Towerview LLC v. Cox Radio, Inc., 2013 Del. Ch. LEXIS 139 (June 28, 2013)
Five years after the 2008 economic meltdown, observers look back with a good deal of hindsight. But when the Delaware Court of Chancery recently assessed the reliability of prerecession management projections for its discounted cash flow analysis (DCF), hindsight is precisely what it wanted to avoid.
After a radio broadcasting business merged into a wholly owned subsidiary of its parent company, a group of shareholders, the petitioners, asked the Chancery for a statutory appraisal. To determine the fair value of their stock on the merger date (May 29, 2009), both sides presented experts. They both agreed that the DCF was the appropriate valuation method but clashed over the issue of how committed management was in May 2009 to long-range projections (2009-2013) that were done before the economic collapse. In fact, in the wake of the crisis, in January 2009, management had produced another forecast for the year, which it updated again for each month leading up to the transaction. The May 20, 2009, forecast was the most recent one before the merger. This projection suggested a far less optimistic view of the future: Projected revenues were 16.8% lower, and operating cash flow was 40.1% lower than the respective values in the 2009 LRP. Still, there were signs that management did not entirely distance itself from the LRP.
Cyclical or secular change? The petitioners’ expert assumed that in early 2009 the industry and the company were in a cyclical slump from which they would—and would expect to—re-emerge. The steep 2008 recession would be followed by a steep recovery, and the company would return to the 2009 LRP after 18 months (i.e., in late 2011). Accordingly, he used the May 2009 forecast to project cash flows for 2009 and the 2009 LRP to project cash flows for 2010 through 2013.
In contrast, the company’s expert assumed that, by the merger date, company management and radio industry observers realized that the industry was undergoing a “secular” change, which had begun before the 2008-2009 collapse. Management considered the 2009 LPR obsolete and did not expect a return to its financial projections. Therefore, the expert incorporated the May 2009 forecast for 2009 EBITDA and then estimated 2010-2013 by using the actual EBITDA compound annual growth rate (CAGR) that the company showed in the four years following the most recent 2000-2001 recession.
This approach, the court decided, was the correct analytical framework. Even though the court normally considered premerger management projections “an appropriate starting point from which to derive data in the appraisal context,” here it was “wary” of accepting the argument that a valuation on the merger date “would anticipate a near-term return to even the 2009 LRP’s 2011-2013 cash flow projections.”