Business Valuation in a Volatile Economy: Three
From America's fiscal crisis have emerged a number
of test cases for bankruptcy courts, attorneys and business valuation experts.
The three cases discussed below - one an outgrowth of the S&L scandal -
illustrate common qualities of bankrupt and distressed companies and the
peculiar challenges that valuation professionals must confront in producing
reliable valuation reports amid chaotic financial conditions.
Refinancing of TOUSA
rapidly during the 2003-2007 housing boom, homebuilding giant TOUSA, Inc., made
a last, disastrous acquisition in 2005, funded with over $675 million in secured
financing provided by Citigroup. When the bubble burst, TOUSA defaulted, and
Citigroup insisted that the company cause its subsidiaries to borrow $500
million secured by liens on substantially all their assets. According to court
The company's restructuring advisor (Lehman
Bros.) called the $500 million deal the "best alternative" for TOUSA
shareholders but declined to provide a fairness opinion.
TOUSA's CEO warned that the company was
"dangerously overleveraged" and in "desperate need" of equity. Even if
de-leveraging was successful, he said, the company could probably not
service its debts and would "crash and burn."
Even Citicorp harbored significant doubts about
TOUSA's solvency but pressed forward, motivated by the prospect of
A multi-million-dollar incentive bonus for
TOUSA's CEO was contingent on completing the refinancing, as was $2.9
million in Lehman Bros. fees.
A hastily prepared fairness opinion, provided
by a third-party firm, relied heavily on management projections and the
promise of a $2 million fee for finding solvency.
The deal closed in 2007, but, within a year, the
company lost over 98% of its market value and filed for Chapter 11 protection.
In In re: TOUSA, Inc., 2009 WL 3519403 (Bankr. S.D. Fla.) the unsecured
creditors claimed that the transactions involving TOUSA's subsidiaries were
fraudulent because the subsidiaries were insolvent at the time of refinancing.
In a 186-page opinion, the Bankruptcy Court
examined the testimony from the parties' insolvency experts in great detail,
including their assumptions, methodologies and possible motives. The Court found
"serious problems" with the lenders' first expert, including his
"cherry-picking" of data. Even more problematic, the lenders' second expert
claimed that "no court" had ever rejected his opinion as unreliable, but the
Court found this was "simply not true." Worse, the expert contradicted his
deposition testimony in court, which "served only to erode [his] overall
credibility further." Finally, the fairness opinion was incredible, undermined
by haste and conflicts of interest.
By contrast, each of the analyses provided by the
plaintiffs' experts was reliable. In combination, "the analyses derive even
greater force" and persuaded the Court to find that TOUSA and its subsidiaries
were "grossly insolvent" as a result of the July 2007 transaction.
In In re: DBSD North
America, Inc., 2009 WL 3491060 (Bankr. S.D.N.Y.), the debtors were a
next-generation mobile satellite service provider. Despite obtaining over $51
million in secured first-tier financing and a $752 million secured, second-tier
facility, the debtors were unable to rent their broadcast spectrum and sought
Chapter 11 relief. They filed a deleveraging pan that would exchange 95% of
their stock for the $752 million in second-lien notes. The first-tier lenders
objected, contending that the cram-down failed to provide them the "indubitable
equivalent" of their secured claims.
To determine the debtors' total enterprise value
(or TEV), the parties' experts applied three methods: a guideline comparables
analysis, comparable transactions, and discounted cash flow (DCF). With varying
assumptions and weightings, however, their opinions created a wide,
multi-billion-dollar spectrum of value, radically ranging from $70 million to
The Court found "serious problems" with both
experts' DCF approach. In particular, the lenders' expert assumed a continuous
stream of "unrelenting" negative cash flows, which the Court found unrealistic,
serving only to skew his opinion to the low extreme. Only the comparable company
analysis was reliable, the Court concluded, in part because both experts used
the same guideline companies and produced mean values that were "only" $45
million apart. Because the debtors' expert gave more weight to this approach
than did the lenders' expert, the Court found his was the "best assessment" of
TEV, in the range of $492 million to $692 million, sufficient to keep the
secured lenders' investment "safe" during the proposed restructuring.
The Impact of FIRREA
In First Annapolis
Bancorp., Inc. v. U.S., 2009 WL 349020 (Fed. Cl.) the plaintiff/bank agreed
to purchase a failing federal thrift for $13.7 million. In exchange, the
government agreed to relax its capital and supervisory goodwill requirements.
Within a year, however, Congress passed the Financial Institutions Reform,
Recovery and Enforcement Act (FIRREA), effectively eliminating those
forbearances, breaching the agreement between the government and the bank, and,
the Court held, causing the plaintiff to fail.
The government presented two experts to obviate
damages. The first claimed that the bank was in such dire financial condition at
the time of the acquisition that it would have failed regardless of the
government's breach. Its second expert said the government's forbearances were
"essentially worthless" and, even without them, the bank would have failed.
The Court rejected the government's position.
Neither expert specifically analyzed when the bank became non-viable, and both
admitted that FIRREA negatively impacted the bank. They tried to cite myriad
causes for the bank's demise but failed to establish that any had the same
dramatic impact as FIRREA, which "destroyed [the bank's] ability to operate,"
the Court held. The Court cited credible evidence from the plaintiff's expert
showing the bank was viable at the time of the purchase and was meeting its
capital benchmarks until the government's breach "put it on an unavoidable
course to insolvency." Based on these findings, the Court awarded full
restitution of the bank's $13.7 million investment.