwin knew or should have known...
that the negotiated price was unfair.’’
The Court found, however, that two officers and one
outside director were jointly and severally liable for
breach of fiduciary duty to shareholders. The outside
director was deemed to be knowledgeable in the telecom
industry, and was found liable even though he was not
on the Special Committee. This decision will not en-
courage qualified and knowledgeable persons to serve
on boards.
Heng Sang
Ng v. Heng Sang Realty Corp.
2004 WL 1151980
Court of Chancery, Del. (Vice Chancellor Jacobs)
24 April 2004 (revised 18 May 2004)
(Affirmed by Supreme Court, Del., 27 January 2005)
Transaction date: 12 July 2000
Plaintiff’s expert: J. Mark Penny, Hempstead
& Co.
Defendant’s expert: Roger Grabowski, S&P CVC
Appraisal: Landauer Realty Group
Valuation of Company: Empire Valuation Consultants
Deal price: $93,500 per share
Plaintiff’s valuation: $217,000 per share
Defendant’s valuation: $78,000 per share
Appraised value: $170,000 per share
Heng Sang was a real estate company that owned a
five-story building in the SoHo area of New York City.
It benefited from the real estate boom of the 1990s and
wanted to convert from a C corporation to an S corpo-
ration. Landauer had appraised the building at $21.9
million. Empire valued the company at $9.35 million
($93,500 per share) using the Landauer appraisal. Peti-
tioner, who owned 20% of the Company, refused to
support the conversion and was squeezed out based on
the $93,500 per share valuation.
The Court set out the issues to be decided:
1. the appropriate tax rate in DCF analysis;
2. the inclusion of undocumented expenses; and
3. the use of net asset value in an appraisal.
Penny valued Heng Sang at $20.0 million based on
DCF using an 11% tax rate, the maximum rate for an S
corporation, and he valued it at $23.4 million based on
‘‘adjusted asset value.’’ His conclusion averaged these
numbers.
Grabowski valued the Company at $7.8 million,
applying a C corporation tax rate of 44.7% to operating
income. (The Court noted that this would equate to
about 25% of gross revenues.) Grabowski reduced the
cash flows by deducting the rental value of the Com-
pany-occupied space in the building and deducting cer-
tain undocumented G&A expenses based on a
discussion with management.
The Court rejected Penny’s argument that Heng Sang
should be valued as an S corporation, because it was a C
corporation and could not have converted without the
consent of the petitioner. However, it also rejected
Summer 2006 Page 55
20
Footnote 56 says, ‘‘Nor is there any merit to defendants’ criticism
(articulated through Mr. Matthews) that in Prof. Zmijewski’s terminal
year (2002), depreciation exceeds CapEx, a state of affairs that cannot
goonforever....TheflawinthiscriticismisthatZmijewskiprojected
cash flows only; he did not forecast the individual components of free
cash flow, including CapEx or depreciation. Accordingly, there is no
basis to conclude that Prof. Zmijewski forecasts perpetual divergent
depreciation and CapEx.’’ This footnote is factually incorrect, because
Zmijewski’s DCF calculations clearly showed each component of his
projection, and his computation of terminal value was based on the
mismatched capital expenditure and depreciation numbers.
Grabowski’s assumption that Heng Sang would pay
taxes totaling approximately 25% of gross revenues.
The Court said, ‘‘An analysis of Heng Sang’s perfor-
mance ... establishes that Heng Sang paid, on average,
5.6% of gross revenues in taxes,’’ and it decided that a
tax rate equal to 11% of net operating income was
reasonable.
The Court’s conclusion failed to recognize that a
company pays the full marginal rate on incremental
income. The Court did not address the obvious differ-
ence between (a) taxes as a percent of revenues and (b)
the marginal tax rate on incremental income. Rather, it
appears that the Court implicitly assumed that increases
in executive salaries and other expenses would be ac-
companied by parallel increases in revenues.
The Court accepted Grabowski’s rental adjustment
for owner occupancy, but it rejected the undocumented
G&A expenses.
The defendant challenged Penny’s use of net asset
value, relying on the Supreme Court’s decision in Paskill
Corp. v. Algoma Corp.
21
Pas k ill rejected net asset value as
the sole valuation criterion.In Heng Sang, however, the
Court ruled that Landauer’s appraised value of the build-
ing was ‘‘not a ‘theoretical liquidation value’ of the kind
proscribed by Pask ill ,’’ but instead was based on DCF.
Moreover, the Court said that Penny’s ‘‘adjusted net asset
value’’ was not a ‘‘theoretical liquidating value’’ because it
reflected future income stream, taxes, and maintenance
expenses. In any event, net asset value was only one
element of Penny’s valuation.
The decision directed the parties to agree on the value
of Heng Sang based on the Court’s rulings. The final
valuation (not in the record) of $170,000 per share was
quite favorable for the petitioner.
JRC Acquisition (800-JR Cigar)
Cede & Co. v. JRC Acquisition Corp.
2004 WL 2271592
Court of Chancery, Del. (Chancellor Chandler)
10 February 2004
Transaction date: 4 October 2000
Petitioner’s expert: Charles DeVinney, Curtis
Financial Group
Respondent’s expert: Gregg Jarrell, University of
Rochester
Fairness opinion: Merrill Lynch
Deal price: $13.00 per share
Petitioner’s valuation: $16.80–$19.80 per share
Respondent’s valuation: $12.67 per share
Appraised value: $13.58 per share
The merger was a going-private transaction in which
a 78% shareholder acquired the minority shares of 800-
JR Cigar.
DeVinney relied on comparable transactions and
DCF. The Court rejected his $16.80 per share valuation
based on comparable transactions because the selected
companies were manufacturers, while 800-JR Cigar, Inc.
(JR) was a distributor. Jarrell used DCF. He also used
two other approaches as ‘‘market checks’’ —other bona
fide offers for JR, and control premiums in 2,000 trans-
actions from January 1995 to August 2000.
