Opinion ID: 2375637
Heading Depth: 1
Heading Rank: 3

Heading: Weighting the Components of Fair Value

Text: Where the evidence reveals the existence of a free and open market, characterized by a substantial volume of transactions that makes the market a fair reflection of the judgment of the investing public, a court may justifiably assign a greater weight to stock market price than to net asset value or investment value. See, e. g., Leighton v. American Tel. & Tel. Co., 397 F.Supp. 133 (S.D.N.Y.1975); Southdown, Inc. v. McGinnes, 89 Nev. 184, 510 P.2d 636 (1973); Application of Marcus, 273 App.Div. 725, 79 N.Y.S.2d 76 (1948), aff'd 303 N.Y. 711, 103 N.E.2d 338 (1951). [P]rices, in an established market in normal times, of a widely held stock bought for investment by well informed persons [are] entitled to `considerable weight'. Martignette v. Sagamore Mfg. Co., 340 Mass. 136, 139, 163 N.E.2d 9, 13 (1959). In the case at bar the appraiser recommended assigning stock market price a weight of 40%. The dissenting shareholders argue that the market for Libby common stock was, in the time period immediately preceding the tender offer, too thin to be a reliable indicator of fair value and, therefore, that the appraiser should have assigned less weight to the stock market price component of fair value. A thin market is characterized by a low volume of public trading. Courts have reduced the weighting assigned to stock market price in cases where evidence of a thin market is present. See, e. g., David J. Greene & Co. v. Dunhill International, 249 A.2d 427 (Del. Ch.1965). In the record of the present case, however, we see no such evidence as to invalidate the appraiser's 40% weighting. On the contrary, the record convincingly demonstrates that the stock market price of May 23, 1975, was determined by a substantial market of willing buyers and willing sellers. Libby was a public company, and ownership of its common stock was widely dispersed. Prior to the tender offer, 3.768 million shares were held by persons other than Nestle, constituting a sizeable public float available for trading. Moreover, those shares were widely distributed among some 15,700 shareholders of record. Trading activity in Libby stock was relatively brisk. The stock was listed on the New York Stock Exchange (NYSE), the Midwest Stock Exchange, and the Pacific Stock Exchange. In the year preceding the tender offer, more than one million Libby shares (excluding shares purchased by Nestle and its affiliates) changed hands. During the first quarter of 1975, Libby's average daily trading volume was 2,700 shares, well in excess of the daily trading volume in other cases where stock market price has been given primary emphasis in the determination of fair value. See, e. g., Application of Marcus, supra, 273 App.Div. at 728, 79 N.Y.S.2d at 78-79 (daily average of 700 shares traded on NYSE); Jones v. Healy, 184 Misc. 923, 936, 55 N.Y.S.2d 349, 360 (Sup.Ct.1945) (about 1,000 shares per day traded on NYSE). The dissenters also contend that Nestle's position as a majority shareholder prior to the date of the tender offer should have induced the appraiser to give less weight to the stock market price component. We recognize that an acquiring parent corporation which occupies the position of a majority shareholder may be able to control the timing of the decision to merge based on the parent's anticipation of a substantial increase in the subsidiary's earnings. A majority shareholder may have access to information affecting future prospects of the subsidiary corporation that is not available to the general public, and that is not yet reflected in the market price of the subsidiary's stock . . .. Thus the acquiring corporation may be in a position to induce appraisal at a time when the outsiders seeking the appraisal have little or no capacity to ascertain . . . the likelihood that the enterprise is currently worth more than its past record suggests. Brudney & Chirelstein, Fair Shares in Corporate Mergers and Takeovers, 88 Harv.L. Rev. 297, 305-06 (1974). See Universal City Studios v. Francis I. duPont & Co., 312 A.2d 344 (Del.Ch.1973), aff'd 334 A.2d 216 (1975); Endicott Johnson Corp. v. Bade, 37 N.Y.2d 585, 376 N.Y.S.2d 103, 338 N.E.2d 614 (1975). Nestle's ownership of 61% of all Libby shares prior to its announcement of its tender offer and impending merger on May 27, 1975, was of course well known to the expert witnesses and the appraiser. We find nothing in this record to justify making a further reduction of the already reduced weight of 40% accorded to stock market price by the appraiser on the basis of expert testimony. In summary, whatever weaknesses inhere in stock market price as an indicator of the fair value of Libby stock, we conclude that the appraiser's recommendation of a weight of 40% for this component reflects careful consideration of all relevant circumstances. He reduced stock market price to a minority position among the component factors, and considering the weaknesses that impair reliability of investment value and net asset value in the case at bar, the appraiser in our judgment was none too high in his assessment of a relative weight of 40% for stock market price. We accept his recommendation.
