Opinion ID: 1488138
Heading Depth: 2
Heading Rank: 2

Heading: The Petitioners' Expert Testimony

Text: The petitioners' expert, Marc Sherman, performed three different financial analyses of MCHC: a comparable transactions analysis, a DCF analysis, and a comparable company analysis. In his comparable transactions analysis, Sherman split the selected comparable transactions into three categories: similar sized transactions, the initial Verizon transaction, and the CD settlement. For the similar sized transactions category, Sherman considered five transactions that occurred between May 2000 and January 2001, each involving a cellular company with approximately the same number of POPs. The remaining two categories (the initial Verizon transaction and the CD settlement) involved single transactions that were included in the analysis because they were related to the sale of MCHC. Sherman then analyzed each category using his four cellular system metrics (POPs, subscribers, EBITDA, and revenue). For each metric, Sherman computed a value of MCHC based on the category of comparable transactions, and then weighted these values to derive his final overall valuation. Sherman did that as follows: he first weighted the metrics based on their importance in valuing cellular companies. He then weighted the category of comparable transactions within each metric. The result of that process is shown infra on the table, which breaks down Sherman's categories, metrics, valuations, and weightings as follows: Metric Category Category Valuation Weighting Weighting POPs 45% Verizon Transaction $199,278,316 20% CD Settlement $199,286,698 10% Similar Sized Transactions $136,352,297 15% Subscribers 20% Verizon Transaction $226,758,135 15% CD Settlement $225,865,136 5% Operating Cash Flows 25% Verizon Transaction $160,650,176 20% CD Settlement $226,738,142 5% Revenue 10% Verizon Transaction $236,517,971 7% CD Settlement $224,240,681 3% Total 100% 100% Multiplying the valuations by their respective weightings, Sherman computed a value of $192 million based on comparable transactions. To that figure he added the $20 million value of the non-operating assets to arrive at a comparable transactions value for MCHC of $212 million. Sherman also performed a DCF analysis. Because of the lack of management projections, Sherman created forecasts of MCHC's cash flows based on predictions by others for the cellular industry and the economy. In creating those forecasts, Sherman relied primarily on Paul Kagan, an outside industry expert. [17] Sherman also looked to industry growth reports that showed an annual growth rate for the wireless industry of 16%. The next step in Sherman's DCF analysis was to determine the discount rate using a weighted average cost of capital (WACC) approach. Applying that approach to the inputs he determined for each component of the WACC formula, Sherman arrived at a discount rate of 13.25%. For his DCF projection period, Sherman used a ten-year period from June 1, 2001 to May 31, 2011. Before projecting the cash flows, however, Sherman first adjusted them by removing two irregularities: (i) a non-recurring $861,000 bad debt expense resulting from Montgomery having installed a new billing system, and (ii) the rent of $638,000 MCHC paid annually to Old North, a wholly owned subsidiary of Palmer. [18] Lastly, using a capitalization rate of 9.25% and a growth rate of 4%, Sherman calculated a terminal value of $258 million. From these inputs, Sherman arrived at a final enterprise (DCF) valuation of $150 million for Montgomery as a going concern, operating asset of MCHC. To that figure Sherman added the value of Montgomery's non-operating assets, which increased his valuation to $170 million. Finally, to that sum, Sherman applied a control premium of 31%, thereby increasing his DCF valuation to $216 million. [19] In his third (comparable company) analysis, Sherman found only two comparable companies, neither of which was similar in size to Montgomery. Sherman excluded companies that had international operations, multiple lines of business, or prepaid customers, as well as companies that used PCS technology. After selecting his comparable companies, Sherman applied the same metrics that he used in his comparable transactions analysis and gave them the same weight. That approach resulted in a valuation of $206 million. After adding in the value of the non-operating assets, Sherman's ultimate comparable company valuation of MCHC was $226 million. Thus, Sherman's three analyses valued MCHC within a range of from $212 million to $226 million. Sherman derived his final fair value by combining the results of his three analyses into a weighted average, giving 80% weight to the comparable transactions value, 15% weight to the DCF value, and 5% weight to the comparable company value. Sherman's heavy weighting of the comparable transactions analysis reflected his judgment that the transaction data, particularly the initial Verizon transaction price, were the best indication of value for MCHC. In contrast, Sherman gave little weight to the DCF analysis because of his concerns about the reliability of MCHC's financial data and the lack of management projections. He gave even less weight to the comparable company valuation because of the scarcity of publicly traded companies to which MCHC could reliably be compared. Combining the results of the three analyses into a weighted average yielded a fair value for MCHC of $213,455,619, or $21,346 per share. In making its independent determination of MCHC's fair value, the Court of Chancery adopted Sherman's overall valuation framework, and most  but not all  of Sherman's inputs. The Court made adjustments to some of the inputs that it did not adopt. The result was to reduce Sherman's valuation of $213,455,619 ($21,346 per share) to a final valuation of MCHC of $196,217,373, or $19,621.74 per share [20] Because the Vice Chancellor's valuation analysis is discussed more extensively elsewhere in this Opinion, at this point we summarize the Court's critical valuation rulings only briefly. First, with respect to the comparable transaction analysis, the Vice Chancellor determined that the Verizon transaction price and the CD settlement price were valid inputs. But, the Court adjusted Sherman's CD settlement price by eliminating what Sherman perceived (incorrectly, the Court determined) to be a minority discount. The Court then independently increased the CD settlement figure ($470 per POP) by 15% to eliminate a so-called settlement haircut, to arrive at a value of $540.50 per POP. [21] Second, the Court adjusted Sherman's DCF valuation by eliminating the 31% control premium that Sherman had added to his DCF value. [22] That adjustment reduced Sherman's DCF valuation of MCHC from $216 million to $170 million. [23] Third, and most significant, the Court adjusted the weights that Sherman had accorded to the values derived by his three valuation methods. Sherman had weighted the comparable transaction value at 80% of total fair value. Because the effect of that weighting was to give the Verizon transaction an overall weight of 50%  a weight the Court found to be too significant  the Vice Chancellor reduced the weight accorded to the comparable transactions valuation from 80 to 65%. [24] Finally, because Sherman had corrected the figures derived from MCHC's financial statements in a reasonable manner, and also had looked to third party authority for guidance on other inputs, the Court determined that the 15% weight Sherman had accorded to the DCF valuation should be increased to 30%. [25]