Court Opinion

ID: 4439166
Source: CourtListenerOpinion
Date Created: 2019-09-18 14:02:35.508221+00
Date Added: 2024-06-11T14:53:02.906922
License: Public Domain

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE

                                                 :
    IN RE: APPRAISAL OF                          :     CONSOLIDATED
    JARDEN CORPORATION                           :     C.A. No. 12456-VCS
                                                 :

                                          ORDER

         On this     16th   day of September, 2019, upon consideration of Petitioners’

Motion for Reargument (the “Motion”) and the Respondent’s Opposition to

Petitioner’s Motion for Reargument (the “Response”), it appears that:

         1.     On July 19, 2019, the Court issued its post-trial opinion in this appraisal

    action (the “Opinion”) in which the Court appraised the fair value of Jarden

    Corporation at the time of its merger with Newell Rubbermaid, Inc. at $48.31 per

    share. I based that appraisal on Jarden’s Unaffected Market Price (as defined in the

    Opinion).1 I also determined that this fair value determination was corroborated by:

    (i) other market evidence, including a pre-merger Jarden stock offering at $49.00

    per share; (ii) my independent discounted cash flow (“DCF”) analysis, which

    yielded a value for Jarden of $48.13 per share; and (iii) to a lesser degree,

    Respondent’s merger-price-less-synergies analysis, which yielded a value of $46.21

    per share. These valuation measures stood in contrast to Petitioner’s proffered fair

1
    In re Appraisal of Jarden Corp., Consol. C.A. No. 12456 (Del. Ch. July 19, 2019) (“Op.”).
    value of $71.35 per share based on a comparable companies analysis, which I

    rejected as incredible for reasons stated in the Opinion.

           2.      In the Motion, Petitioner’s argue that my DCF analysis does not

    corroborate my fair value determination because the DCF results were the product

    of certain structural and mathematical flaws.        Specifically, Petitioners argue

    I miscalculated Jarden’s unlevered free cash flows, miscalculated the weighted

    average cost of capital (“WACC”), miscalculated the terminal value and failed to

    make        proper   adjustments   for   certain    tax     shields   and   unfunded

    pension/postretirement liabilities. According to Petitioners, correcting for these

    errors results in a DCF value for Jarden of between $61.59 and $64.01 per share.

    And because this valuation is not corroborative of the Court’s appraisal based on

    Jarden’s Unaffected Market Price, Petitioners maintain that the Court must adjust

    its appraisal to reflect at least the range indicated by the corrected DCF analysis.

           3.      “A motion for reargument under Court of Chancery Rule 59(f) will be

    denied unless the court has overlooked a controlling decision or principle of law

    that would have controlling effect, or the court has misapprehended the law or the

    facts so that the outcome of the decision would be different.”2 In the appraisal

    context, this court has granted reargument in instances where the court has made

2
 Those Certain Underwriters at Lloyd’s, London v. Nat’l Installment Ins. Servs., 2008
WL 2133417, at *1 (Del. Ch. May 21, 2008).

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    structural or mathematical errors in the course of performing its own DCF analysis.3

    For reasons explained below, I agree with Petitioners that my DCF analysis must

    be corrected as the result of errors made in structuring the DCF model and

    calculating the value.4 I disagree, however, that the corrected DCF yields a fair

    value in the range of $61.59 and $64.01 per share.