DeVinney’s DCF value was $19.80 and Jarrell’s was
$11.76–$13.58. (Merrill Lynch had calculated DCF val-
ues of $9.49–$12.63 for its fairness opinion.) The ex-
perts disagreed as to growth rate, debt-equity ratio, size
premium for CAPM, and tax rate.
The Court rejected each of DeVinney’s numbers and
chose numbers close or equal to Jarrell’s for each
variable in the DCF analysis. It used Jarrell’s 10%
debt-equity ratio rather than DeVinney’s 25%, reasoning
that JR had no debt before the transaction. It used the
micro-cap premium based on the historical stock price
and used JR’s historical tax rate.
The Court rejected Jarrell’s analysis of other bids
because only two buyers were contacted. It appropriately
rejected his control premium study, stating:
The only thing that the transactions in Jarrell’s
sample had in common are [sic] that they all are
transactions. The data is not segregated by indus-
try or date. The one-day premiums vary consider-
ably; the standard deviation is 32%. Additionally,
it is not clear that any analysis of premiums over
all transactions has any bearing on ‘fair value’ in
an appraisal action.
The Court’s valuation was only marginally higher
than the transaction price.
Liberty Digital
Finkelstein v. Liberty Digital, Inc.
2005 WL 1074364
Court of Chancery, Del. (Vice Chancellor Strine)
26 January 2005
Transaction date: 14 March 2002
Petitioners’ expert: Steven Feinstein, Babson
College
Respondent’s expert: Marc Katz, Lehman Bros.
Fairness opinion: none
Deal price: $3.31 per share in stock
Petitioners’ valuation: $9.82 per share
Respondent’s valuation: $2.51 per share
Appraised value: $2.74 per share
Page 56 Business Valuation Review
21
747 A.2d 549 (Del. 2000).
Liberty Digital was merged into Liberty Media in a
short-form merger.
22
Shareholders received 0.25 Liberty
Media Class A shares for each share of Liberty Digital.
The parties stipulated that the fair value of all net
assets other than an ‘‘Access Agreement’’ with AT&T
was $2.15 per share. The only issue in the appraisal was
the value of the Access Agreement, which ‘‘was essen-
tially a contract right and a vague one at that.’’ Liberty
Digital had the right to ‘‘preferential access to channel
space on AT&T’s digital cable network if and when
AT&T, at its own volition, decided to deploy ‘advanced
set-top boxes’ that would facilitate the delivery of so-
called ‘interactive television programming.’’’ There were
no specific terms, so the Access Agreement was no more
than an ‘‘agreement to agree.’’
Feinstein valued the Access Agreement at $2.2 bil-
lion. The Court totally rejected Feinstein’s valuation,
stating that his valuation was ‘‘based on wildly specula-
tive and outrageously optimistic assumptions.’’
The Court accepted Katz’s ‘‘more rational and realis-
tic’’ approach, with some adjustments. The Court’s val-
uation was less than the market value of the shares
issued in the merger.
MedPointe (Carter Wallace)
Cede & Co., Inc. v. MedPointe Healthcare, Inc.
2004 WL 2093967
Court of Chancery, Del. (Vice Chancellor Noble)
16 August 2004 (revised 26 August & 10 September
2004)
Transaction date: September 28, 2001
Petitioners’ expert: Michael van Biema, Columbia
Business School
Defendant’s expert: Richard Ruback, Harvard
Business School
Fairness opinion: Houlihan Lokey Howard &
Zukin
Deal price: $20.44 per share
Petitioners’ valuation: $37.13 per share
Defendant’s valuation: $19.40 per share
Appraised value: $24.45 per share
Carter-Wallace was a publicly traded company with
two business segments, Consumer Products and Health-
care. At the closing date, the Consumer Products Divi-
sion was sold in an asset sale and the Healthcare Division
was merged with MedPointe Healthcare in a cash merg-
er. The asset sale was conditioned on the merger, and
vice versa. The shareholders received consideration equal
to approximately 85% of the average market price in the
four months preceding the fairness opinion.
The fact that there were two separate transactions
conditioned on each other raised an unusual issue in this
case. The Court set forth the key question:
What was the nature of the company at the time of
the Merger (i.e., should the Company at the time of the
Merger be considered as the two historical divisions or
as a healthcare business plus the proceeds of the sale of
the Consumer Products Division)?
The petitioners’ argued that the entity to be valued in
the appraisal was the entire Company. The asset sale of
Consumer Products had resulted in payments of $3.18
per share of capital gains taxes and other expenses; the
petitioners’ argued that this amount should not be de-
ducted in determining value under §262. The Court
pointed out that an asset sale does not trigger appraisal
rights in Delaware, and that ‘‘the right to appraisal is a
narrow statutory right to redress the stockholder’s ability
under common law to stop a merger.’’
23
The Court said
that the asset sale was an ‘‘operative reality,’’ and that
the entity to be valued was Carter-Wallace after the asset
sale, giving effect to all expenses ensuing from the sale.
Since the value of the net proceeds from the sale of
the Consumer Products Division was not a subject of
dispute, the Court then focused on the experts’ valua-
tions of the Healthcare Division.
Van Biema used DCF as his primary approach. He
employed comparable companies as a check on his DCF
conclusion. He utilized a 7% growth rate through 2006
in his projections (similar to the Houlihan Lokey and
management projections) and 4% thereafter (which was
greater than the 2% used by Houlihan Lokey in arriving
at its fairness opinion and by J.P. Morgan as advisors to
Carter-Wallace). Van Biema’s WACC was 9.4%, using
a risk-free rate 1% lower than thirty-year Treasuries, a
risk premium of 4.5%,
24
and a capital structure with
20% debt. His terminal value was determined four ways:
multiples of revenues, EBITDA and EBIT (based on
comparable companies), and a growth model. He val-
ued the Healthcare Division at $15.35–$21.87 per share.
Ruback relied only on DCF. He used the manage-
ment projections that were prepared two months after
the merger agreement (but four months before closing).
