Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-5_02-cv-05509/USCOURTS-cand-5_02-cv-05509-2/pdf.json

Nature of Suit Code: 190
Nature of Suit: Other Contract Actions
Cause of Action: 28:1441 Petition For Removal--Other Contract

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ORDER GRANTING IN PART AND DEFERRING IN PART THEDECISION ON DEFENDANT'SMOTION TO EXCLUDETHE

EXPERT WITNESS TESTIMONY OF SEAN BADDING

C-02-05509-RMW

E-FILED on 6/17/05

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

SAN JOSE DIVISION

METABYTE, INC. and VIVEK MEHTA,

Plaintiffs,

v.

CANAL+ TECHNOLOGIES, S.A.,

Defendant.

No. C-02-05509 RMW

ORDER GRANTING IN PART AND

DEFERRING IN PART THE DECISION ON

DEFENDANT'S MOTION TO EXCLUDE THE

EXPERT WITNESS TESTIMONY OF SEAN

BADDING

[Re Docket No. 196]

Canal+ Technologies, S.A. ("Canal+") moves to preclude Metabyte, Inc. ("MNI") and Vivek

Mehta (collectively "plaintiffs") from offering the testimony of expert witness Sean Badding ("Badding"). 

The court has considered Badding's report and the moving and opposing papers. For the reasons set forth

below, the court grants Canal+'s motion with respect to Badding's opinion on the fair market value of MNI

common shares and grants in part and defers its decision in part on the motion with respect to Badding's

opinion that MNI's financial statements demonstrate that the company met its budget and revenue goals for

certain specified dates.

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ORDER GRANTING IN PART AND DEFERRING IN PART THEDECISION ON DEFENDANT'SMOTION TO EXCLUDETHE

EXPERT WITNESS TESTIMONY OF SEAN BADDING

C-02-05509-RMW

2

I. BACKGROUND

A. Badding's Valuation Opinion

A potential issue in this case is the measure of the fair market value ("FMV") of the third tranche of

common stock held by the optionees at the time of their exercise of the Put Option for the third tranche. 

This issue will come into play if the jury finds that Canal+ breached the Put Option by not purchasing shares

in the third tranche. Badding calculates the FMV of MNI as of February 6, 2004 to be $87.47 million,

"assuming that MNI management intended to operate the company." Badding Report at 21. 

The Put Option calls for valuators to use seven practices and assumptions when determining MNI's

FMV: 

a. The FMV shall be calculated for the total issued for Common Stock of the Company

on a fully diluted basis;

b. Assuming a willing seller and a willing purchaser;

c. Taking into consideration the capital structure of the Company;

d. Without giving effect to any 'control premium' or similar consideration;

e. Givingparticular weight to any recent issuances of equity securities by the Company to

investors and the valuation of the Company implied thereby;

f. Taking into consideration multiples of [earnings before interest and taxes ("EBIT")],

[earnings before interest, taxes, depreciation, and amortization ("EBITDA")], net income

and sales revenue;

g. Taking into consideration the valuations of similar types of companies carrying similar

types of businesses, but subject to the shareholding structure of the Company.

Put Option section 1.2(c)(iii). Badding claims to have combined these factors with "the best practices of

the technology industry for valuing private equities." Badding Report at 12.

Badding notes that there are three general approaches to valuing privately-held companies: the

market approach, the income approach, and the asset-based approach. Badding chose the market

approach because he believes that the income and asset-based approaches are inapplicable due to MNI's

status as an emerging company without an income track record or tangible assets. The market approach

involves comparing an emerging company with "one or more 'guideline companies' to arrive at a relative

valuation." Id. at 13. After considering nine potential guideline companies, Badding picked TiVo. 

Badding then employs a practice he calls the "direct ratio" version of the market approach to

determine MNI's value by comparing MNI's capitalization with TiVo's market capitalization. Id. at 18. 

