Salt Evaporation Plant Reason for Damages Analysis: On January 17, 2001, there was a natural gas leak from a natural gas storage facility. Gas was found at the subject’s facility within days of the leak. The level of gas detected was sufficient to cause the Hutchinson Fire Chief to order evacuation of the facility. Dennis Bingham 2007 IBA National Conference
Summary Description of Business • Our client was a salt evaporation plant that produced food and feed grade, mechanically evaporated salt from injection mining. It also owned hundreds of acres of land under which the salt is found. • Over many years of salt mining, huge caverns remain from which the natural gas would seep.
Problem • As of the date of valuation, according to independent experts, there was no method to determine • How much gas remained in the ground under the facility and • There was no method to totally cure or remediate the presence of the natural gas in the foreseeable future.
How We Attempted to Solve the Valuation • We set out to find resources that would help us to quantify a loss in value. • Approach the loss of value from the perspective of what a willing buyer or seller would do.
When a Detrimental Condition Exists • When there is evidence of environmental contamination, or structural damage, or issues of safety to public health, a detrimental condition is said to exist. • The main driver of a loss of value when a detrimental condition exists, is an uncertainty for the buyer.
Valuation MethodsMethodology for Economic Damages • In arriving at an estimate of economic damages we prepared two analyses: • “but-for” or the unimpaired situation and • “after” or the impaired situation • The difference between these two estimates represents our estimate of economic damages.
Valuation Methods Selected • Multiple-period discounting. • Adjusted book value. • Merger and acquisition methods.
Multiple-Period Discounting Method • The factors impacting the negative effect on value included the following: • Increased risk to the subject’s economic income and, • The potential that buyers may be unable to obtain financing and that buyers would require a reduced price for the enterprise due to the risk of future explosion. • We prepared the “but-for” analysis using a standard valuation methodology (including the build-up method to determine the cost of capital). • We prepared two “after” the environmental accident forecasts. The forecasts utilized CAPM methodology.
Forecast 1 • We assumed that as a result of the potential interruption in the subject’s economic income stream a willing buyer would require a higher rate of return on the investment to compensate for the higher risk.
Forecast 2 • We assumed that as a result of the potential interruption in the subject’s income stream that lenders would be unwilling to finance the business risk. Therefore, buyers would need more equity invested, which would increase the discount rate. • We estimated the increased discount rate by calculating a WACC for the subject assuming 10% equity financing.
Adjusted Book Value Method (Excess Earning) • The factors impacting the negative effect on value included the following: • The value of the subject’s real estate would be lower in the “after” scenario because the subject would have an additional risk characteristic that is greater than the companies analyzed in the “but-for” analysis and, • Increased risk to the subject’s economic income. • Over the years Shenehon has been involved in numerous assignments regarding the impact of contamination on real estate values. We compiled a database of 25 such environmental-affected transactions (majority in the MSP area). • We determined the diminution from “unimpaired” value by environmental issues (for example: hydrocarbon contamination, natural gas/methane contamination, chemical contamination, and toxic metal contamination). • We identified discounts from unimpaired value for natural gas/methane contamination ranging from 12% to 61% with a median of 14%. After further analysis, we estimated a 15% adjustment was appropriate in this case. This discount was applied to the subject’s fixed assets (land, building, plant equipment and office equipment).
Merger and Acquisition Methods • The value of the subject’s business would be lower in the “after” scenario because the subject would have an additional risk characteristic that is greater than the companies analyzed in the “but-for” analysis. • We calculated the “but-for” value using transaction data that was publicly reported on four salt producers. In addition, we used eight private transactions that were reported in Done Deal States (SIC 2899). • In arriving at an “after” value we relied on the data base of 25 such environmental-affected transactions (majority in the MSP area) discussed earlier. • We determined the diminution from “unimpaired” value by environmental issued (for example: hydrocarbon contamination, natural gas/methane contamination, chemical contamination, and toxic metal contamination). • We identified discounts from unimpaired value for natural gas/methane contamination ranged from 12% t0 61% with a median of 14%. After further analysis, we estimated a 15% adjustment was appropriate in this case. This discount was applied to the subject’s fixed assets. • We separately adjusted the salt reserves and goodwill multiples by 22% and 10% respectively.
