Reviewing and Critiquing a Valuation Report

Type of Matter:

A business valuation was prepared immediately before a complex stock transaction was finalized. That valuation report was later scrutinized in response to a claim that it was improper and erroneous.

Background:

A complex stock-for-stock transaction was contemplated between owners of a closely-held business involving over 20 subsidiaries. In contemplation of that transaction, the company retained a valuation expert to place a value on a portion of the business. The transaction was consummated at the value determined by that expert. Subsequently, the valuation conclusion was challenged and Arxis was retained to evaluate the report.

Arxis Work:

A copy of the complete report and all documentation that was originally supplied to the valuation expert was provided to Arxis. With that information we attempted to replicate the calculations, assumptions, and conclusions presented in the report. As a result, numerous substantial errors were identified. It was a collection of some of the most common valuation errors wrapped up in one report:

  • An invested capital risk rate (WACC) was used to value a cash flow to equity benefit stream. This, by definition, results in an incorrect conclusion.
  • The expert properly concluded that public companies were inappropriate to use as guideline companies. However, throughout the rest of the report public companies were used to project cash flow, capital expenditure levels, and working capital.
  • Public company data was used to determine the WACC rate for the subject company. This was inappropriate given the conclusion that public companies were not comparable to the subject company.
  • The expert did not consider, or adjust for, non-operating assets and non-operating income and expenses.
  • The sale of similar privately held companies (Market Approach) was not considered. This was problematic since there were hundreds of transactions in the same SIC code as the subject company available.
  • Prior transactions (several) of company stock were not considered.

Result:

The report was so flawed that all parties agreed it had to be set aside and a new valuation performed. A substantial amount of money had been spent on a valuation that was flawed on every level.