January 2011 | Issue 50
A new Delaware case illustrates again that the Discounted Cash Flow approach seems to be the favored valuation method in the Delaware courts. It also shows, however, that for the method to prevail, the projections underpinning it need to be sound and reasonable.
In September 2005, John Q. Hammons Hotels, Inc. (“JQH”) was acquired by Jonathan Eilian for $24 per share in cash. A number of JQH shareholders sued, claiming, among other things, that the $24 per share price was inadequate. The matter, In re John Q. Hammons Hotels, Inc. Shareholder Litigation (January 14, 2011), ended up in front of Chancellor Chandler in the Delaware Court of Chancery.
Both sides presented expert witness testimony on the issue of the fair value of the shares. The defendants presented the testimony of a finance professor from the University of Pittsburgh. He used a discounted cash flow (“DCF”) analysis to value JQH as at September 16, 2005, determining the value of the company’s shares to be between $14.97 and $18.71 per share.
Defendant’s expert relied on “management-approved” projections in performing his DCF analysis, and employed a 7.5% weighted average cost of capital. He chose not to use the comparable companies approach to value. He felt that it was not reliable, because of the lack of comparable companies.
Plaintiff’s expert also relied on a DCF analysis, as well as a comparable companies analysis and a comparable transactions analysis. He concluded that the value of the JQH shares at the time of the merger was $49 per share. This was more than twice the $24 merger price.
Plaintiff’s expert also adopted a 7.5% weighted average cost of capital. He relied on a set of projections that, although they had originally been prepared by management, had been modified, using what the Court felt were “unrealistic assumptions.” The Court rejected plaintiff’s calculations because of what it felt were unrealistically high projections.
The Court also rejected plaintiff’s expert’s comparable companies approach because of the substantial differences between JQH and the selected comparables.
Because of its numerous flawed assumptions and comparisons, the Court concluded that the plaintiff’s expert’s report had no relevance to the issue of whether the $24 per share merger price was fair to minority stockholders.
It is also reasonable to assume that the Court took note of and was influenced by the fact that the $24 price (which represented a more than 300% premium to the unaffected stock price) was the result of a nine-month competitive process between two bidders, which had pushed the bids from $13 up to $24 per share.