Badding uses three main points of comparison. First, on January 10, 2000, TiVo had issued 37.75 million

shares, which were selling at $71.50 per share, for a total market capitalization of $2.7 billion. MNI had

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1 Badding also considered, but ultimately rejected, a method of determining the FMV of

MNI by which TiVo's market capitalization is divided by the number of units deployed, the quotient is

discounted by 60%, the discounted quotient is then multiplied by the number of MNI units deployed, and

that product is then discounted by 30%. Id. at 20-21. 

ORDER GRANTING IN PART AND DEFERRING IN PART THEDECISION ON DEFENDANT'SMOTION TO EXCLUDETHE

EXPERT WITNESS TESTIMONY OF SEAN BADDING

C-02-05509-RMW

3

issued 23.54 million shares at $1.33 per share for a total of $31.3 million. Because 31.3 million is 1.16%

of 2.7 billion, Badding determined that, on January 10, 2000, MNI had 1.16% of TiVo's value. Second,

Badding compares these variables on July 24, 2001. On that date, Badding notes that MNI's value was

9.22% of TiVo's. Because Badding believes that MNI compares favorably with TiVo, he opines that this

ratio held constant until February 6, 2004. On that date, TiVo's market capitalization was $948.7 million. 

Badding thus concluded that, on February 6, 2004, MNI was worth 9.22% of $948.7 million, or $87.47

million.1 

B. Badding's Milestones Opinion

Another issue in this case is whether MNI satisfied "Technical Milestones" and "Financial

Milestones"—conditions precedent to MNI's common shareholders' exercise of the first and second

tranche option shares. The Put Option assigned MNI's Board of Directors the task of establishing the

Financial Milestones. According to plaintiffs, Canal+ refused to negotiate them in good faith, but MNI

essentially met its Financial Milestones by meeting certain budget and revenue goals allegedly set by MNI's

Board. Badding opines that "MNI's financial statements demonstrate that the company met these goals for

the period from July 24, 2001 to July 24, 2002 and as of July 24, 2003." Badding Report at 5-12. 

II. ANALYSIS

A. Standard Under Daubert

Federal Rule of Evidence 702 provides that courts may admit expert testimony if it is both relevant

and reliable: 

If scientific, technical, or other specialized knowledge will assist the trier of fact to

understand the evidence or to determine a fact in issue, a witness qualified as anexpert by

knowledge, skill, experience, training, or education, may testify thereto in the form of an

opinion or otherwise, if (1) the testimony is based upon sufficient facts or data, (2) the

testimony isthe product ofreliable principles and methods, and (3) the witness has applied

the principles and methods reliably to the facts of the case.

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ORDER GRANTING IN PART AND DEFERRING IN PART THEDECISION ON DEFENDANT'SMOTION TO EXCLUDETHE

EXPERT WITNESS TESTIMONY OF SEAN BADDING

C-02-05509-RMW

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See Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579, 592 n.10 (1993) (proponent of expert

testimony must prove admissibility by a preponderance of the evidence). In addition, Federal Rule of

Evidence 403 mandates the exclusion of evidence that is substantially more prejudicial than probative. 

To determine whether an expert's proposed testimony is reliable, a trial judge may consider (1)

whether it can be tested or whether it is purely subjective; (2) whether it has been subject to peer review

and publication; (3) the known or potential rate of error; (4) the existence and maintenance of controls; and

(5) whether it has been generally accepted in the scientific community. See Kumho Tire Co., Ltd. v.

Carmichael, 526 U.S. 137, 149-50 (1999). "[A]ny step that renders [an expert's] analysis unreliable . . . 

renders the expert's testimony inadmissible. That is true whether the step completely changes a reliable

methodology or merely misapplies that methodology." In re Paoli R. R. Yard PCB Litigation, 35 F.3d

717, 745 (3d Cir. 1994).

B. Badding's Valuation Testimony

Canal+ argues that Badding's valuation testimony is unreliable because Badding (1) is not properly

qualified as an "expert" and (2) improperly applied the market-based approach.

Canal+ first asserts that Badding "is not qualified to render valuation testimony" because "[h]e

received his 'training' in business valuation on the job," has "no formal valuation training," and has never

been disclosed as an expert witness before. Mot. Excl. at 3:21-4:13. The court disagrees. It is wellestablished that Rule 702 "contemplates a broad conception of expert qualifications" and "an expert may be

qualified either by 'knowledge, skill, experience, training, or education.'" Thomas v. Newton Intern.