His WACC was 12.84%, using a risk-free rate equal to
twenty-year Treasuries, a risk premium of 7.3% (relying
on Ibbotson), and a capital structure with no debt. His
terminal value was determined using a growth model
Summer 2006 Page 57
22
In a Delaware short-form merger, there is no fairness requirement,
and the only remedy for shareholders is appraisal. Glassman v. Unocal
Exploration Corp., 777 A.2d 242 (Del. 2000).
23
Citing Applebaum v. Avaya, 880 A.2d 206 (Del. 2002).
24
The decision stated that van Biema relied on ‘‘recent academic work
of Professors Fama and French’’ rather than Ibbotson for his equity risk
premium.
with 2% growth. He valued the Healthcare Division at
$7.61 per share.
The Court accepted the management projections em-
ployed by Ruback as reasonable; they did not differ
materially from van Biema’s projections. It decided on a
3.35% long-term growth rate and a debt-free capital
structure consistent with Carter-Wallace’s history. The
Court decided on a 9.95% WACC, using twenty-year
Treasuries and the Fama-French risk premium. It deemed
Ruback’s discount rate to be too high in relation to the
discount rate used in prior valuations of Carter-Wallace.
Using a growth model for terminal value, the Court
valued the Healthcare Division at $11.60 per share.
The Court’s $24.25 per share valuation was about $4
above the transaction price and about $13 below the
valuation by the petitioner’s expert
Montgomery Cellular (Court of Chancery)
Dobler v. Montgomery Cellular Holding Co., Inc.
2004 WL 2271592
Court of Chancery, Del. (Vice Chancellor Lamb)
30 September 2004
Transaction date: 30 June 2001
Petitioners’ expert: Marc Sherman, Huron
Consulting Group
Respondent’s expert: Kenneth Gartrell, Ken Gartrell
& Co.
Fairness opinion: none
Deal price: $8,102.23 per share
Petitioners’ valuation: $21,346 per share
Respondent’s valuation: $7,840 per share
Appraised value: $19,621.74 per share
Montgomery Cellular was a 94.3% owned subsidiary
of Price Communications Wireless, Inc. (PCI). Mont-
gomery Cellular and PCI were both private companies.
PCI had an agreement to be acquired by Verizon Wire-
less for $2.06 billion, contingent on completion of
Verizon Wireless’ pending IPO.
25
Montgomery Cellular
was one of sixteen PCI subsidiaries. The minority share-
holders of Montgomery Cellular were squeezed out in a
short-form merger at a price chosen by PCI with no
advice from a third party and no analysis. The price was
purportedly based on price paid per capita (POP) used in
the settlement of another appraisal case of a PCI affili-
ate, Cellular Dynamics.
PCI had agreed with Verizon Wireless that its acqui-
sition price would be reduced by an amount equal to 13.53
the minority shareholders’ pro rata share of fiscal 2000
EBITDA. The Court noted that this provision gave PCI an
incentive to buy out minority shareholders of Montgomery
Cellular (and other PCI subsidiaries) at less than 13.53
EBITDA. It also noted that Montgomery Cellular was
possibly the most valuable of PCI’s companies.
Sherman performed a DCF analysis as well as com-
parable company and comparable transaction analyses.
Since there were no management projections, he created
a ten-year forecast based on industry forecasts by Paul
Kagan & Associates.
26
Sherman used a cost of equity of
20.64% and a WACC of 13.25%. His terminal value
was calculated using a growth model with a 4% growth
rate. He added a 31% ‘‘control premium’’ to his DCF
calculation ‘‘to account for suspected financial irregular-
ities that he could not specifically identify.’’ His DCF
valuation was $21,600 per share.
Sherman’s comparable transaction analysis included
five cellular companies of similar size, the proposed
Verizon Wireless transaction, and the Cellular Dynamics
settlement. He used only POPs for the five similar-size
companies but used four metrics—POPs, subscribers,
revenues and EBITDA—for Verizon Cellular and Cel-
lular Dynamics. His valuation, based on comparable
transactions with predominant weight to the Verizon
Wireless deal, was $21,200 per share.
Sherman’s comparable company analysis applied the
same four metrics to two selected comparable compa-
nies, both of which were approximately twenty times
larger than Montgomery. His valuation based on com-
parable companies was $22,600 per share. He gave a
15% weight to DCF, 80% to comparable transactions,
and 5% to comparable companies in reaching his final
valuation of $21,346 per share.
Gartrell performed a comparable company analysis
and a DCF analysis, but no comparable transaction
analysis. His comparable company analysis used multi-
ples of revenues and EBITDA. He applied a 35% ‘‘con-
trol premium,’’ but took a discount of 33% for what he
described as Montgomery’s ‘‘combinatory deficiency’’
compared to other companies. He also took an addi-
tional 15% discount as a stand-alone company. He also
considered the prices paid in the FCC’s C-block auction
of cellular licenses. His comparable company valuation
was $8,050 per share.
The Court found that Gartrell’s ‘‘combinatory defi-
ciency’’ valued Montgomery as a stand-alone entity
without the pre-existing benefits of being part of a
regional network, assigning no value to the fact that it
benefited from being part of the PCI group. It also stated
that the C-block auctions were not relevant. The Court
Page 58 Business Valuation Review
25
The Verizon Wireless IPO did not take place. Verizon Wireless and
PCI renegotiated their transaction in December 2001. The Verizon
Wireless/PCI transaction closed in August 2002 at a price of $1.7
billion.
26
The Court pointed out that both sides agreed that Kagan was a
credible source.
therefore ruled that Gartrell’s comparable company val-
uation was invalid as a matter of law.
Gartrell created his own five-year forecasts using the
GNP growth rate of 3.3%. (Other inputs were not
discussed in the decision.) His DCF valuation was
$7,630 per share. Because he had used a generic GNP
growth rate and had created his forecasts without any
research into Montgomery Cellular’s strategy, the Court
found Gartell’s DCF analysis to be ‘‘meaningless.’’