UN-Fairness Opinion Consulting firm (David) v. Big (Bad?) Investment Bank (Goliath) Peter Butler 2007 IBA National Conference
Fujitsu’s acquisition of Amdahl • Valuation problem • 12.00/share = fair price? • Yes – Big (Bad?) Investment bank • No – Small consulting firm • Amdahl • Conversion from hardware/equipment (40% of revenue) distributor to provider of computer information services and software (60%) • IT – faster growth; larger multiples
Why unfair? Financial analysis • Relative valuation (Historical) • Blended 60/40 mix: $19.97 - $22.41 • Price/sales; price/book • Relative valuation (forward-looking) • Blended 60/40 mix: $16.95 • Price/earning (future) • Acquisition premium • 18.5% (5-days out) v. 45.61% (60/40 mix) • 1.6% (day before) v. 45.61% • Amdahl recently traded as high as $13.375
Undue influence - “Googlewack” facts • Fujitsu already 42% shareholder in Amdahl • Fujitsu – major supplier to Amdahl • Two companies shared research & development • Fujitsu controlled at least 3 seats on Amdahl’s board of directors • Fujitsu had access to non-public information • None of the other large Amdahl shareholders was even consulted regarding the transaction before the announcement • Prior to offer, Fujitsu acknowledged that it would not sell its shares in the event of a competing bid • Assurances from Fujitsu that current Amdahl management would keep jobs • Amdahl agreed to inform Fujitsu if there were other interested parties
Analysts’ responses • The $12 offer did not take into account the future value of Amdahl’s growing software and services business. • When it looked like the company was on the brink of doing a lot better, it’s going to be Fujitsu that ends up making the real money. • Being in a position of major supplier and 42% shareholder allows Fujitsu to buy the company for $850 million, of which nearly half could be paid from Amdahl’s balance sheet.
Big (Bad?) Investment Bank “Un-Fairness Opinion” • Choice of comparable companies – suspect • Low future growth expectations relative to transformation of company and industry • Used adjusted and worst case scenarios that were between 20% - 80% below earning projections of Amdahl management • Amdahl management’s projections conservative based on street’s consensus • Only spoke with Fujitsu’s investment bankers • Fujitsu is also a client
Conclusions • UNFAIR fairness opinion • If you come up against big (Bad?) investment bank – do not be intimidated • Chances are the shareholders’ best interests have not been accounted for
The Case of the Disappearing Debt Valuation or Lost Profits with Changing Assumptions Engagement Type: Business Valuation Client: 100% Shareholder of Company Valuation Method: Discounted Cash Flow Model (DCF) Numerator: Cash Flows to Total Invested Capital (TIC) Denominator: Weighted Average Cost of Capital (WACC) Capital Structure: Actual (calculated by iteration) Value of Equity: TIC minus actual debt Keith Pinkerton 2007 IBA National Conference
The Case of the Disappearing Debt Engagement Type: Business Valuation Client: 100% Shareholder of Company Valuation Method: DCF Numerator: Cash Flows to TIC Denominator: WACC Capital Structure: Hypothetical Value of Equity: TIC minus hypothesized debt
The Case of the Disappearing Debt Engagement Type: Calculation of Lost Profits (Into Perpetuity) Client: 100% Shareholder of Company Valuation Method: DCF Numerator: Cash Flows to TIC Denominator: WACC Capital Structure: Actual (calculated by iteration) Value of Equity: TIC minus actual debt
The Case of the Disappearing Debt Engagement Type: Calculation of Lost Profits (Into Perpetuity) Client: 100% Shareholder of Company Valuation Method: DCF Numerator: Cash Flows TIC Denominator: WACC Capital Structure: Hypothetical Value of Equity: TIC minus hypothesized debt
The Case of the Disappearing Debt Key Points • Start-up company. VC Funding 8/1/03, Val Date 1/1/04 • Technology-based (Internet) company • Gross revenues from inception less than $500K • Litigated matter, opposing expert uses DCF to TIC • 10-year DCF with imbedded Gordon Growth model • Employs a hypothetical 60/40 (d/e) capital structure • CoE = 22%, CoD = 4.2%, WACC = 14.9% • Initially subtracts no debt b/c “there is no debt” @ t=0 • Later claims no debt subtract b/c it’s a lost profits calculation, not a valuation
The Case of the Disappearing Debt Difference: $873 Difference: $1,236 Go
The Case of the Disappearing Debt Application to Finite Cash Flow Stream • Should some amount of debt be subtracted even in finite period of lost profits. . . • when cash flow to total invested capital is the measure of damages… • and when the plaintiff group does not include creditors?
