No matter how many times I see it happen, I’m always intrigued when a new stock valuation decision comes along in an oppressed shareholder buyout proceeding in which the opposing experts come up with valuations light years apart. How is it that two impeccably credentialed business appraisers, operating under the same independence principle, looking at the same data, and following the same valuation guidelines, can produce such divergent numbers? Is the court required to accept one or the other, or should it appoint its own neutral appraiser, or compute value itself?
Last December I wrote about one ill-fated valuation decision in which the lower court adopted wholesale one of the two widely divergent expert appraisals, only to be reversed on appeal and remanded for a new valuation hearing. Today I write about another valuation decision in which the trial court rejected both experts’ appraisals and came up with its own computation of fair value. Matter of Beattie (PlanData Systems Corp.), 2009 NY Slip Op 30181(U) (Sup Ct Suffolk County Jan. 15, 2009).
PlanData Systems Corp., located in Huntington, New York, offers space management services to owners and facility managers of commercial buildings. The business uses a proprietary computer program called SpaceMan to design and manage the clients’ commercial properties. In 2006, 40% shareholder Ronald Beattie sought judicial dissolution of PlanData under the oppressed minority shareholder statute, Section 1104-a of the Business Corporation Law. The 60% shareholder, Steven Smith, elected to purchase Beattie’s shares for fair value under the buyout statute,BCL Section 1118. After the two shareholders failed to reach agreement on price, the fair value question went to a hearing before Suffolk County Commercial Division Justice Elizabeth Hazlitt Emerson.
Each side presented a valuation report and testimony by a well-credentialed expert business appraiser. The primary difference in approach stemmed from characterizing PlanData either as a software company or a services company. Beattie’s expert testified that he was "instructed" to assume that PlanData is best described as a software company. His valuation relied on a separate calculation of the replacement cost of the SpaceMan software prepared by a computer consultant who also testified as an expert on Beattie’s behalf. This expert based his calculation in the sum of $718,000 on "good-faith estimates" of the amount of time and labor expense it would take to recreate a program like SpaceMan, derived from "industry norms and his overall business experience" rather than specific data from PlanData’s books and records.
Beattie’s expert appraiser incorporated the $718,000 software replacement cost in his valuation of the company using the three common valuation methods: Asset (Cost) Approach, Market Approach and Income Approach. He testified that none of these methods alone provided an accurate assessment of fair value and that a weighted approach using data produced by all three methods was more appropriate. The court’s decision does not disclose his weighting percentages or the underlying figures; it simply notes the expert’s testimony that he selected the percentages based on his "business judgment and experience." Using his weighted approach the expert arrived at a value of $618,000 for Beattie’s 40% interest. Beattie’s expert also contended that no discount for lack of marketability should be applied.
Smith’s expert also considered the Asset, Market and Income Approaches. He rejected the Market Approach due to lack of data on companies sufficiently similar to PlanData. He also rejected the Asset Approach because it is generally used for the companies "the real value of which is in assets such as real estate." In relying on the Income Approach alone he reasoned — contrary to Beattie’s expert — that PlanData is a company that provides services for its clients using various software programs, but it is not a software company. He noted that over 83% of company revenue is derived from measuring and drafting services. Using the company’s historical financial data and a 19.11% capitalization rate under the Income Approach, Smith’s expert computed a value of $102,159 for PlanData, to which he applied a 25% discount for lack of marketability, resulting in a value of $30,648 for Beattie’s 40% interest. He then added 40% of the company’s "excess cash" to arrive at a total value of $128,829 for Beattie’s shares. The difference between the two competing appraisals? Approximately 500%.
Justice Emerson did not adopt either side’s valuation. She concluded that the record did not support Beattie’s expert’s use of a weighted average of the three methods and the percentage assigned to each. She faulted his use of the Market Approach for lack of sufficiently similar transactions. More importantly, she disagreed with Beattie’s expert’s "use of [software] replacement cost as a proper method of valuing PlanData" and noted that the analysis "also contains a number of important assumptions that do not relate to specific data derived from PlanData’s books and records."
Smith’s expert’s analysis fared better insofar as Justice Emerson agreed that the Income Approach is the proper valuation method. She also agreed with his capitalization rate and some of his income adjustments. However, she declined to adopt his calculations in certain key respects and instead came up with her own "alternative calculation." The main differences in the court’s calculation were: an increase in the company’s average net income; an increase in the add-back of officer "perks"; and a significant decrease in the officer reasonable compensation figures. The court’s calculation almost doubled Smith’s expert’s valuation of Beattie’s 40% interest, to $245,626.39. (The last page of the court’s decision is a helpful line-item chart of the court’s adjustments to Smith’s expert’s Income Approach calculations.)
Finally, Justice Emerson also agreed with Smith’s expert’s application of a 25% marketability discount which, in my view, has become something of a default percentage in the Second Department. The discount is not applied against the allocation of excess cash.