The Court accepted Sherman’s DCF calculation, ex-
cept that it rejected Sherman’s arbitrary 31% ‘‘control
premium.’’ It generally agreed with Sherman’s compara-
ble transaction analysis, but it determined that Sherman
had overvalued the Cellular Dynamics settlement. It
accepted his comparable company analysis. The Court
increased the weight of DCF from 15% to 30% and
decreased the weight of comparable transactions from
80% to 65%. The decision does not state that any
premium for control was included in the comparable
company calculations.
The Court’s valuation of $19,621.74 per share was
far above the transaction price, slightly below the valu-
ation by the petitioners’ expert, and about 8% higher
than if it had been based on the 13.53EBITDA speci-
fied in the Verizon Cellular contract.
Montgomery Cellular (Supreme Court)
Montgomery Cellular Holding Co., Inc. v. Dobler
880 A. 2d 206 (Del. 2005)
Supreme Court, Del.
1 August 2005
The Supreme Court upheld the Court of Chancery’s
valuation. It reversed only with respect to the Court of
Chancery’s denial of petitioners’ request for fee-shifting.
It said:
Although the bad faith exception does not apply to
the conduct that gives rise to the substantive ap-
praisal claim in a short form merger, evidence of a
party’s prelitigation conduct can be relevant to
show the motive or intent driving that party’s con-
duct during that appraisal litigation. Here, Price’s
failure reasonably to ascertain MCHC’s fair value
before setting the merger price was a motive for
Price later to lie under oath and to allow the
destruction of documents to obstruct the petitioners’
efforts to uncover evidence of MCHC’s true value—
evidence that was essential to enforcing the only
remedy that was available to the petitioners.
The Supreme Court added:
Finally, MCHC introduced, and relied upon, ex-
pert valuation testimony that the Court [of Chan-
cery] found was ‘‘fatally flawed’’ in both its
methodology and its data. The Court was forced
to reject completely the valuation testimony of
MCHC’s expert, Gartrell, because the Vice Chan-
cellor found that testimony was not credible and
was designed to ‘‘to deprive the minority share-
holders of the existing value’’ in the company.
The case was remanded for determination of reason-
able attorneys’ and expert witness’ fees to be paid by
respondents to petitioners.
PFPC Worldwide
Andoloro v. PFPC Worldwide, Inc.
2005 WL 2045640
Court of Chancery, Del. (Vice Chancellor Strine)
19 August 2005
Transaction date: 6 March 2003
Plaintiffs’ expert: Brett Margolin, LECG
Defendant’s expert: Donald Puglisi, University of
Delaware
Valuation opinion: Salomon Smith Barney
SSB valuation range: $20.78–$34.26
Deal price: $34.26 per share
Plaintiffs’ valuation: $60.76 per share
Defendant’s valuation: $19.86 per share
Appraised value: $32.81 per share
The transaction was a squeeze-out of a private com-
pany by its founding parent and majority shareholder,
PNC Financial Services. Most minority shareholders
were senior employees. The litigation was a consolida-
tion of an appraisal case and entire fairness case.
Both experts used DCF and comparable companies,
but Margolin testified that DCF was far preferable.
The Court stated management tended toward ‘‘unwar-
ranted optimism’’ and that there was ‘‘more basis to
conclude that the projections were too rosy than that
they were too bleak.’’ However, the Court decided to use
management’s projections in ‘‘substantially unaltered
form.’’
Margolin used a three-stage approach, with intermedi-
ate growth rates assumed in years six to nine. Puglisi used
a two-stage DCF calculation using a single growth rate
from year six. The Court used the three-step approach,
but with substantially lower growth than Margolin.
Margolin measured Beta using monthly data points
for five years for his comparable companies. Puglisi
used weekly data points for two years. The Court
calculated the average of four Betas, using the medians
of two years and of five years for all six comparable
companies and for four of these companies that it
determined to be better comparables. The Court’s Beta
was 1.20, compared to Margolin’s 1.04 and Puglisi’s
Summer 2006 Page 59
1.22. The Court calculated a discount rate of 13.92%
and rounded it down to 13.5%.
PFPC owed $1.29 billion to its parent company, of
which $1.1 billion had been used for an acquisition.
PNC had intended to refinance PFPC in an IPO. The
debt was due in installments, with $0.35 billion due on
December 1, 2004 (21 months after the merger date).
The entire debt would become due if any maturity was
not paid off in full when due.
Margolin assumed that PNC would roll the debt over
in perpetuity, and based his WACC on this premise.
Puglisi used a target capital structure. The Court rejected
both approaches. It used an all-equity capital structure
for its cost of capital calculation. The Court took the
outstanding debt into account by discounting the debt to
its scheduled maturity dates, using the discount rate of
13.5% that it used for PFPC as a whole.
27
The Court’s
value based on DCF was $32.08, compared to Margo-
lin’s $60.76 and Puglisi’s $21.35.
The Court agreed with Puglisi that the comparable
company method was applicable. Puglisi applied
EBITDA multiples using estimated 2004 results from
analysts’ reports. The Court rejected plaintiffs’
criticism of Puglisi’s use of these estimates, noting that
his method was ‘‘if anything, likely to overstate
PFPC’s value on the Merger date.’’ The Court also
accepted Puglisi’s use of median multiples without any
adjustment, rejecting plaintiffs’ claim that PFPC was a
superior company.
Puglisi used median multiples for all six comparable
companies, but the Court gave equal weight to the
median EBITDA multiple of all six comparable compa-
nies (8.53) and the median EBITDA multiple of the four
better comparable companies (6.73). Puglisi applied a
38% ‘‘control premium.’’ The Court reduced Puglisi’s
number to 30% to eliminate a portion of the premium
attributable to synergies, calling this premium ‘‘very
generous to the plaintiffs.’’ It arrived at a value of
$34.99 based on comparable companies.