         4.     Unlevered Free Cash Flows - The calculation of free cash flows in the

    Opinion’s DCF model does not add back depreciation or deduct Jarden’s year-over-

    year increase in net working capital. Petitioner corrects this error by adding

3
 See, e.g., Doft & Co. v. Travelocity.com Inc., 2004 WL 1366994 (Del. Ch. June 10, 2004);
Henke v. Trilithic Inc., 2005 WL 3578094 (Del. Ch. Dec. 20, 2005); DFC Global Corp. v.
Muirfield Value P’rs, L.P., 172 A.3d 346 (Del. 2017).
4
  Ironically, in the Opinion, I cautioned that our courts should not wade “deep into the
weeds of economics and corporate finance” without “the guidance of experts trained in
these disciplines.” Op. at 2. Yet that is precisely what I did when I endeavored to conduct
my own DCF analysis upon concluding that the credible evidence did not support certain
aspects of both of the competing experts’ DCF valuations. While I stand by that factual
determination, I did not adequately account for the fact that making adjustments to the
experts’ DCF models might require that other adjustments be made in order to stay true to
the DCF methodology. I made other unforced errors as well. With the assistance of the
parties, and their experts’ supplemental affidavits, I have attempted to correct those errors
here as best I can acknowledging fully that there must be a “better way to run a railroad.”
In view of the fact that the parties’ experts could not agree on any of the significant inputs
for the DCF analysis, I am more convinced than ever that the experts’ inability to agree on
inputs is evidence that DCF is not reliable here, particularly given the presence of a reliable
“market-based metric.” In re Stillwater Mining Co., 2019 WL 3943851, at *61 (Del. Ch.
Aug. 21, 2019). The better approach, therefore, would have been to leave it at that rather
than “parse through the inputs and hazard semi-informed guesses about which expert’s
view was closer to the truth.” Id. Having endeavored, instead, to work through the DCF
on my own, I will see that process through to the bitter end by engaging in the revised DCF
presented here.

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depreciation and subtracting the increase in net working capital. I agree that this

adjustment is proper, and reflect the adjustment below:

      5.     Weighted Average Cost of Capital - The Opinion’s calculation of

WACC incorrectly adjusted for tax twice, by making tax adjustments to the after-

tax cost of debt. Petitioner corrects for this error by omitting this second tax

adjustment from the after-tax cost of debt. I agree that this adjustment is appropriate,

and reflect the adjustment below:

                                           4
         I calculate the cost of equity, as I did in the Opinion, by using the capital asset

pricing model (CAPM), which defines the cost of equity as follows:

                       𝑟𝑒 = 𝑟𝑓 + 𝛽 × (𝑟𝑚 − 𝑟𝑓 ) + 𝑆𝑖𝑧𝑒 𝑃𝑟𝑒𝑚𝑖𝑢𝑚

Where:

    rf        =     Risk-free rate (represented by 10-yr U.S. Treasury bond rate)

    β         =     Predicted equity beta (levered)

    (rm − rf)=      Equity risk premium

         I calculate the after-tax cost of debt by multiplying the pre-tax cost of debt

(4.31%) by (1 - tax rate). To arrive at WACC, I multiply the cost of equity by the

equity to total capitalization, multiply the after-tax cost of debt by the debt to total

capitalization and add these two numbers together.

         6.    Terminal Value - The terminal value equation cited in the Opinion

conceptually intends to calculate the terminal value in perpetuity based on the year

T+1 unlevered free cash flows, growing at the terminal growth rate and discounting

WACC. Petitioner points out that the Opinion’s DCF Model does not use Terminal

FY21 NOPAT of $1,273 million in its formula to calculate the terminal value.

                                              5
Instead, the Opinion’s DCF Model uses Terminal FY21 unlevered free cash flows

of $939 million.5 Petitioner corrects for this error as follows:

      [A] FY20 NOPAT x 3.1% TGR; Opinion, pp. 110, 141; Exhibit 1
      [B] Panel A: Opinion, p. 141; Exhibit 1, Panel B: n/a
      [C] Panel A: Opinion, p. 141; Exhibit 1, Panel B: n/a
      [D] Panel A: FY21 Revenue x (average (Capital Expenditures / Revenue) for FY 16–FY20);
          Opinion, pp. 136, 141; Exhibit 1; Panel B: n/a
      [E] Panel A: [A] + [B] - [C] - [D]; Opinion, p. 141; Exhibit 1; Panel B: n/a
      [F] Panel A: [E] x (1 - 27.75% Terminal Investment Rate); Opinion, p. 141; Panel B: [A] x
          (1 - 27.75% Terminal Investment Rate) (see Opinion, pp. 115, 135–136, citing JX 1816 at
          ¶ 95; JX 2515, Damodaran, Investment Valuation at 313)
      [G] WACC - TGR = 6.94% - 3.10% if using the Court’s WACC and 7.29% - 3.10% if using the
          corrected WACC (see Opinion, pp. 110, 135; Exhibit 3)
      [H] [F] / [G]
      [I] Row [A]
      [J] Row [F]
      [K] [I] - [J]

5
  Op. at 141 (the Opinion’s DCF Exhibit used FY20 NOPAT of $1,235 million ×
(1 + Terminal Growth Rate of 3.1%).

                                               6
         Petitioner then uses the Opinion’s 27.75% Terminal Investment Rate (TIR),

Terminal FY21 NOPAT and the capitalization factor to arrive at the final Terminal

