Know Thyself: Self-Awareness in Corporate Valuations
By: Annette Becker and Kristen Berry
In Kendall Hoyd and Silver Spur Capital Partners, LP v. Trussway Holdings, LLC (C.A. No. 2017-0260-SG), the Delaware Court of Chancery (the “Court“) addressed the perennial challenges related to corporate valuations. The central question involved the determination of a corporation’s proper price-per-share in the context of an appraisal action arising from the conversion of a corporation into an LLC by merger. The Court rejected the use of “comparable companies” and “precedent transaction” analyses, defaulting to the use of discounted cash flow (DCF) analyses in the formulation of its corporate valuation.
TII is a private company that specializes in the manufacture of prefabricated trusses, which are rafters or struts that typically support roof structures, for the multi-family housing market. As the result of a previous settlement between Trussway Holdings, LLC, a Delaware limited liability company (“Trussway“), and Kendall Hoyd, Silver Spur Capital Partners, LP, a former, minority owner in Trussway (the “Petitioner“), was the sole petitioner in this appraisal action. The action involved the valuation of a wholly-owned subsidiary of Trussway, Trussway Industries, Inc. (“TII“) following the merger of Trussway’s predecessor, Trussway Holdings, Inc. (“Holdings“) into TW Merger Sub, Inc., with Trussway LLC being the surviving entity. The Petitioner did not vote in favor of nor did it consent to the merger. While Trussway and Petitioner agreed on the value of the corporate assets and liabilities, they disagreed on the value of the Trussway subsidiary, TII, at the time of the merger.
Prior to the merger, TII employed the assistance of an investment bank for purposes of selling TII. The investment bank concluded that TII’s enterprise value (“EV“) could range from $202 million to $298 million. The bank went through a sales process that yielded seven parties who expressed an interest in acquiring TII. Management conducted presentations that included pre-merger nine-year projections (the “Project Point Projections“). The Project Point Projections contemplated future, strategic initiatives, all of which accounted for 39% and 43% of projected revenue and EBITDA, respectively, by 2025. Moreover, the Project Point Projections forecast TII’s overall value as $235.9 million in 2017, which would grow at an accelerated rate (between 2.2% and 14.9% annually) through 2025. It is against this background that the merger was completed, whereby each share of common stock in Holdings was cancelled and converted into common units of Trussway. Shortly thereafter, TII received, but rejected, a cash-free, debt-free purchase price of $170 million.
Since the crux of the issue involved the valuation of TII in establishing the price owed to the former stockholders of Holdings as the result of the merger, both Trussway and Petitioner proposed to the Court a price-per-share as of the merger date ($387.82 and $225.92, respectively). Trussway’s $387.82 price-per-share was based on the weighted value of its expert’s DCF, comparable companies, and precedent transaction analyses. Alternatively, Petitioner’s valuation was based on its expert’s weighted use of two DCFs: one based on the Project Point Projections and the other based on a five-year period. As the result of the idiosyncratic nature of the business, the Court deemed the use of comparable and precedent modes of analysis inappropriate in determining the price-per-share. In other words, since DCFs value a company based on historical performance, rather than on comparative metrics or market analogs, the DCF was deemed the most objective model.
As to the comparable companies and precedent transaction analyses, the Court found that other firms were “too divergent from TII, in terms of size, public status, and products, to form meaningful analogs for valuation purposes.” Moreover, the previous $170 million offer price served only as a “reasonableness check,” not a substantive valuation metric. In defaulting to the use of the DCF model, the Court accepted the use of the nine-year Project Point Projections, despite their abnormally long temporal framework, as the result of the “cyclical” nature of the multi-family housing industry. The Court reasoned that this timeframe would “eliminate cyclical distortion[s].” Nevertheless, the Court conceded that all projections, especially one of this duration, are often subject to human error. As a result, the Court also adopted the Petitioner’s DCF analysis based on the five-year terminal period, giving both it and the Project Point Projections DCF 50% weight, respectively. By deferring to both Trussway’s and Petitioner’s preferred mode of DCF, the Court reasoned that it eliminated the parties’ substantive differences on the use of unlevered and relevered beta and the weighted average cost of capital (WACC). Finally, since the Court gave 50% weight to the Project Point Projections DCF, it defaulted to the use of a growth, as opposed to an exit, model in determining residual, or terminal, growth.
The use of the Court’s two-pronged DCF analyses, in conjunction with the addition of assets and the subtraction of liabilities, resulted in a value of $143,318,615, or $236.52 per share, for Trussway. This price-per-share was quite close to that proposed by Trussway, of $225.92 per share, and far afield of Petitioner’s claimed $387.82 per share. This case demonstrates the Court’s emphasis on context when deploying valuation models. Companies with unique market traits should be mindful of how they compare to potential peers and self-evaluate accordingly.