In accepting a ‘‘control premium,’’ the Court cited the
Third Edition of Dr. Shannon Pratt’s Valuing a Business
(1996) rather than the Fourth Edition (2000). On the
page cited by the Court, Pratt wrote, ‘‘[H]aving arrived
at a publicly traded equivalent value, the only remaining
adjustment necessary for a minority interest value is the
shareholder-level attribute of lack of marketability.’’
28
However, this citation does not stand for the proposition
that a ‘‘control premium’’ must be added to adjust the
prices of all publicly traded shares. In the Third Edition,
the author also stated, ‘‘If conditions in the market for
companies in the industry at the valuation date can be
sold for more than the aggregate value of the publicly
traded minority shares, then a control premium probably
is warranted [emphasis added]’’
29
It appears from the
Court’s discussion that Puglisi’s ‘‘control premium’’ was
derived from a broad universe of acquisitions rather than
being industry-specific.
The Fourth Edition of Valuing a Business is more
explicit in rejecting the automatic use of ‘‘control pre-
miums.’’ It stated, ‘‘Valuation analysts who use the
guideline company valuation method and then tack on
a percentage ‘control premium’ based on Mergerstat
Review control premium averages, had better reconsider
their methodology.’’
30
In its final conclusion, the Court gave a 75% weight
to EBITDA and 25% to comparable companies.
Technicolor (Court of Chancery)
Cede & Co. v. Technicolor, Inc.
2003 WL 23700218 and 2004 WL1933113
Court of Chancery, Del. (Chancellor Chandler)
31 December 2003 (revised 9 July 2004)
Transaction date: 23 January 1983
Petitioner’s expert: John Torkelsen
Respondent’s expert: Peter Easton, Ohio State
University
Fairness opinion: Goldman Sachs
Deal price: $23.00 per share
Petitioner’s valuation: $63.77 per share
Respondent’s valuation: $22.62 per share
Appraised value: $21.98 per share
31
This appraisal arose from the 1983 squeeze-out cash
merger that followed a November 1982 tender offer in
which MacAndrews & Forbes acquired more than 90%
of Technicolor. Cinerama, Inc.,
32
a 4.4% shareholder,
challenged the fairness of the merger and also sought
appraisal. This case has been the subject of six Supreme
Page 60 Business Valuation Review
27
The Court of Chancery defined net debt as ‘‘debt less cash, cash
equivalents and cash proceeds from in the money vested options.’’ In a
previous decision (Andoloro v. PFPC Worldwide, 830 A.2d 1232 (Del
Ch. 2003), Vice Chancellor Strine had ruled that unexercised options
owned by the petitioners were not eligible for appraisal under §262.
The decision does not set forth the calculation of the number of
outstanding shares used as a divisor. To the extent, if any, that those
‘‘in the money vested options’’ owned by the petitioner were dilutive,
they would have adversely affected the appraised value of the out-
standing shares.
28
Shannon P. Pratt, Robert F. Reilly and Robert P. Schweihs, Val u in g
a Business: The Analysis and Appraisal of Closely Held Companies,
Third Edition (Irwin, 1996), 210.
29
Ibid., 304–5.
30
Shannon P. Pratt, Robert F. Reilly and Robert P. Schweihs, Val u in g
a Business: The Analysis and Appraisal of Closely Held Companies,
Fourth Edition (McGraw Hill, 2000), 357. The Court cited the Fourth
Edition in its discussion of DCF analyses.
31
Revised from the $23.22 figure that was in the 31 December 2003
opinion.
32
Cede & Co was the nominee that held the shares on behalf of
Cinerama.
Court decisions and more than a dozen decisions by
three successive Chancellors.
The previous appraisal in this case by Chancellor
Allen in October 1995 (based on the record of a pre-
vious trial in 1990) was reversed and remanded by the
Supreme Court in October 1996.
33
After Chancellor
Allen retired, Chancellor Chandler designated a neutral
master to prepare an appraisal report based on the 1990
trial record. He stated that he would arrive at his own
findings after the two sides raised their exceptions to the
neutral expert’s report. The petitioner appealed on the
grounds that Delaware law does not permit the use of a
neutral expert in an appraisal case. The Supreme Court
agreed with the petitioner, and in July 2000 it directed
that a new trial be held.
34
At the retrial in 2003, Torkelsen, who had testified for
Cinerama in 1990, used DCF as his only methodology.
He increased his valuation to $63.77 from his 1990
valuation of $62.75, using a higher discount rate but
increasing his perpetuity growth rate from 5% to 7.35%
and changing his depreciation forecasts. Chancellor
Chandler pointed out that the higher discount rate, with-
out the other changes, would lower Torkelsen’s valua-
tion by $12.12. Torkelsen rejected management’s
forecasts and created his own, which the Court con-
cluded were ‘‘erroneous and unreasonable.’’ The Court
concluded that Torkelsen’s testimony was unreliable,
stating that his methodology ‘‘cast serious doubt on the
integrity and reliability of his expert report.’’
Easton
35
relied on management’s forecasts with his
own extrapolations to calculate a DCF value of $22.62.
Chancellor Chandler concluded that Easton’s extrapola-
tions were rational and that Easton was ‘‘more reliable
and persuasive.’’ However, the Court did not use East-
on’s ‘‘residual operating income method.’’ Neither expert
used comparable companies or comparable transactions.
Chancellor Chandler used DCF to value each of
Technicolor’s operating business segments separately.
He valued businesses that were to be sold at the present
value of expected proceeds, and he deducted debt and
the capitalized corporate expenses (excluding the pa-
rent’s management fee). He concluded that the appraisal
value was $21.98 per share, far below Torkelsen’s
$63.87 and slightly below Easton’s valuation of $22.62
and the $23.00 paid in the merger.
36
Technicolor (Supreme Court)
Cede & Co. v. Technicolor, Inc.
884 A.2d 26 (Del. 2005)
Supreme Court, Del.
