Resolving or Explaining Valuation Disputes Reviewed by Momizat on . Through Pop Culture References It often takes more time and skill to explain something simply and shortly and less time to use a lot of words, spreadsheets, and Through Pop Culture References It often takes more time and skill to explain something simply and shortly and less time to use a lot of words, spreadsheets, and Rating: 0
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Resolving or Explaining Valuation Disputes

Through Pop Culture References

It often takes more time and skill to explain something simply and shortly and less time to use a lot of words, spreadsheets, and technical jargon. Nevertheless, pop cultural references can be used to quickly crystalize issues because many people are familiar with them and their underlying meaning. This article identifies some pop cultural references that can be used to help resolve or explain valuation disputes.

Resolving or Explaining Valuation Disputes Through Pop Culture References

Introduction

“If you can’t explain it simply, you don’t understand it well enough.” This statement may appear to be a paradox, like another famous quote: “If I had more time, I would have written a shorter letter.” However, it often takes more time and skill to explain something simply and shortly and less time to use a lot of words, spreadsheets, and technical jargon. Nevertheless, pop cultural references can be used to quickly crystalize issues because many people are familiar with them and their underlying meaning. This article identifies some pop cultural references that can be used to help resolve or explain valuation disputes.

Valuation through Storytelling

Valuation is part science and part art. The science part is typically straightforward because practitioners tend to use similar approaches. The art part, on the other hand, is much more subjective. Textbooks tend to focus a lot on the science and not so much on the art.

Large differences in values proffered by dueling experts are frequently driven by differences in their underlying stories. One expert may see a company poised for profitable growth whereas another expert sees a company doomed to fail due to the burden of too much debt. Some practitioners believe crypto currencies will play a crucial role in the future whereas others think crypto currencies will ultimately share the same fate as pet rocks or Pets.com. There are large variances in forecasts that drive these differences, but the forecasts are driven by different stories.   

Reference #1: Show Me the Money

A recently fired sports agent desperately tries to retain the right to represent a football player in the movie Jerry Maguire. This football player says he will stay with the agent for the time being, but the agent must “show me [i.e., him] the money” to keep his business. It is a classic movie scene because the recently fired agent screams this phrase while he is still at his former employer’s office.

The “show me the money” scene is a dramatization of a simple but powerful concept: Show, do not tell. Or more colorfully: money talks and BS walks.

“Show me the money” can distill certain valuation disputes too. For example, one expert may contend a company is worth “a lot” whereas another expert counters that it is worth “a little.” The best way to resolve this dispute (if available)[1] is to highlight money-backed decisions that imply the company was in fact worth “a lot,” “a little,” or somewhere in between. It is much more compelling when an expert (or someone with no skin in the game) puts their money where the expert’s mouth is. Contemporaneous actions speak much louder than contemporaneous (or after-the-fact) words.

Perhaps nobody made this point more compellingly than Judge Easterbrook from the 7th Circuit, who wrote:

… self-interest concentrates the mind, and people who must back their beliefs with their purses are more likely to assess the value [ ] accurately than are people who simply seek to make an argument. Astute investors survive in competition; those who do not understand the value of assets are pushed aside. There is no similar process of natural selection among expert witnesses and bankruptcy judges.[2]

Reference #2: More Cowbell

“I got a fever! And the only prescription … is more cowbell!” “More cowbell” is a Saturday Night Live (SNL) skit that goes behind the scenes of the Blue Oyster Cult’s recording of “Don’t Fear the Reaper.” Will Ferrell—while wearing the textbook definition of a shmedium shirt—plays the cowbell in an increasingly annoying fashion. The other bandmembers are understandably upset. Surprisingly, the music producer encourages Will Ferrell to be as annoying as possible with the cowbell because it somehow results in a better song. The other bandmembers ultimately agree. Apparently, there is no such thing as too much cowbell for this song.

The “more cowbell” skit is a great way to frame the debate over the efficient market hypothesis (EMH).

The EMH posits that market prices reflect the value of a security when using all publicly known information. Investors cannot “beat the market” without inside information, which means the best course of action is to invest in low-cost index funds.

Of course, the active investment management industry disagrees with this premise. Its members attempt to generate incremental risk-adjusted returns that are greater than the marginal costs incurred to obtain them. These excess returns are not available if the market is semi-strong efficient. (We are keeping inside information out of this discussion, so no “I am not uncertain” Billions-type of excess returns.)