Appraising the“Googlewacks” 2007 IBA National Symposium Masterminds Track II June 22, 2007 KC Conrad 2007 IBA National Conference
Unique Business Valuations: Reining in that Final Value 2007 IBA National Conference
Valuation Problem: Customer Base Substantially – U.S. Government Intelligence Community 39% Department of Defense 61% Subject produced “things” which are deployed or sent into the field. 2007 IBA National Conference
Description of Business: The Company’s Three Main Products: • Software Engineering • Electro-Mechanical Integration • - Prototyping Services (Commonly known as bending metal & writing code) 2007 IBA National Conference
Description of Business: The Company provided critical system engineering and software engineering expertise for the development of advanced systems for the: Intelligence Community Department of Defense Homeland Security 2007 IBA National Conference
Description of Business: These services where used for: • Space Systems • C4ISR • Intelligence & Defense Community Command, Control, Communications, Computer, Intelligence, Surveillance and Reconnaissance (C4ISR) 2007 IBA National Conference
Obstacle: Conrad Business Appraisers did not hold the required U.S. Government Security Clearance 2007 IBA National Conference
Problems to Solve: • What information would Subject provide (security issues) ? • What economic factors affect the company? • Who are their competitors? • Availability of industry data? • Potential pool of buyers? 2007 IBA National Conference
Approach to Value 1: I formed negative questions during management’s interview: • You probably do not provide services on a sub-contracting basis? • The economy doesn’t affect the business you do for the government? • All of your competitors a larger than you? • They don’t do exactly what you do? • You never had a problem getting employees through security clearance? • Hypothetically speaking…? 2007 IBA National Conference
Approach to Value 2: Searched : Lockheed Martin; Boeing; Raytheon; Honeywell; Northrop Grumman Reviewed 10k’s: For similar type of services offered and outlook Examined likely pool of potential buyers 2007 IBA National Conference
Value Conclusion: Income Approach – MPDM Market Approach – Guideline Company $ 23,600,000.00 $ 23,600,000.00 2007 IBA National Conference
Appraising the Googlewacks Brent McDade 2007 IBA National Symposium Masterminds Track II June 22, 2007
Beefy Brisket Chop Shop Valuation Date 10/31/2004 Controlling Interest Basis Divorce Appraising the Googlewacks
Historical Industry Conditions Recent history very attractive Low carb diets and realization that fat not all bad increasing domestic demand Lots of production along the Canadian border Canada a net exporter of cattle to be processed in the United States Appraising the Googlewacks
Looming Concern: BSE Bovine Spongiform Encephalopathy Outbreak in UK in 1986 Related to: Scrapie in sheep and goats Chronic Wasting Disease in deer and elk FSE in cats Variant Creutzfeldt-Jakob Disease (vCJD) in humans Appraising the Googlewacks
Mad Cow Disease Cause not known Believed to be transmitted by eating infected protein (prion) Resistant to heat, UV light, radiation, normal sterilization processes Not destroyed by cooking Transmitted by eating material infected with prions Back of mind concern until … Appraising the Googlewacks
May 20, 2003 BSE discovered in Alberta, Canada United States almost immediately bans importation of Canadian cattle and beef products Supply of cattle moves sharply to the left, increasing costs Company suffers from short supply of Canadian beef, but not nearly as much as plants further north Company in fixed price contracts, so profitability suffers a little Company begins selling some spot market cuts domestically U.S. beef product prices increase somewhat, as supply from Canadian processors eliminated Appraising the Googlewacks
Fiscal Year Ending October 31, 2003 Industry rocked by BSE Cattle prices in the US skyrocket, particularly near the Canadian border Tyson, Smithfield, and other big players close plants The Company benefits from all this and has its most profitable year ever, driven by a large upswing in inventory valuation Location near Omaha allows the Company to access US cattle at prices lower than more distant plants Company successful in maximizing revenue per carcass with sales to Japan and Mexico By this time, oversupply of cattle in Canada has resulted in incentives to build processing capacity there – moves quickly, since age of cattle is a significant factor in quality (value) of cuts US begins importing Canadian boxed beef – but not Canadian cattle – in 8/03 Appraising the Googlewacks
If anything can go wrong, it will… In December of 2003, BSE is found in the U.S. herd Almost immediately, 40 countries close their borders to US beef products Ouch Company begins hurriedly refocusing its marketing efforts on domestic sales Requires operational changes, as cuts are somewhat different Inventory of cuts preferred by Europeans not very valuable Inventory of “parts” valuable in Mexico and Asia less than worthless, as brains go from product to hazardous waste New Canadian competitors ramping up production; Canadian cattle prices about 70% of cattle prices in US Appraising the Googlewacks
Fiscal Year Ending October 31, 2004 Company has its worst year in recent history, reflecting about 10 months of closed-border activity Margins down dramatically Despite record production and revenue, pretax income down well over 50% from 2003 Pretax income about 60% of historical norm Company struggling to reinvent itself as a supplier to the US market Appraising the Googlewacks
Valuation Date October 31, 2004 October 21-23, 2004: Meetings between US and Japanese officials result in tremendous uncertainty about when, if ever, the Japanese border will reopen to US beef Australia has become the world’s largest exporter of beef products and the leading supplier to Japan Plants are continuing to close in the United States as the public companies shift their operations to other countries Appraising the Googlewacks
Capitalization of Earnings Based ongoing earning power estimate on: Average 2004 adjusted pretax with historical normal pretax (2000 – 2002) Pre-BSE level of production x 2004 level of gross profit per head – assumes production rebounds but profitability based on current Used relatively low multiple due to high risk and little room for volume growth Appraising the Googlewacks