December 2014 | Issue 77
This valuation proceeding arose out of a four-year litigation struggle between John Ferolito and Domenick Vultaggio, the co-founders of AriZona Beverages. AriZona is the largest privately-owned beverage company in the United States.
Stated simply, the case involved the valuation of the AriZona entities (“AriZona” or “company”); a collection of companies that produce food and beverages, most notably, ready-to-drink (RTD) iced tea. The two founders and their families each own 50% of the company.
The need for a valuation arose out of an effort by Ferolito to require Vultaggio to purchase Ferolito’s shares. Ferolito believed that the company was worth $3.2 billion. Vultaggio valued the company at $426 million. A trial on the matter was held in New York Supreme Court in Nassau County in the spring of 2014. Ferolito v AriZona Beverages USA LLC, 2014 N.Y. Misc. LEXIS 4709 (Oct. 14, 2014).
Founded in Brooklyn in 1992 by Ferolito and Vultaggio, the company was a success almost from its founding. In 1994 the company moved to Nassau County. The move began to sow the seeds of discontent between Ferolito and Vultaggio, starting with Ferolito’s displeasure with the significant increase that the move to Nassau added to his commuting time from New Jersey. Ultimately, the parties agreed that Vultaggio would have final authority over the business. Profits continued to be equally distributed between them, however. The two families have received over $500 million each in distributions since AriZona was founded.
The law in New York provides that the respondent in a dissolution proceeding may purchase the shares of the petitioner seeking dissolution “at their fair value.” The court was faced with the task of determining the fair value of the company. It concluded that the valuation should not incorporate any “strategic” or “synergistic” element of value, as such an element “would be too speculative to quantify with any certainty.”
Both parties presented valuation experts. Both parties attempted to determine value utilizing the discounted cash flow (DCF) approach to value. Ferolito’s expert applied an 80% weight to the DCF approach and 20% weight to an approach based on “comparable” merger and acquisition transactions. Vultaggio argued that the DCF approach should be the sole basis of measurement of value.
The court agreed with Vultaggio. It concluded that AriZona was sui generis, and that there were no companies that were truly comparable to it, thus ruling out the comparable company approach to value.
Both parties also ruled out the net asset approach to value. Accordingly, the valuation came down to application of the discounted cash flow approach to value. This required a projection of the company’s future cash flow, which, in turn, required a projection of future revenues and costs. The cash flow would then be discounted to the present at an appropriate discount rate.
The court, in general, found the plaintiff’s projections of revenues and costs, including their 4 ½ % terminal growth rate, to be more reliable than the defendant’s,
The parties had little disagreement on the discount rate to apply to the cash flows. The court adopted plaintiff’s 10.8% versus defendant’s 11%.
Key Man Discount
The court pointed out that New York’s Business Corporation Law permits a valuation discount of a company’s anticipated cash flow “to reflect the contributions of current essential personnel.” He concluded in this case that the “presence, charisma, work ethic, leadership and talent “of co-founder Domenick Vultaggio warranted an adjustment to the valuation to reflect the risk that the company might in the future lose the benefit of his services.
Discount for Lack of Marketability
A discount for lack of marketability (DLOM), when applied to a valuation, is intended to adjust the valuation to reflect the fact that shares in a privately-held company may not be readily liquidated for cash. In this case, defendant argued that the court should apply a DLOM of 35%. Plaintiff argued that no DLOM is warranted. The court concluded that a discount was appropriate, but reduced the amount to 25%.
Risk of Insolvency
The defendant argued that any valuation other than one based on defendants’ assertions would render the company insolvent. The court rejected this argument, stating that an adjustment for this risk “could provide Vultaggio with a windfall he could easily exploit if he decided to sell the shares he acquires from the Ferolito parties.” He further pointed out that the risk of insolvency depends not just on the valuation, but on the terms and conditions of any payout of that valuation. The court concluded that it “rejects Vultaggio claim that the amount of the award …. to the Ferolito parties, in itself, is somehow hazardous to AriZona’s health in a cognizable way.”
The court concluded that its “back-of-the-envelope” calculations, based on DCF methodology, suggest a valuation for AriZona of about $2 billion. After adjustment for DLOM and pre-judgement interest, the award works out to about $1 billion for the shares at issue. The detailed terms and conditions are to be worked out at a future proceeding.