December 2010 | Issue 49
In recent years, when faced with the need to determine the value of a business, the Delaware Chancery Court has come to employ the Discounted Cash Flow (DCF) approach as its principal method for ascertaining value. In a September 2010 case, however, WaveDivision Holdings, LLC and Michigan Broadband, LLC (“Wave”) v. Millennium Digital Media Systems, LLC et al (“Millennium”), the Court, although presented with a DCF approach to value, elected to place its reliance elsewhere.
Millennium and Wave are both broadband cable operators. In February 2006, Millennium and Wave entered into an asset purchase agreement under which Millennium was to sell its Michigan and Northwest cable operations to Wave. In July, 2006, Millennium sold these operations to somebody else. In this breach of contract action, Millennium was accused by Wave of violating a number of provisions of its asset purchase agreement, including a “no-shop” provision.
Theory of Damages
Vice Chancellor Strine, for the most part, agreed with Wave that Millennium had breached its agreement, and that Wave was entitled to damages. The proper measure of damages, he said, “is based upon the reasonable expectations of the parties ex ante. Millennium must put Wave in as good a position as they would have been had Millennium not breached.”
In broad strokes, the Court said that Wave was entitled to receive as damages the value it expected to receive from the transaction, had it been completed, minus costs avoided by not having to perform (most obviously the purchase price) and minus any mitigation that Wave was able to achieve.
The first step in the damages analysis, then, was to determine the value of the systems. Wave’s valuation expert began with the EBITDA (earnings before interest, taxes, depreciation and amortization) of the systems for 2006 of $24.9 million. He then estimated the expected growth rate of EBITDA from 2006 to 2009, producing a 2009 EBITDA of $42.4 million. The growth rate was based on the growth rates of EBITDA enjoyed by other systems acquired by Wave. He then applied a multiple of 7.8 times to the estimated 2009 EBITDA, producing a value of $332.2 million. This translated to damages of $85.5 million after mitigation and adjustments.
Millennium’s expert valued the two systems as of July 28, 2006, using a discounted cash flow approach. He used as a basis for his projections, a set of forecasts that Wave had presented to its bank to obtain financing for the transaction (Base Case Projections). After a number of adjustments, the Base Case Projections produced a value as of July 28, 2006, of $140.2 million for the systems. Since this was less than the $157 million purchase price contemplated by the purchase agreement, he concluded that Wave was not entitled to any damages.
The Court’s approach to quantifying damages was that they must be based on the buyer’s reasonable expectations at the time of the breach. He criticized Millennium’s method of calculating damages, which was to value the properties at the date of breach as if they were going to be sold immediately after purchase. Under this approach, said the Court, “If this were the proper measure of damages, buyers would be reluctant to ever purchase anything because so long as the sales process was market-based there would be by definition no injury to the jilted buyer if the seller reneged.”
The Court then set out to determine the expected value of the systems at December 31, 2009. It began by estimating the 2009 EBITDA by adopting the projections that Wave had made for bankers in connection with the transaction. He believed that “Wave’s Base Case projections that it provided to its lenders are the fairest representation of Wave’s expectations in the record.”
The Court then observed that the Base Case Projections could be used to perform either a DCF analysis or a multiple of EBITDA analysis. Millennium had argued for a DCF analysis. Wave countered that it was common in the cable industry to value systems using a multiple of EBITDA analysis. Furthermore, both Wave and Millennium itself had used the multiple of EBITDA approach when looking at possible transactions.
The Court concluded that the multiple of EBITDA was the appropriate approach, because it was the approach upon which Wave based its expectations, and because it appeared to be a common approach in the cable industry. By applying a 7.8 X multiple to an adjusted projected 2009 EBITDA of $34 million, the Court arrived at a December 31, 2009 exit value of $265.3. From this he subtracted the contracted purchase price and other costs and mitigation income to produce damages of $14.9 million.
This case can be viewed as an example of a Court, in a valuation matter, showing deference to methods of analysis which are commonly used in the financial community.