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April 03, 2007 Maverick Valuation - An Invented Methodology
Nellson Nutraceutical, 2006 Bankr. LEXIS 3186 (November 29, 2006)
Nellson Nutraceutical, a privately held manufacturer of nutrition bars, filed for Chapter 11-bankruptcy protection in 2006. At issue was the company's $355 million and $10 million in secured and unsecured debt, for the debtors to be "in the money" Nellson's enterprise value needed to exceed $365 million. In September 2006, the bankruptcy court held a hearing to determine the company's enterprise value. Four valuation experts testified in case, three of which utilized standard methodologies - discount cash flow ("DCF"), comparable transactions and comparable companies. A standard DCF analysis segments an entity's future cash into two parts: (1) the projected free cash flow for the interim periods determined via a company's projected financial statements; and (2) a terminal value which estimates the value of a long-term investment in the entity.
The three valuation experts utilizing a standard DCF used a multiple of Nellson's projected 2011 earnings before interest, taxes, depreciation and amortization ("EBITDA") as the metric to calculate the company's terminal value. However, the lender's expert modified the DCF terminal value calculation by subtracting the company's normalized projected capital expenditures ("Cap Ex"), subsequently producing lower enterprise value for Nellson. During questioning, the lender's expert testified that he had never used this methodology in any report or ever submitted similar analysis to a tax court.
The tax court rejected the modified to the terminal value calculation citing FRE 702 and the Daubert standard as partial rational for its decision. The court found that the methodology had not been tested, peer-reviewed or generally accepted in the business valuation industry. The court opinion stated, that the evidence indicated that the modified methodology of using EBITDA minus Cap Ex was simply invented and struck the testimony and report from the record.
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