Enterprises, 42 F.3d 1266, 1269 (9th Cir. 1994) (quoting Fed. R. Evid. 702) (reversing district court's

exclusion of proposed expert's testimony on qualification grounds where expert's sole claim to specialized

knowledge was job-related); Big Island Candies, Inc. v. Cookie Corner, 269 F. Supp. 2d 1236, 1248

n.17 (D. Haw. 2003) (expert's "work experience is extensive enough to qualify him as an expert . . .

whether or not he holds an academic degree"). In his deposition, Badding explained that his on-the-job

training "[t]hough . . . not formal in the eyes of perhaps the academic world," was "equivalent to getting a

degree in the valuations and in the analysis part of it since that was my day-to-day job." Badding Depo. at

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ORDER GRANTING IN PART AND DEFERRING IN PART THEDECISION ON DEFENDANT'SMOTION TO EXCLUDETHE

EXPERT WITNESS TESTIMONY OF SEAN BADDING

C-02-05509-RMW

5

26:20-23. Thus, Badding 's lack of academic credentials, standing alone, does not doom his status as an

expert.

Canal+ then argues that Badding's "direct ratio" method is flawed. The court agrees.

Badding's selection of TiVo as the only "guideline" company in itself renders his analysis unreliable. 

The differences between TiVo and MNI are so significant that Badding's utilization of the ratio between the

market capitalizations of the two companies for calculating MNI's value renders Badding's analysis

unreliable. The following table highlights a few of the significant differences that makes the use of TiVo as a

guideline company unreasonable.

TiVo MAI

Spent millions to market and advertise its

brand name, which is well recognized.

Has no brand value and is unknown to

subscribers of services.

Has direct relationship with subscriber

including direct billing and ability to obtain revenue

from certain service upgrades.

Has no knowledge of who the subscribers

are and no ability to contact directly. Receives no

revenue from ultimate users of technology and no

reasonable expectation of future revenue from

users.

Controls user interface with subscriber and

what is presented to that customer.

Has no control over user interface.

Business model involves marketing

product and service directly to customer.

Original business model of MNI

management targets future advertising revenue (or,

in accordance with Canal+'s model, licensing to

service providers).

A further difficulty with Badding's analysis is that he assumes that MNI intends to follow the

advertising business model advocated by Manu Mehta when, in fact, the controlling members of the MNI

Board had expressed a preference for the licensing model advocated by Canal+. Therefore, although

Manu Mehta's vision may well have been the more insightful and potentially more lucrative, as of the time of

the exercise of the third tranche, Mr. Mehta was no longer an officer and MNI's direction was away from

the advertising business model. Badding ignores that reality.

Even if one assumes that TiVo is an appropriate guideline company, Badding's "direct ratio" method

does not follow an accepted "market approach." As pointed out by Canal+'s rebuttal expert, Badding's

method deviates from the traditional market-based approach because it oversimplifies what should be a

multiple-step analysis. Badding did not determine how well TiVo was performing in light of its financial

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2 Other courts have endorsed Thomas' version of the market approach. See, e.g., Okerlund

v. U.S., 53 Fed. Cl. 341, 347 n.7 (Fed. Cl. 2002) (market approach involves creating "market multiples,"

which "are multiples of some type of capital as priced in the public market or as priced in a private

transaction relative to some underlying company fundamental, such as book value, earnings or cash flow").

ORDER GRANTING IN PART AND DEFERRING IN PART THEDECISION ON DEFENDANT'SMOTION TO EXCLUDETHE

EXPERT WITNESS TESTIMONY OF SEAN BADDING

C-02-05509-RMW

6

fundamentals. This process entails dividing its stock value by its revenue, net income before and after taxes,

gross and net cash flow, dividends or dividend paying capacity, EBIT, and EBITDA. A reliable market

approach first generates a robust comparison of the guideline company's market capitalization relative to its

performance. See Thomas Report, Granneman Decl. Ex. C, at 4. These comparisons yield "value

measures": a ratio of by how much the guideline company's market capitalization exceeds each individual

economic variable. Id. The market approach then turns to the target company. The second step of the

market approach is to multiply the target company's financial fundamentals by the same "value measures,"

thereby deriving its worth in light of its economic performance. Id. Badding's technique of comparing MNI

and TiVo's stock value ignores vital economic indicia and "provides no information about when, or if,

sustainable future benefits will be realized." Id.