There can be credible arguments for and against the EMH. This perspective may be best captured by the 2013 Nobel Prize in economics that went to the founder (Eugene Fama) and a leading critic (Robert Schiller) of this hypothesis. Notably, the most famous stock picker in history (Warren Buffet) is paradoxically a leading advocate of the EMH. Thus, Warren Buffet effectively says: Do as I say, not as I do. It is an interesting debate.

Nevertheless, the debate (like Will Ferrell playing the cowbell) is a feature, not a bug, from EMH advocates’ perspective. The EMH is in fact dependent on naysayers who repeatedly try to beat the market but are doomed to fail. It is the active investors’ actions that enable the market to become semi-strong efficient, which allows other investors to be free riders. Thus, the EMH becomes weaker when more people believe in it and stronger when fewer people believe in it. It is for this reason that there can never be too much cowbell (naysayers)—as annoying as it may be—for supporters of the EMH.

For a more detailed discussion on this topic, see: https://quickreadbuzz.com/2017/05/10/proponents-efficient-market-hypothesis/ and https://quickreadbuzz.com/2017/05/24/debate-efficient-market-hypothesis-effect-contested-valuations/.

Reference #3: These Go to 11

A guitarist claims to have special amplifiers in the mockumentary Spinal Tap. Ordinary amplifiers have dials that go to 10 whereas this guitarist’s amps have dials that go all the way to 1. An interviewer asks why these amplifiers do not just have the loudest setting at 10 like ordinary amplifiers (i.e., make 10 on these special amplifiers louder). The guitarist dismisses the premise of the question when he responds: “these go to 11.” Of course, the superficial inclusion of 11 on the dials does not actually make the amplifiers any louder.

I am reminded of this movie scene when someone includes a company specific risk premium (aka a “fudge factor”) in a discount rate to offset some perceived problem with the estimate for expected cash flows. This practitioner adopts a “two wrongs make a right” approach by using (a) cash flows that are too high and (b) a discount rate that is too high. Because value is positively correlated with cash flows and negatively correlated with discount rates, these two “wrongs” in theory cancel each other out.

Of course, it would be better to just get the cash flows correct (or make 10 louder on the amp) in the first place. After all, “no wrongs make a right” is much better than “two wrongs make a right.” 

However, it is difficult to address the degree to which the projections are inflated. That explains the allure of the backdoor reduction to projections via a higher discount rate. But if we do not know the extent to which the projections are inflated, we also do not know how much of an increase in the discount rate is required to offset it. So, this approach turns out to be “two wrongs hopefully (but I have no idea if it works) makes a right.” 

The convoluted logic of using a “fudge factor” is like the logic used by the guitarist who thinks an amplifier that goes to 11 is somehow louder than an amplifier with dials that only go to 10.

Reference #4: Really?!

“Really?!” was a recurring SNL skit. Seth Meyers and Amy Poehler mocked illogical behavior with one word: “Really?!” For example, then Atlanta Falcons quarterback Michael Vick was caught trying to circumvent airport security by hiding weed in the compartment of a specialized water bottle. The SNL response included:

I don’t know if you’ve heard, but you can’t bring bottled water past security anymore. So you hid your weed—which is not allowed on a plane—in another thing that is not allowed on a plane. That’s like hiding your weed in the barrel of a gun or in the mouth of an endangered species. Really?! 

Many of us have been involved in disputes where the other side takes extreme positions that seem very difficult to support. Those who proffer these views can seem like “Baghdad Bob,” Saddam Hussein’s military spokesman who made obvious false statements such as “There are no American infidels in Baghdad. Never!” during the American-led invasion of Iraq. The rebuttal to these positions can be boiled down to one word: “Really?!”

I was once involved in such a case that ultimately encouraged two of the lawyers to write an article calling for the end of valuation-related expert testimony as we know it. These lawyers were influenced by the appellate court’s (3rd Circuit) view that the district court treated the expert testimony at trial as a “side show” due to the overwhelming contemporaneous fact evidence. These lawyers wrote an article titled “Campbell, Iridium, and the Future of Valuation Litigation” in The Business Lawyer.[3]

The lawyers proposed a new paradigm where valuation-related testimony is not routinely allowed. Instead, they suggested a process where a litigant would first have to “establish by motion that the non-expert contemporaneous market evidence is insufficient to permit the finder of fact to make a reasoned determination of value.”[4] In effect, this change would require a proactive showing that testimony should be included, as opposed to the current practice of reactively challenging certain testimony (e.g., under Daubert grounds). Notably, market evidence is defined broadly to include contemporaneous indicators that go beyond security prices (e.g., views of company insiders or creditors).