4 May 2005
Appraised value
Chancery Court: $21.98 per share
Supreme Court: $28.10 per share
The Supreme Court sustained the Court of Chancery
on all valuation issues but two. The exceptions were
not criticisms of the Chancellor’s opinion, but were
derived from the Supreme Court’s determination that
certain prior Chancery Court rulings were ‘‘the law of
the case.’’ Therefore, these two factors—the amount of
Technicolor’s debt and a 15.28% discount rate for the
DCF calculation—could not be changed by the Chan-
cellor. The Chancellor had used a somewhat higher
debt number than had been used earlier and had ap-
plied a 19.89% discount rate in his decision. These
adjustments raised the appraised value by 28%. The
decision closes by instructing the Court of Chancery
‘‘to enter judgment ... so that this litigation, at long
last, is brought to an end.’’
Travelocity
Doft & Co. v. Travelocity.com, Inc.
2004 WL 1152338 and 2004 WL 1366994
Court of Chancery, Del. (Vice Chancellor Lamb)
20 May 2004 (revised 21 May; supplemented by letter
opinion 10 June 2004)
Transaction date: 11 April 2002
Petitioners’ expert: William Purcell
Respondent’s expert: Paul Gompers, Harvard
Business School
Fairness opinion: Salomon Smith Barney
Deal price: $28.00 per share
Petitioners’ valuation: $33.70–$59.95 per share
Respondent’s valuation: $11.38–$21.29 per share
Appraised value: $30.43 per share
The transaction was a squeeze-out in a short-form
merger. Both experts used DCF, arriving at the values
listed. Both used a comparable company analysis with a
single comparable, Expedia. Purcell testified that the
value based on the comparable company method was at
least $35, and Gompers arrived at $22.08.
The Court rejected DCF as an appropriate methodol-
ogy in this situation. It stated, ‘‘The problem in this case is
that the most fundamental input used by the experts – the
projection of future revenues, expenses and cash flows –
were not shown to be reasonably reliable.’’ The Court was
‘‘persuaded from a review of all the evidence that the
Travelocity five-year plan does not provide a reliable basis
for forecasting future cash flows.’’ It noted that Salomon
Smith Barney did not use a DCF analysis for its fairness
opinion, and that a Salomon managing director testified
that ‘‘nobody could predict what this business was going
Summer 2006 Page 61
33
Cede & Co. v. Technicolor, Inc., 684 A.2d 289 (Del. 1996).
34
Cede & Co. v. Technicolor, Inc., 758 A.2d 485 (Del. 2000).
35
The expert used by Cinerama in 1990 had passed away.
36
Chancellor Allen had valued Technicolor at $21.60 in his opinions
in 1990 and 1994.
to do in the next five years.’’ It criticized Purcell for
relying uncritically on Travelocity’s five-year plan, and
criticized Gompers for creating a forecast that arrived at a
value far below the deal price.
Both experts agreed that a multiple of DCF was the
most appropriate measure to use in the comparable
company analysis. Purcell testified that Travelocity
should be valued at a 10% discount to Expedia, and
Gompers used a 40% discount to Expedia. Salomon had
used a 20%–30% discount. The Court used 35%.
Neither expert testified that a ‘‘control premium’’ was
applicable. Nonetheless, the Court, sua sponte, added a
30% ‘‘control premium,’’ pointing out that ‘‘ recent ap-
praisal cases that correct the valuation for a minority
discount...consistently use a 30% adjustment.’’ This
arbitrary addition of a ‘‘control premium’’ is discussed
and criticized earlier in this article,
Despite the addition of a ‘‘control premium,’’ the
Court’s valuation was less than 10% over the transaction
price.
Trilithic
Henke v. Trilithic Incorporated
2005 WL 2899677 and 2005 WL 3578094
Court of Chancery, Del. (Vice Chancellor Parsons)
28 October 2005 (supplemented by letter opinion 20
December 2005)
Transaction date: 1 June 1993
Petitioner’s expert: R. Victor Haas, Haas Business
Valuation Services
Respondent’s expert: Brett Margolin, LECG
Fairness opinion: None
Deal price: NA
Petitioner’s valuation: $1,625,631.50 for 25% of
equity
Respondent’s valuation: $55,606.25 for 25% of equity
Appraised value: $164,765.54 for 25% of
equity
The transaction that triggered the appraisal was a
merger of a Delaware corporation into an Indiana cor-
poration with the same name (in effect, a recapitalization
changing the state of incorporation). Shareholders of the
Delaware corporation received shares in the Indiana
corporation; no cash was paid. Trilithic’s principal busi-
ness was supplying instruments to cable companies.
Haas used only a DCF calculation. He based his
projection on the interim four-month data, with no
adjustment for seasonality, and applied a 10% growth
rate. The Court rejected Haas’ valuation because of the
lack of support for his assumptions.
Margolin performed a DCF analysis in which he
arrived at a negative value for Trilithic’s equity. He
assigned no weight to his own comparable company
analysis because of the size difference between Trilithic
and the comparable companies. He used the comparable
transaction method to determine Trilithic’s equity value,
relying only on Trilithic’s acquisition of its instruments
division four years earlier. The Court rejected Margo-
lin’s valuation because it found the use of that prior
transaction to be unreasonable.
The Court performed its own discounted cash flow
analysis. It assumed revenue growth of 5% (projected
2% cable industry growth plus 3% inflation), and used a
35.1% profit margin based on its adjustments to histor-
ical results. It applied a 40% tax rate. Since Trilithic’s
bank lender had asked that its line of credit be replaced,
the Court applied its 24% cost of equity to an all-equity
capital structure. It deducted bank debt at face value,
pointing out that Trilithic’s inability to refinance its line
of credit meant that it could not benefit from the differ-
ence between the face value and the market value of its
debt. It included Trilithic’s bank overdraft as debt.
However, it reduced the value of a loan that was payable
by its terms at 3% of gross revenues starting three years
after the valuation date by applying a 24% discount rate.
The Court added the proceeds from the sale of non-
operating assets that closed a month after the valuation
date. In its restated opinion, the Court added back
accounts receivable and debt due from the acquirer of
the non-operating assets.