2

 

Of course, experts enjoy leeway to adjust recognized methods to account for the particularities of

unique situations. However, Badding's "direct ratio" method appears flawed. For one, although Badding

asserts that the "direct ratio" method is based on the "best practices of the technology industry for valuing

private equity," (Badding Report at 12), he provides no support for that proposition. Badding's expert

report does not claim to rely on any published sources. Likewise, during his deposition, he was unable to

name a valuation textbook that supported his "direct ratio" method: 

Q. Is there a publication that you know of that I could go to that would

describe for me the method that you have used to develop a valuation ratio

which you have called the direct ratio correlation in your report?

A. There's not one specific individual textbook that I can direct you to

that will cover the direct ratio. Is that what you're asking, the direct 

ratio correlation?

Q. Yes. What I was wondering is with respect to the methodology

 you've used in your report—and you describe this aspect of it as the

direct ratio correlation—is there a an [sic] authoritative text in the 

business valuation world that I could go to that would describe for me the methodology that

you have used, even if it doesn't call it the direct ratio

correlation method?

A. I'm sure there would be a a [sic] textbook that shows that valuation 

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ORDER GRANTING IN PART AND DEFERRING IN PART THEDECISION ON DEFENDANT'SMOTION TO EXCLUDETHE

EXPERT WITNESS TESTIMONY OF SEAN BADDING

C-02-05509-RMW

7

process made to determining parts of the fair—or parts of the marketbased approach that includes comparables with financials to a guideline 

company.

Badding Depo. at 89:20-90:16. Notably, Badding's testimony that he has previously seen a market-based

approach based on comparing "financials to a guideline company" seems more consistent with the

recognized multiple-step approach, which looks to underlying "financials," not just stock value. In their

opposition, plaintiffs cite two texts that they claim show that the market-based approach is superior to the

asset-based or income approaches. However, these texts do not support Badding's specific "direct ratio"

application of the market-based approach. Moreover, plaintiffs make no showing that Badding actually

consulted these sources. Cf. Turner v. Iowa Fire Equipment Co., 229 F.3d 1202, 1209 (8th Cir. 2000)

(excluding expert's opinion despite fact that counsel located three articles supporting it because expert

"simply did not rely on those items in formulating his opinion"). Plaintiffs fail to establish that the "direct

ratio" method is grounded in recognized valuation practices. 

Badding's method also overlooks the requirements of the Put Option. The Put Option sets forth

seven factors for a valuator to consider when determining MNI's FMV. Badding's method focuses on one

such criteria: "the valuations of similar types of companies carrying similar types of businesses." Put Option

section 1.2(c)(iii). Badding does not consider MNI's most recent 

"issuance( ) of equity securities by the Company to investors and the valuation of the Company implied

thereby"—a criterion which the Put Option mandates valuators give "particular weight." Id. He does not

discuss that on November 6, 2001 MNI issued a Common Stock Warrant for $0.25 a share. Similarly, he

does not consider multiples of EBIT, EBITDA, net income, and sales revenue. This omission is particularly

troubling because the Put Option's requirement that valuators consider "multiples" of financial fundamentals

seems to call expressly for a traditional market-based approach. Plaintiffs argue that "[i]n his valuation,

Badding considered, and utilized where appropriate, seven criteria prescribed in the Put Option." Opp.

Mot. Excl. at 5:13-14. Yet, although Badding recites the Put Option's criteria on page twelve of his expert

report, he never mentions them again.

Plaintiffs cite Henry v. Champlain Enterprises, Inc., 288 F. Supp. 2d 202 (N.D.N.Y. 2003),

Tracinda Corp. v. DaimlerChrysler AG, 362 F. Supp. 2d 487 (D. Del. 2005), Rondout Valley Cent.

