Only a week after a New York trial court issued its contentious ruling that KO’d DLOM in Zelouf, a different court pronounced on the issue in another pot-stirring fair value proceeding that featured an “extremely successful company,” extremely contentious business partners, and extremely well-known valuators.
The successful company is AriZona (of iced tea fame), founded in 1992 by the plaintiff and the defendant and now the largest privately owned beverage company in the United States. Both partners were equal shareholders but after a few years into the business venture, they started to have a falling out. For the good of the business, they decided that the defendant should take control of the day-to-day decisions. They also signed an owners’ agreement limiting the transfer of shares in AriZona to a designated class of transferees.
Two prominent suitors: At one time or another, two industry giants expressed an interest in acquiring part or all of AriZona. One was Tata, a global conglomerate and the second largest tea manufacturer in the world. In 2005, Tata estimated AriZona might be worth as much as $4.5 billion, and it came up with similar estimates over the next 10 years. But Tata never performed due diligence on AriZona and never obtained board approval for pursuing an acquisition.
The other suitor was Nestlé. In July 2010, it expressed interest in buying the plaintiff’s 50% interest for $1.3 billion conditioned on Nestlé’s ability to conduct due diligence, to eventually acquire the defendant’s shares, and to reach an agreement with both partners to control the company. After the plaintiff rejected the proposal, Nestlé increased the offer to $1.45 billion. Ultimately, discussions foundered. Nestlé’s board of directors never authorized any acquisition of AriZona. Nestlé said it was unable to obtain “good financial data” from AriZona.
A few months later, the plaintiff, frustrated by the transfer restriction in the owners’ agreement and the failed attempts to sell his shares, sued for the dissolution of the company. In return, the defendant decided to pursue a buyout. The court’s valuation of the plaintiff’s 50% interest drew on elements from both sides. No expert’s analysis was the clear winner.
As to the valuation method, both sides agreed to use a discounted cash flow (DCF) analysis and rejected the net asset value (NAV) approach. But the plaintiff’s experts also advocated in favor of using a comparable transaction analysis, albeit weighting the resulting value at only 20% and assigning the remaining 80% to the DCF value.
The defendant objected that the proposed comparables were not sufficiently similar in size, timing, and products and were “synergistic market transactions” that the controlling case law did not recognize. The court agreed. AriZona, it said, was “truly sui generis, and thus any attempts to find comparable companies are truly lacking.” Also, the expressions of interest from Tata or Nestlé were unreliable indicators of the value of AriZona. Neither company had access to audited financials or was able to do due diligence, and neither company’s board of directors had approved an acquisition. The only method resulting in a reliable value calculation was the DCF, the court decided.
Liquidity risk? The parties’ experts differed on a number of DCF components, including DLOM. The defendant’s expert proposed a 35% rate. The owners’ agreement was proof that the partners could not easily liquidate their shares. The plaintiff’s expert maintained there was no justification for a DLOM. The company had been successful and major companies had expressed an interest in buying part or all of it.
The court sided with the defendant. It quickly distinguished this case from Zelouf, in which the court ruled against the use of a DLOM since there was no real liquidity risk because the business at issue probably would never be for sale. The liquidity risk in this case was real, the court said. The stalled Nestlé negotiations exemplified the plaintiff’s difficulty of liquidating his shares. At the same time, the defendant’s own expert, a recognized authority on valuations, allowed that “smaller discounts are often appropriate for large and growing companies.” This described AriZona, the court said, reducing the DLOM to 25%. The court’s “back of the envelope” calculation suggested AriZona was worth about $2 billion on the valuation date.
Takeaway: Expressions of interest in a company are not bona fide offers and, by extension, are not reliable indicators of value. Also, New York courts continue to find a rationale for applying a DLOM in fair value proceedings despite the questions the recent Zelouf decision raised about the theoretical underpinnings of DLOM.
Find an extended discussion of Ferolito v. AriZona Beverages USA LLC, 2014 N.Y. Misc. LEXIS 4709 (Oct. 14, 2014), in the January issue of Business Valuation Update; the court’s opinion will be available soon at BVLaw.