The Court’s valuation was approximately triple the
defendant’s valuation, but only 10% of the petitioner’s
valuation. The Court noted that the lengthy delay in
bringing the case to trial stemmed primarily from delays
by the petitioner.
Union Illinois (Union Financial Group)
The Union Illinois 1995 Investment Limited Partnership
v. Union Financial Group, Ltd.
847 A.2d 340
Court of Chancery, Del. (Vice Chancellor Noble)
19 December 2003 (revised 5 January 2004)
Transaction date: 31 December 2001
Petitioners’ expert: Michael Mayer, Intercap, Inc.
Respondent’s expert: David Clarke, Griffing Group
Fairness opinion: Stifel, Nicolaus & Company
Deal price: $9.40 per share þ$1.60
contingent [never earned]
Petitioners’ valuation: more than $16 per share
Respondent’s valuation: $8.20 per share
Appraised value: $8.74 per share
Petitioners (the O’Brien family) owned 38% of Union
Financial Group (UFG). Denis O’Brien, son of the
founder, was CEO prior to being replaced in 1999. The
O’Briens and the Board agreed that UFG, which the
Federal Reserve called a ‘‘troubled financial institution,’’
Page 62 Business Valuation Review
should be sold. The O’Briens hired an investment bank-
er that had worked with UFG’s investment banker in the
search for buyers. After an auction (which the Court
called ‘‘fair’’ ), UFG was acquired by First Banks in a
cash merger.
Mayer relied on a DCF valuation based on his opti-
mistic adjustments to the management’s projections. He
used a WACC of 10.43% which, as the Court con-
cluded, ‘‘suggested that an equity investor in UFG
would require less than the average cost of capital for
an equity investment in a banking institution.’’ The
Court rejected Mayer’s analysis. The Court noted that if
Mayer had applied his 10.43% discount rate to the
management projections, he would have valued UFG at
$8.16. This figure is below the deal price and very close
to the defendant’s valuation.
Clarke valued UFG at $8.74 by deducting a 13%
‘‘synergy discount’’ from the merger price and assuming
a 50% likelihood of receiving the contingent payments
(which were never earned). He also performed a DCF
analysis of the management projections, using an 18%
cost of equity, which included a 2% company-specific
discount. Clarke’s DCF value was $5.06.
The Court, expressing discomfort with both experts’
inputs into their DCF analyses, rejected their DCF
valuations and decided not to use DCF. It described the
DCF method as inferior to the value derived from a
sales process with several interested buyers. The Court
agreed with Clarke that the merger price, adjusted to
remove the value of synergy, was the appropriate mea-
sure of value, and it adopted Clarke’s $8.74 number.
United States Cellular
In re United States Cellular Operating Company
2005 WL 43994
Court of Chancery, Del. (Vice Chancellor Parsons)
9 September 2004
Transaction date: 31 October 2000
Petitioners’ expert: Richard Harris, Harris &
Associates
Respondent’s expert: John Sanders, Bond & Pecaro
Valuation opinion: Duff & Phelps
Janesville Cellular Telephone Company
Deal price: $43.85 per share
Petitioners’ valuation: $72.89 per share
Respondent’s valuation: $45.11 per share
Appraised value: $54.00 per share
Sheboygan Cellular Telephone Company
Deal price: $21.45 per share
Petitioners’ valuation: $41.39 per share
Respondent’s valuation: $22.05 per share
Appraised value: $30.13 per share
Janesville and Sheboygan, both of which were private
companies, were merged into U.S. Cellular in simulta-
neous short-form mergers based on valuations by Duff
& Phelps.
Duff & Phelps and both experts used DCF and
comparable transactions as their valuation methodolo-
gies. No management projections were available beyond
2001, the year following the transaction.
Harris valued Janesville at $72.70 using DCF and
$73.08 using comparable transactions; he valued She-
boygan at $39.64 using DCF and $43.15 using compa-
rable transactions. Harris prepared a ten-year forecast in
which he used some, but not all, of Duff & Phelps’
assumptions. He used an 11.34% discount rate (D&P
had used 12%), and calculated terminal value using a
growth model with 6% perpetual growth. In his compa-
rable transaction analysis, he valued Janesville and She-
boygan based only on price paid per subscriber.
Sanders valued Janesville and Sheboygan using DCF,
and used comparable transactions only as a check on his
DCF conclusions. He created his own forecast, applied a
12% discount rate, and utilized 8x EBITDA to calculate
terminal value. He looked only at prices paid per capita
(POPs) in his comparable transactions.
The Court concluded, ‘‘Both experts presented fair-
ness opinions that were, at times, unreasonable in their
projections and contrary to Delaware case law.’’
The Court performed its own DCF calculation using
its own judgment, some of Duff & Phelps’ assumptions,
some of Harris’ assumptions, and a few of Sanders’
assumptions. It used a 12% discount rate and an EBIT-
DA multiple of 10x for terminal value. The Court’s DCF
values were $57.14 for Sheboygan and $28.25 for Janes-
ville.
The Court used a per-capita approach in its compara-
ble transaction analysis. It did not deduct a premium for
change of control. The Court’s comparable transaction
values were $46.67 for Sheboygan and $34.52 for Janes-
ville.
The Court gave a 70% weight to DCF and a 30%
weight to comparable transactions. The respondent’s
expert had valued both companies marginally above the
transaction prices; the Court’s valuations were somewhat
closer to the transaction prices than to the petitioners’
valuations.
Gilbert E. Matthews, CFA, is Chairman of Sutter
Securities Incorporated in
San Francisco, California.
Summer 2006 Page 63
Presentation
Full-text available
This presentation discusses and critiques court decisions in Delaware that applied the now-rejected assumption that market prices of shares always include a minority discount.
