Opinion ID: 794065
Heading Depth: 2
Heading Rank: 2

Heading: The Due Diligence Process

Text: 6 The ESOP team began its due diligence review of CommutAir in early January 1994. In anticipation of the meeting on January 14th, CommutAir Vice President Andrew Price submitted management projections of the company's financial performance to HLHZ. Price's projections, which were prepared in November 1993, used CommutAir's financial data from 1992 through October 1993 and forecast the company's performance through 1995. HLHZ asked Price to submit a revised forecast that projected performance through 1998. For the revised projections, Price relied primarily on data from the final two months of 1993. 7 On February 2, 1994, members of the ESOP team, including Andrew Stull (a representative of HLHZ) and Michael Shea (a financial analyst from U.S. Trust), visited CommutAir headquarters to evaluate Price's projections and assess the airline's financial status. In preparation for this meeting, both HLHZ and KMC forwarded due diligence requests to CommutAir, and Stull and Shea began gathering company documents and receiving background information on CommutAir. 1 At the meeting, representatives from U.S. Trust and HLHZ toured CommutAir's facilities and met with the company's senior management. Sullivan described the meetings as rigorous and claimed that he and other members of CommutAir's senior management were grilled for hours. 8 Some time prior to February 28th, HLHZ provided Goldberg with a preliminary valuation report concluding that CommutAir had a total equity value of $180 million. Goldberg made handwritten notes on this document identifying areas of concern in preparation for a meeting with HLHZ to discuss the basis of its valuation. In reference to the management projections submitted by Andrew Price, Goldberg wrote, 1994 — projections look robust. He also noted: Equity risk high — judgment about forecasts uncertain. Next to the schedule containing HLHZ's comparative publicly-traded company analysis, Goldberg noted that HLHZ's selection of above-the-median multiples would have to be justified, as would HLHZ's use of a 9.5% long-term growth rate. Goldberg asserts that these notes represented only some of his concerns; others he communicated to HLHZ orally. U.S. Trust in-house financial analyst Michael Shea testified that he too expressed concerns during multiple phone calls with HLHZ but, like Goldberg, kept no written records indicating the content of these calls. 9 On February 28th, Goldberg and Shea met with Stull to discuss HLHZ's preliminary valuation. Although Goldberg and Shea took no notes, Stull did. Stull's notes concern, inter alia, the justification for the projected growth rate, the use of above-the-median multiples for comparable companies, the fact that the dividends were set to terminate upon payment of the debt, the threat of competition from other airlines, and the use of a weighted average cost of capital that exceeded the industry average. Stull's notes also contain questions, descriptions of topics that would require additional research, and directives to himself to take out certain numbers, explain various calculations, and call [somebody] about regional airlines growth. Following the February 28th meeting, Goldberg asked KMC to draft a security purchase agreement that specified the terms of the convertible preferred stock so that the parties could begin negotiations. In early March, Goldberg received a draft of HLHZ's opinion on the fairness of the proposed transaction. This draft opinion addressed the concerns expressed in Goldberg's notes on the preliminary valuation statement and in Stull's notes from the February 28th meeting: it further reduced the total equity value of CommutAir from $180 to $174 million; removed the highest selected comparable company multiples; and changed the long-term growth rate from 9.5% to 9%.