The determination of investment value represents an estimate of the corporation's earning capacity. Investment value is fixed in a two-step process. First, based on the corporation's recent earnings history, an average annual earnings figure is calculated. In arriving at this figure, one must select a period of years of sufficient length to assure an adequate data base. Here the expert offered by petitioner chose to survey earnings over the most recent five year period, 1971-1975. [11] In addition to the selection of the applicable time frame, the determination of average annual earnings requires the exercise of subjective judgment in excluding from consideration those gains and losses that are viewed as extraordinary ( i. e., gains or losses stemming from transactions not expected to recur). [12] The second step in the process of calculating investment value is to select a capitalization ratio, or earnings multiplier. The product of the capitalization ratio and the average annual earnings figure yields the investment value of the corporation under examination. The earnings record of Libby had undergone some fluctuation in the years preceding the Nestle tender offer. Petitioner's expert witness compiled the following figures representing its earnings per share: Year ending June 30 Earnings (loss) per share Excluding Including Extraordinary Extraordinary Items Items 1966 $ 0.87 $ 0.94 1967 0.70 0.74 1968 1.19 1.19 1969 (0.11) (1.85) 1970 (1.26) (1.01) 1971 0.04 1.47 1972 (0.19) (0.07) 1973 0.45 (0.90) 1974 1.08 1.38 1975 1.00 1.00 In computing the average annual earnings per share, petitioner's expert concluded he should give more weight to the recent years of 1973, 1974, and 1975 than to the earlier years of 1971 and 1972 because increased capital expenditures during the early 1970s accomplished a significant upgrading of Libby's operating facilities and made the earnings record of the later years a better predictor of future earnings. By assigning a weight of 2/13 to each of the years 1971 and 1972 and a weight of 3/13 to each of the more recent three years, that expert computed an average annual earnings for that five year period of $0.56 per share. [13] Petitioner's expert then examined the capitalization ratio of companies comparable to Libby in order to determine an appropriate earnings multiplier. Finding Del Monte, Green Giant, and Stokely-Van Camp to be comparable companies based on their participation with Libby in the national market for canned fruits and vegetables, petitioner's expert made an extensive study of the sales, profit margins, inventory turns, capital spending history, and dividends records of each of those three companies and contrasted those data with comparable data on Libby. He found capitalization ratios of 6.0, 6.6, and 5.5 for Del Monte, Green Giant, and Stokely-Van Camp, respectively. From the fact that Libby had lagged well behind all three of its competitors in all the areas investigated, the expert concluded that Libby should be assigned a capitalization ratio of 4.5. Applying this multiplier to Libby's average annual earnings of 56 cents per share, he determined that the investment value of the dissenting shareholders' stock was $2.52 per share. The appraiser concluded that petitioner's expert exercised fair and rational judgment in his computation of investment value. We agree. The expert witness presented by the dissenting shareholders gave his opinion that Libby's earnings record was so erratic that no weight whatever should be assigned to investment value as a component of fair value. Indisputably, the erratic nature of Libby's earnings detracts from the relative weight that should be accorded investment value computed on the basis of averaging widely fluctuating annual earnings. On the other hand, the erratic nature of Libby's earnings is apparently a fact of life of its business, depressing the intrinsic value of its shares, and if that fact is appropriately recognized in a reduced capitalization ratio, it should properly have an impact on the fair value determination. The mere fact that Libby's earnings record has been erratic is no reason for denying investment value any part at all in the determination of fair value. It is merely another factor to consider in assessing the relative reliability of the three tests of stock value. On this record the appraiser had ample support in according a 40% weight to investment value. Conceptually, investment value is a central component of fair value. The assets of a company are of value chiefly because of their earning capacity. . .. 8 Cavitch, supra, § 169.07[3]. Here Libby had a history of returning a profit in each of the three years immediately preceding the tender offer and in seven of the preceding ten years. We accept the appraiser's recommendation that investment value be assigned a weight of 40% in this case.