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ORDER GRANTING IN PART AND DEFERRING IN PART THEDECISION ON DEFENDANT'SMOTION TO EXCLUDETHE

EXPERT WITNESS TESTIMONY OF SEAN BADDING

C-02-05509-RMW

8

School Dist. v. Coneco Corp., 321 F. Supp. 2d 469 (N.D.N.Y. 2004), and Tyler v. Bethlehem Steel

Corp., 958 F.2d 1176 (2d Cir.1992) as supporting the proposition that defendant's criticisms of Badding's

opinion go to its weight, not to its admissibility. The court disagrees. For one, none of plaintiffs' authorities

involves the issue of whether the expert's testimony was relevant as well as reliable. In addition, each of

plaintiffs' cases involves a situation where other indicia of reliability bolstered the expert's opinion. See

Henry, 362 F. Supp. 2d at 221 ("the use of [the expert's] methodologies" were "accepted"); Tracinda

Corp., 362 F. Supp. 2d at 494-95 (upholding admissibility of two experts' opinions where one expert used

"standard regression analysis that has been used by other academic studies" and had even been employed

by the opposing party's expert and the other expert's conclusions fell within the range of other analyses that

had been "prepared prior to litigation"); Rondout, 321 F. Supp. 2d at 478 (expert's report "bears a

remarkable resemblance to that of economists' reports and valuations, and, to be candid, there exists very

little deviation from those standard economic valuation processes"); Tyler, 958 F.2d at 1188 (expert based

critical assumption on "an official government document"). Plaintiffs cite no such external support for the

"direct ratio" method. 

The court grants Canal+'s motion to exclude Badding's opinion of MNI's FMV. It is not

sufficiently reliable to justify admission.

C. Badding's Milestones Opinion

Canal+'s sole challenge to Badding's Milestones Opinion is that it is not relevant because MNI's

operating under budget could not have been a Financial Milestone. Neither Badding nor Canal+'s experts

are competent to testify as to whether or not Financial Milestones were set, whether they should be implied,

or whether they should be considered to exist. The experts may, however, assist the jury by explaining

what the financial records of MNI show, if that is relevant to an issue (e.g., if relevant, Badding could show

how net income or loss is shown by MNI's financial records). 

The decision on whether to admit any testimony by Badding on what MNI's financial records show

is deferred pending a specific proffer.

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ORDER GRANTING IN PART AND DEFERRING IN PART THEDECISION ON DEFENDANT'SMOTION TO EXCLUDETHE

EXPERT WITNESS TESTIMONY OF SEAN BADDING

C-02-05509-RMW

9

III. ORDER

The court (1) grants Canal+'s motion to exclude Badding's testimony on the value of MNI's

common stock and (2) grants Canal+'s motion to exclude Badding's testimony as to what any MNI goals

or Financial Milestones were but defers ruling on whether Badding can testify as to what MNI's financial

statements show.

DATED: 6/17/05 /s/ Ronald M. Whyte

RONALD M. WHYTE

United States District Judge

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ORDER GRANTING IN PART AND DEFERRING IN PART THEDECISION ON DEFENDANT'SMOTION TO EXCLUDETHE

EXPERT WITNESS TESTIMONY OF SEAN BADDING

C-02-05509-RMW

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Notice of this document has been electronically sent to:

Counsel for Plaintiff:

E. Jeffrey Banchero ejb@kastnerbanchero.com 

Counsel for Defendant(s):

Christian Parker cparker@salans.com 

William Abrams william.abrams@pillsburylaw.com 

Jonathan G. Kortmansky jkortmansky@sandw.com

Krishna K. Juvvadi kkjuvvadi@rkmc.com 

Vernon H. Granneman vernon.granneman@pillsburylaw.com 

Counsel are responsible for distributing copies of this document to co-counsel that have not registered for

e-filing under the court's CM/ECF program.

Dated: 6/17/05 /s/ MAG

 Chambers of Judge Whyte

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