Value. The Opinion derived the 27.75% TIR by averaging Dr. Hubbard’s 33.9%

terminal investment rate (from the McKinsey formula for TIR6) and Jarden’s 21.6%

historical five-year average.7 As explained in the Opinion, I took the average of

Dr. Hubbard’s investment rate and Jarden’s historical five-year average because

I found that Dr. Hubbard had inexplicably included six years in his TIR, while the

terminal growth rate included only five.8 “By including the sixth year [the 2010

investment rate of 64.3%] in his calculation, Dr. Hubbard was able to reach a

significantly higher number for Jarden’s historical average growth.”9

         I agree with Respondent that maintaining 27.75% as the TIR in this revised

DCF valuation does not make sense for two reasons. First, as the Opinion notes and

endorses, “the return on new invested capital should equal the company’s WACC”10

and, as explained above, WACC (as amended here) is 7.29%. The Opinion’s TIR

improperly departs from this principle. Second, I no longer see a basis to account or

6
    TIR = g/RONIC.
7
    Op. at 110–12.
8
    Op. at 114.
9
    Op. at 114.
10
     Op. at 113 (citing Trial Tr. 1046:11–1049:23 (Hubbard); JX 2516; JX 2515).

                                             7
adjust for the unjustified sixth year of comparable growth as proffered by

Dr. Hubbard.11 This allows a straightforward application of the McKinsey formula,

as endorsed in the Opinion, to arrive at TIR given the corrected WACC and the

terminal growth rate.12

      Respondent has presented in the Response the following calculation for

determining the terminal value, adjusted for revised RONIC:

While I agree with the methodology employed in this calculation, I note that my

math yields $17,462, not $17,464. In any event, I rely on the terminal value

($17,465) calculated in the revised DCF (below) since it is the product of the

unrounded numbers with which the parties now otherwise agree, except for the TIR.

To be clear, I adjust the terminal value calculation in order for RONIC to equal

WACC under the McKinsey formula, by multiplying one minus the revised terminal

investment rate (3.1%/7.3%) by the FY21 net operating profits after tax (or NOPAT)

11
   In this regard, Respondent makes a valid point that the Court did not cite to finance
literature or the record in reaching its “blended TIR.” Response at 11.
12
  See Trial Tr. 1064:24–1065:6 (Hubbard); JX 2516 at 249–50; JX 2515 at 291; JX 1816
¶ 94; Aff. Prof. Hubbard ¶ 7 (Aug. 2, 2019).

                                           8
(a value of $1,273.3). I then divide the resulting product ($731.8—the FY21

unlevered FCF) by the capitalization factor (7.29% - 3.1% = 4.19%) to reach the

terminal value of $17,465.

         7.     Enterprise Value - The Opinion’s DCF model treated FY16 as a full

year, and thus includes all of the FY16 unlevered free cash flows in its calculation.

The problem, as Petitioner correctly notes, is that the merger closed in the first

quarter of FY16 so the calculation of FY16 free cash flows should be adjusted to

reflect the partial year.

         Dr. Zmijewski adjusted for the partial FY16 by multiplying the full year FY16

forecasted unlevered free cash flows by the portion of the year that remained after

the merger.13 Dr. Hubbard adjusted for the partial FY16 by calculating partial year

FY16 unlevered free cash flows as equal to the full year FY16 forecasted unlevered

free cash flows minus the actual first quarter FY16 reported unlevered free cash

flows.14 I adopt Dr. Zmijewski’s approach for the FY16 partial year adjustment

because, in my view, it more accurately accounts for the fact that the merger date

(April 15, 2016) was in the first few days of the second quarter of FY16.

13
     JX 1818, Ex. VI-7A.
14
     JX 1816, Ex. 16.

                                           9
      8.     Convertible Debt - The Opinion’s DCF model mistakenly adopted

Dr. Hubbard’s adjustment of $1.71 billion for convertible debt. Convertible debt is

dependent on pre-tax cost of debt and the value of equity. Because the Opinion

changed Dr. Hubbard’s pre-tax cost of debt and made other changes that affect

equity value, the value of convertible debt must also change. Dr. Hubbard updated

the convertible debt valuation from my DCF model to reflect the revised cost of debt

(4.31% pre-tax) and the revised enterprise value that follows from the other

corrections. Convertible debt, as the parties acknowledge, is derived from valuing

both the debt component and the warrant component of the convertible notes.