Generally net asset value should not be heavily weighted in stock valuation unless the valuation being made is for liquidation purposes. Where the acquired business will be continued as a going concern, the value of the corporate assets bears little or no relation to the value of the stock of the corporation. A recent decision of a Delaware court noted: There is good reason for not taking the asset-value factor seriously. The average market price of a common stock over the years depends chiefly on the earnings power and the dividend payments. These, in turn, usually do not bear any close or reasonably consistent relation to the asset value. . . . Investors and speculators have found that the asset value is typically no guide at all to earning-power value or average market price. Hence they have gradually come to give the asset-value factor practically no weight. Gibbons v. Schenley Industries, Inc., 339 A.2d 460, 473 (Del.Ch. 1975), quoting from Graham, Dodd, Cottle & Tatham, Securities Analysis 217 (4th ed. 1962). To have its maximum persuasiveness in finding the fair value of Libby stock, net asset value should have been determined by a current appraisal of all the corporation's property, tangible and intangible. No such asset appraisal was made in the case at barby either petitioner or the dissenting shareholders. As a substitute for net asset value, both sides relied on net book value determined from Libby's audited balance sheet. [14] The net value of corporate assets reported on the balance sheet in accordance with accounting convention represents principally historical cost less book depreciation. Book value of property would be equal or even close to its actual current value only by sheer coincidence. There is nearly complete agreement that book value does not accurately represent the fair value of corporate assets. Note, Valuation of Dissenters' Stock, 79 Harv.L.Rev. 1453, 1457 (1966). As Judge Learned Hand stated over fifty years ago: The suggestion that the book value of the shares is any measure of their actual value is clearly fallacious. It presupposes, first, that book values can be realized on liquidation, which is practically never the case; and second, that liquidation values are a measure of present values. Every one knows that the value of shares in a commercial or manufacturing company depends chiefly on what they will earn, on which balance sheets throw very little light. Borg v. International Silver Co., 11 F.2d 147, 152 (2d Cir. 1925). In the opinion of petitioner's expert, net asset value should receive a weight of 20%, only half the weight accorded each of the other two factors. The dissenting shareholders' expert, however, contended that net asset value should be the sole criterion for determining fair value; that is, should receive a weight of 100%. Recognizing that net asset value was the weak link in the chain of appraisal factors and that there were dangers inherent in the use of book value as a valuation tool, the appraiser agreed with petitioner's expert. We believe the court should accept the appraiser's recommendation. The shareholders' expert placed exclusive weight on net asset value because of his belief that stock market price and investment value were unreliable indicators of fair value in this case. We have already indicated, however, that in our view stock market price and investment value, although here subject to deficiencies as indicators of fair value, were properly assigned weights of 40% each. In view of the obvious imprecision of using book value as a measure of asset value and also in view of the fact that net asset value, even if accurately appraised, is in the words of Judge Hand in Borg v. International Silver Co., supra at 152, little indication of what people will pay for the shares, the weighting of 20% recommended by the appraiser is, if anything, on the high side.
In summary, we accept in the case at bar the appraiser's recommended weight assignments of 40% to stock market price, 40% to investment value, and 20% to net asset value, considering the way in which each of those elements of fair value was here determined. The relative weight to be given to those three elements depends much upon the facts of the individual case, including the relative confidence that the weighting tribunal has in the accuracy of those three subsidiary determinations themselves. On all the facts of this case we find no reason for not following the recommendation of the appraiser.