Chapter
Full-text available
State courts employ fair value as the predominant standard to determine the value of minority shares in both appraisal (also known as dissent) and oppression cases. When the courts determine the minority's share price in an appraisal or order the buy-out of an oppressed minority shareholder, the price of the award or buyout is critical for both parties and sets the "fair value" of the minority's shares. Although appraisal and oppression statutes in most states expressly or effectively stipulate that the minority's shares are to be valued at "fair value," there remains considerable confusion about what "fair value" means. To understand fair value as a standard of measurement, it must be considered in contrast to the standards of value called fair market value and third-party sale value, as will be discussed in this Chapter. Both appraisal and oppression cases are governed by state law. That state law includes corporate law statutes, the judicial interpretations of those statutes, and the courts’ holdings under their equitable authority even when the state lacks corresponding statutes. Although fair value is now the state-mandated or accepted standard for judicial appraisal and oppression valuations in almost all states, there are differing interpretations of its meaning and measurement that have evolved through legislative changes and judicial interpretation. . . . . . Note: Updated in 2017 articles - “Statutory Fair Value in Dissenting Shareholder Cases: Part I” and “... Part II”
Control Premiums? Maybe, Maybe Not – 34% of 3 rd Quarter Buyouts at Discounts,'' in Business Valuation Update Valuing a Business: The Analysis and Appraisal of Closely Held Companies
  • G See
  • P Shannon
  • Pratt
See also, e.g.: Shannon P. Pratt, ''Control Premiums? Maybe, Maybe Not – 34% of 3 rd Quarter Buyouts at Discounts,'' in Business Valuation Update, January 1999, 1–2, cited in Shannon P. Pratt, Robert F. Reilly and Robert P. Schweihs, Valuing a Business: The Analysis and Appraisal of Closely Held Companies, Fourth Edition (McGraw Hill, 2000), 357; M. Mark Lee and Gilbert E. Matthews, ''Fairness Opinions,'' in The Handbook of Advanced Business Valuation, Robert F.
The Standard & Poor's Guide to Fairness Opinions
  • Philip J Clements
  • Philip W Wisler
and Philip J. Clements and Philip W. Wisler, The Standard & Poor's Guide to Fairness Opinions (McGraw Hill, 2005), 94.
Minority Discounts and Control Premiums in Appraisal Proceedings Business LawyerFairness Opinions: Common Errors and Omissions,'' in The Handbook of Business Valuation and Intellectual Property Analysis
  • Robert P Schweihs Richard
  • A Booth
  • Gilbert E Matthews
Reilly and Robert P. Schweihs, eds. (McGraw Hill, 2000), 327; Richard A. Booth, ''Minority Discounts and Control Premiums in Appraisal Proceedings,'' Business Lawyer, Nov. 2001, 127; and Gilbert E. Matthews, ''Fairness Opinions: Common Errors and Omissions,'' in The Handbook of Business Valuation and Intellectual Property Analysis, Robert F. Reilly and Robert P. Schweihs, eds. (McGraw Hill, 2004),
Valuing a Business: The Analysis and Appraisal of Closely Held Companies), 419; Michael A. Paschall, ''The 35% 'Standard' Marketability Discount: R.I.P,'' CCH Business Valuation Alert
  • P Shannon
  • Robert F Pratt
  • Robert P Reilly
  • Schweihs
Shannon P. Pratt, Robert F. Reilly and Robert P. Schweihs, Valuing a Business: The Analysis and Appraisal of Closely Held Companies, Fourth Edition (McGraw Hill, 2000), 419; Michael A. Paschall, ''The 35% 'Standard' Marketability Discount: R.I.P,'' CCH Business Valuation Alert, February 2005, 3.
in The Handbook of Advanced Business Valuation
  • Dissenting Shareholders
Dissenting Shareholders,'' in The Handbook of Advanced Business Valuation, Robert F. Reilly and Robert P. Schweihs, eds. (McGrawHill, 2000).
See also, Hintmann v
  • Rapid-American Corp
Rapid-American Corp. v. Harris, 603 A.2d 796 (Del. 1992). See also, Hintmann v. Fred Weber, Inc., 1998 Del. Ch. LEXIS 26 (Del. Ch.
Alabama By-Products Corp Alabama By-Products Corp. v. Neal, 588 A.2d 255 (Del. 1991), where the Court utilized value per recoverable ton of coal reserves as a valuation method
  • E G Neal V
9 E.g., Neal v. Alabama By-Products Corp., 1990 WL 109243 (Del. Ch., 1 August 1990), affd., Alabama By-Products Corp. v. Neal, 588 A.2d 255 (Del. 1991), where the Court utilized value per recoverable ton of coal reserves as a valuation method. 10 Cede & Co. v. Technicolor, Inc., 684 A.2d 289 (Del. 1996).
Straight Arrow Publishers, 701 A.2d 567 (Del. 1997). 12 Cavalier Oil v. Hartnett
  • Gonsalves V
11 Gonsalves v. Straight Arrow Publishers, 701 A.2d 567 (Del. 1997). 12 Cavalier Oil v. Hartnett, 564 A.2d 1137 (Del. 1989);
See also, e.gControl Premiums? Maybe, Maybe Not – 34% of 3 rd Quarter Buyouts at Discounts,'' in Business Valuation Update Valuing a Business: The Analysis and Appraisal of Closely Held Companies
  • Bradford Cornell
  • Corporate Valuation In Shannon
  • P Pratt
  • Robert F Reilly
  • Robert P Schweihs
Bradford Cornell, Corporate Valuation (McGraw Hill, 1993). p. 243. See also, e.g.: Shannon P. Pratt, ''Control Premiums? Maybe, Maybe Not – 34% of 3 rd Quarter Buyouts at Discounts,'' in Business Valuation Update, January 1999, 1–2, cited in Shannon P. Pratt, Robert F. Reilly and Robert P. Schweihs, Valuing a Business: The Analysis and Appraisal of Closely Held Companies, Fourth Edition (McGraw Hill, 2000), 357; M. Mark Lee and Gilbert E. Matthews, ''Fairness Opinions,'' in The Handbook of Advanced Business Valuation, Robert F.