Opinion ID: 1488138
Heading Depth: 1
Heading Rank: 4

Heading: The Valuations Of The Trial Experts and The Decision Of The Court Of Chancery

Text: During the three-day trial, the parties presented their respective positions through the testimony of their valuation experts. [8] The petitioners' expert, Marc Sherman, who was previously a partner of KPMG in charge of its corporate transaction practice, valued MCHC at $21,346 per share as of the merger date. The respondents' expert, Kenneth D. Gartrell, who was previously an accountant and auditor at Ernst & Young before becoming an independent consultant on fair market valuation matters, testified that the standalone value of MCHC as of the merger date was $7,840 per share. Although both experts used similar methods to value MCHC, Sherman looked to third party experts to create his forecasts, whereas Gartrell did not consult outside appraisers or other sources of relevant information. Moreover, only Sherman performed a comparable transaction analysis. The experts' significantly divergent results, the Court of Chancery found, were attributable to those two differences in approach.
The respondents' expert, Gartrell, employed two valuation methodologies: a comparable company analysis and a discounted cash flow (DCF) analysis. In his comparable company analysis, Gartrell focused on 14 rural and regional cellular companies. From that data set he derived revenue multiples of 3.5 for the rural companies and 3.3 for the regional companies, and he derived EBITDA multiples of 7.1 for the rural companies and 15.2 for the regional companies. To eliminate the minority discount embedded in those multiples, Gartrell added a control premium of 35%, which was the mean of his range of control premia (30% to 40%). Applying that 35% premium, Gartrell increased the median revenue multiples from 3.5 to 4.0 for rural cellular carriers, and from 3.3 to 4.0 for regional carriers; and he increased the median EBITDA multiples from 7.1 to 8.4 for rural cellular companies and from 15.2 to 18.9 for regional companies. Having generated revenue and EBITDA multiples, Gartrell proceeded to determine their strategic weights, in order to reflect[] the optimal mix of rural and regional business strategies for MCHC. Gartrell arrived at strategic weights of 79% for rural values and 21% for regional values, which resulted in an initial valuation for MCHC of $122.7 million. Gartrell determined that valuation was too high, based on MCHC's combinatorial deficiency, because (in Gartrell's view) cellular companies are significantly more valuable in specific combinations and Gartrell viewed MCHC as a stand-alone company. To account for MCHC's lack of combinatorial value, Gartrell applied two discounts to the value he had derived for MCHC. He applied the first discount  33%  to account for MCHC's low combinatorial value relative to similar cellular companies. The second discount  15%  accounted for MCHC's complete lack of combinatorial value as a stand-alone entity. Gartrell derived both discounts from the C-Block auction that had been conducted by the Federal Communications Commission (FCC) in 1996. [9] Gartrell used the C-Block auction as a model for valuing MCHC because (in his judgment) MCHC should be valued as an isolated, single license entity, like the start-up PCS bidders at that auction. Applying Gartrell's total 48% combinatorial discount resulted in a stand-alone value for MCHC of $63.3 million. To that amount Gartrell then added the outstanding inter-company receivable, arriving at a final valuation, based on his comparable company analysis, of $80.5 million. Gartrell also performed a DCF valuation of MCHC. Based on MCHC's financial performance for FY 2000 and its year-to-date performance as of June 30, 2001, Gartrell created his own forecasts of MCHC's future financials for a five-year period. He then adjusted those forecasts to subtract the bad debt expense that resulted from MCHC's installation of a new billing system. For his growth rate, Gartrell used the long-term GNP rate, which was 3.3%. Gartrell reasoned that the long-term GNP was the correct growth rate because MCHC had already saturated its market and therefore could not grow faster than the overall economy. Using those growth rates for his DCF analysis, Gartrell valued MCHC at $59.1 million, to which he added the $17.2 million inter-company receivable, to reach a final DCF valuation of $76.3 million. Thus, Gartrell's comparable company analysis and his DCF analysis resulted in a valuation of MCHC that ranged from $76.3 million to $80.5 millionvalues both lower than the unilaterally set price that had been paid to the minority shareholders in the MCHC merger. Having no reason to differentiate between those two values, Gartrell averaged them to arrive at his final valuation for MCHC of $7,840 per share. The Court of Chancery found that Gartrell's valuation approach was legally and factually flawed, and must be disregarded in its entirety, for three reasons. First, the Vice Chancellor found that Gartrell's overall theoretical framework was invalid as a matter of law, because Gartrell's stand alone approach valued MCHC as if it were not a going concern that had contractual relationships with other cellular providers. In fact, the Court found, MCHC had contractual relationships with Palmer and Palmer's larger preexisting networks, and those relationships represented value to which MCHC's minority stockholders were entitled. By valuing MCHC on a counterfactual stand alone basis, the Court concluded, Gartrell intended to deprive the minority stockholders of existing value as of June 30, 2001. [10] Second, the Vice Chancellor found that Gartrell's DCF analysis was fatally flawed and entitled to no weight because: (i) Gartrell used a generic growth rate (the long-term growth rate of GNP) as his growth rate for MCHC without any valid, credible explanation and despite his having had access to industry-specific growth rates; (ii) Gartrell used a constant growth rate, which would yield the same value for MCHC regardless of the time frame; [11] and (iii) Gartrell created the financial projections based entirely on his own judgment, without reference to other available sources of relevant information. For these reasons, the Vice Chancellor determined, Gartrell's DCF analysis was meaningless. [12] Third, the Court of Chancery found that Gartrell's comparable company analysis was invalid because of his methodology and his data. To begin with, Gartrell switched between the mean and the median at critical points. To compute his EBITDA multiples, Gartrell used figures that were the median of their data set, but for every other computation he used the mean. Had Gartrell used the mean numbers consistently throughout, the value of MCHC based on EBITDA would be over $163 million which, when added to the non-operating assets, would be $183 million  a figure much closer to the value reached by the petitioners' expert. [13] Moreover, when calculating the correct weighting for the EBITDA ratio between rural and regional carriers, Gartrell applied a much higher weight (79%) to the rural companies than to the regional companies (21%). That (in the Court's words) was simply not reality, because MCHC was an MSA and had the future potential of an MSA. [14] As the Vice Chancellor found, the conclusion would appear inescapable that Gartrell established a pre-determined valuation figure to which he applied the EBITDA multiples. [15] Lastly, Gartrell chose inputs (based on the C-Block auction) that were not relevant to a valuation of MCHC, because the C-Block auction suffered from obvious and glaring flaws which included outdated data, different technology, an emerging market and inexperienced bidders. The result, the Court found, was that the C-Block data [could] not be termed comparable in any reasonable sense of the word. [16] MCHC has not appealed the Court of Chancery's rejection, in its entirety, of the valuation of its expert, Gartrell.
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]