Dr. Hubbard employs an option-pricing model to arrive at the value of both

components. In doing so, it appears Dr. Hubbard used the share price he derived by

using the rounded terminal value that, as explained above, is not consistent with my

understanding of the proper application of the relevant formula. Nevertheless, I will

not disturb Dr. Hubbard’s calculated value for convertible debt. Not only do

Petitioners use Dr. Hubbard’s method of valuing convertible debt in in their revised

DCF, Dr. Hubbard has represented that he made the appropriate adjustments based

on the revised enterprise value and cost of debt and I have no basis to question that

representation.

      9.     Amortization - The Opinion’s DCF Model does not include any value

from tax savings that Jarden expected to receive from the amortization of intangible

                                         10
assets. Both experts included in their DCF models the value of tax shields that

Jarden expected to receive from the amortization of intangible assets. And both

experts valued these amortization tax shields using a discounted cash flow model.15

         I adopt Dr. Hubbard’s amortization tax shield since he uses the amortization

values found in the Proxy, but I apply the corrected 7.29% WACC and 35% tax rate,

which yields a value of $110.2 million.

         10.   Pension and Post-Retirement Liabilities - The Opinion’s DCF model

does not include any subtraction for pension and post-retirement liabilities in the

calculation of the value of equity. Both experts included a deduction of $159 million

in their calculations of the value of equity. I agree that this adjustment is appropriate.

         11.   The Corrected DCF Valuation - Correcting for the errors noted

above, the corrected DCF valuation is as follows:

15
     JX 1816 ¶¶ 134, 138; JX 1818 ¶ 69.

                                           11
                                        Discounted Cash Flow Analysis                                                 Assumptions

                                                                                                      Termin    WACC:                7.29%
($ in Millions)                                    FY16       FY17      FY18      FY19      FY20        al      Terminal Growth:     3.1%
                                                                                                       FY21     ROIC:                7.29%
                                                                                                                FY21 Rev Growth:     5.0%
Revenue                                           $10,147    $10,640   $11,172   $11,731   $12,317    $12,928   FD Share Count     219.9

     Growth Rate                                     --       4.9%      5.0%       5.0%      5.0%      5.0%

Unlevered Cash Flow                                $751       $884      $970      $1,044    $1,122    $731.8

- Cash Flow for Portion of Year Already Elapsed     210        0          0         0         0          -

Unlevered Free Cash Flow Adjusted for Portion
of Year Already Elapsed                            $541       $884      $970     $1,044    $1,122     $731.8

Capitalization Factor (WACC – TGR)                                                                    4.2%
Terminal Value                                                                                       $17,465
Time Period                                         0.36      1.21      2.22      3.22      4.22       4.22

Discounted Cash Flows                               527       811       830       832       834       12,978

Enterprise Value                                  $16,813
Non-Convertible Debt                               (5,043)
Value of Convertible Debt                          (1,865)
Pension and Postretirement Liability                 (159)
Cash                                                  749
Amortization Tax Shield                               110
Equity Value                                      $10,605

Shares                                             219.9
Share Price                                       $48.23

                  12.       The revised DCF, correcting for the errors properly identified by

   Petitioners and the revised TIR required by a proper application of the McKinsey

   formula yields a fair value for Jarden of $48.23 per share. “Hazardous” as it may be

   to rely upon the results of this valuation methodology in this context, particularly

   when credible market evidence of value is available,16 I am satisfied that the revised

   16
     See Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd., 177 A.3d 1, 35–37
   (Del. 2017) (observing that “[a]lthough widely considered the best tool for valuing
   companies when there is no credible market information and no market check, DCF
   valuations involve many inputs – all subject to disagreement by well-compensated and
                                                                          12
DCF valuation corroborates the Court’s appraisal based on the Unaffected Market

Price of $48.31 per share.

      Based on the foregoing, the Motion for Reargument is GRANTED in part as

it relates to the Court’s DCF valuation, and DENIED in part as it relates to the

Court’s final fair value determination.

      IT IS SO ORDERED.

                                                        /s/ Joseph R. Slights III
                                                             Vice Chancellor

highly credentialed experts – and even slight differences in these inputs can produce large
valuation gaps[,]” and then warning, “the Court of Chancery should be chary about
imposing the hazards that always come when a law-trained judge is forced to make a point
estimate of fair value based on widely divergent partisan expert testimony.”).

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