Discovered E-mails Plus a Contingent Fee Discredit Appraiser's DCF Analysis
Business Valuation Advisor, Spring 2007
In re Oneida Ltd., 2006 Bankr. LEXIS 1985 (August 30, 2006)
During Oneida’s recent Chapter 11 proceeding, the international flatware company met a fork in the road: An ad hoc committee of equity holders intervened, arguing that Oneida was solvent. They objected to the proposed reorganization—which the company had negotiated with its secured lenders before filing, and which would convert a large portion of secured debt into 100 percent of the outstanding common stock of the emergent company.
Although the standard was high, the Court approved the special Equity Committee, not because it found any bad faith, but because it wanted to dispel any implication that the secured lenders had taken control of the company to “freeze out” the unsecured lenders and take the value of the remaining equity.
Approval turns on four valuation reports
The Bankruptcy Court received four expert valuations of the debtors (Oneida and its related companies and subsidiaries), all from investment bankers:
- Debtors. Credit Suisse concluded a total enterprise value of $190 million to $230 million, with a midpoint value of $210 million.
- Secured Lenders. Their financial advisors found a total enterprise value ranging from $190 million to $225 million, with a $207 million midpoint.
- Equity Committee. Its expert presented a total enterprise value of $260 million to $330 million, with a $295 million midpoint value.
- Creditors’ Committee. The unsecured lenders offered a rebuttal expert to critique the three reports for alleged errors in math and methodologies.
The first three valuations relied on a discounted cash flow (DCF) analysis. These experts also started with the company’s aggressive but optimistic financials, applying a weighted average cost of capital (WACC) to arrive at a discount rate. They agreed that WACC depended on an appropriate projection of debt and equity costs, as well as the ratio between the two. All of the experts used substantially the same cost of equity (19.9 percent to 20.5 percent).
Equity Committee goes much lower
Where the experts diverged was on the cost and apportionment of debt. While the other experts used the interest rate that would be charged on the debtors’ actual exit financing (12 percent to 13 percent), only the Equity Committee’s expert used the cost of debt for comparable companies, arriving at a 7.9 percent rate. He cited several valuation texts in support, and while the Court acknowledged the (unnamed) authority, it found the expert’s selection of comparables “problematic at best.”
In addition, the Court found little support for the expert’s use of a 60/40 debt-to-equity ratio in the WACC, compared with the 40/60 ratio that the debtors’ and secured lenders’ experts had used and the 70/30 ratio the rebuttal expert recommended. “It is pure speculation…that these debtors will be able to borrow so much at such low rates in the near-term future,” the Court said, as was the expert’s assumption that the debtors would secure a “B” bond rating. The Equity Committee argued that using the cost of debt and the debt-to-equity ratings of comparable companies removed the stigma of bankruptcy as well as the non-recurring nature of restructuring—but it apparently failed to present any supporting evidence. “There is no reason to believe that the cost of the Credit Suisse exit facility is an unfair indicator of the cost of debt of the Reorganized Debtor,” the Court found, “for a reasonable time going forward.
”The Equity Committee’s expert also made two other “dubious” adjustments to the debtors’ already aggressive projections: He assumed that they could stretch out the payment terms on their overseas debt, and he speculated that the cost of nickel would decrease over time. In light of all the evidence, the Court found the DCF analysis by the secured lenders’ and the debtors’ experts to be more reliable.
Finally, only the Equity Committee expert normalized the debtor’s revenues and EBITDA by reaching backward and forward five years. On cross-examination, however, he admitted that he had “never before used a normalization analysis in a published valuation report.” Moreover, he had relied on a 1920 U.S. Treasury publication regarding the intangible value of goodwill lost by breweries during Prohibition, and he had reached back to years when the debtors generated revenue from business segments that had since closed, adding nearly $8 million to EBITDA and $34 million in revenue, which the Court also found unreliable.
Conflicting testimony, e-mails, and interest
During its original motion for appointment, the Equity Committee had also presented the same expert, who had used the actual cost of the debtors’ exit facility in his analysis (despite later discrediting this approach). Worse, in an e-mail to an associate around the time of the final valuation, the expert had admitted:
We are using the cost of debt of the comps vs. [Credit Suisse]…using the cost of borrowing. What is our rationale? Do we have academic support for this? I testified previously that the cost should approximate the cost of the entire facility.
But the final blow was the expert’s acceptance of a contingency fee—after he had “emphatically” told the Bankruptcy Court at the appointment hearing that he “absolutely would not” enter into such an arrangement. “This contingent fee and the circumstances surrounding it,” the Court concluded, “seriously undermine [the expert’s] credibility.”