Their proposal did not catch on, but their general views regarding certain types of cases have held up well over time. Solvency-related cases have focused on contemporaneous market evidence (i.e., “Show me the money!”). It seems to have become much harder for petitioners to prevail with large payouts in Delaware appraisal cases that argue the publicly traded company was sold too cheaply. (Why shouldn’t Delaware judges defer to real time money-backed transactions?) It is hard to have a battle of the experts in certain cases where one side’s views can be rejected with one simple word: Really?!

Reference #5: All About that Bass

Meghan Trainor had a hit song titled that “All About that Bass.” It was a catchy song that embraced body acceptance.

The phrase can be phonetically recast as “All About that Base.” Certain valuation disputes are ultimately All About that Base, such as base multiples and base earnings.

Sometimes there is a dispute over whether there are any reasonably comparable guideline companies. It can be a legitimate dispute. But it may also be the case that one side is making a result-driven argument (especially when someone takes the position that the guideline companies are comparable enough for discount rate purposes but not for valuation multiple purposes). Consider a solvency analysis (which is a binary test) where the company is solvent if it is worth at least 4x EBITDA and all of the reasonably possible guideline companies trade well above 4x EBITDA. The base multiple in this industry is clearly above 4x EBITDA, which would suggest that this company is solvent. An argument that there are no comps may be All About that Base multiple that the practitioner wants to run away from.

Base earnings are also important. We tend to focus on growth rates, but growth must start from somewhere. It is often easier to grow a stronger base than a weaker base. A company that recently made large investments (strong base) is likely to grow faster than a company in the same industry that has been coasting on investments made several years in the past (weaker base). The ability to grow in many instances is also All About that Base.

Reference #6: To Infinity and Beyond

Buzz Lightyear’s catchphrase in Toy Story was “To Infinity and Beyond.” The phrase is noteworthy because (1) infinity is not a place and (2) one cannot go beyond infinity. It is a clear way to explain that certain outcomes cannot happen.

While inflation may be currently be high, we do not have to worry about approaching infinity in valuations anytime soon. However, the concept can be applied when going in the other direction. Due to limited liability, equity is essentially always positive (even bankrupt stocks often have some option value until the bankruptcy plan is finalized) and cannot be negative (so-called negative equity occurs due to other issues separate from equity).[5] Thus, straight equity cannot go to zero and beyond (i.e., negative).     

Nevertheless, sometimes a practitioner will value straight equity at a negative value. I experienced this once when a practitioner performed an event study that combined several negative events. Setting aside the debate over whether these subsequent events were foreseeable, this practitioner took the interesting step of adding the reductions [e.g., 100% – (50% + 50%) = 0% of stock price] instead of multiplying the reductions [e.g., (100% – 50%) * (100% – 50%) = 25% of stock price] to arrive at the “but for” value.

It is standard practice to multiply when combining reductions, which means the revised stock price cannot go below zero. This practitioner’s addition approach can arrive at revised stock prices that are (significantly) lower than zero. That cannot happen in the real world, which is why this practitioner took the so-called “conservative” approach of not including discounts that added up to more than 100%. This fake conservatism cannot conceal the fact that this approach kind of went to Infinity and Beyond, or more precisely, to Zero and Beyond.

Closing Thoughts

As someone in his late 40s, I acknowledge (and my teenage daughter repeatedly reminds me) that some of my pop cultural references are getting a bit long in the tooth. Hopefully, someone in these pages will identify additional—and more recent—pop cultural references that help resolve or explain valuation-related disputes.

Please note that opinions contained within this article are the author’s and not his employer’s.

[1] Various factors are relevant, such as seniority of the securities (more junior the better) and symmetry of info (less private info that is not disseminated into the broader market the better).

[2] Matter of Central Ice Cream Co., 836 F.2d 1068, 1076 (7th Cir. 1987). This excerpt was highlighted in an article focused on expert valuations: Schwartz, Michael W., and David C. Bryan. “Campbell, Iridium and the future of valuation litigation.” The Business Lawyer (2012): 939–955.

[3] Schwartz, Michael W., and David C. Bryan. “Campbell, Iridium and the future of valuation litigation.” The Business Lawyer (2012): 939–955.

[4] Ibid at 939.

[5] For example, an owner of a company may provide a personal guaranty on a loan issued to the company. The effective net equity position can become negative in this situation (e.g., if the company becomes insolvent and the owner must make the lenders whole), but that is an artifact of the personal guaranty that is separate from the equity.


Michael Vitti, CFA, joined Kroll(formerly Duff & Phelps) in 2005. Mr. Vitti is a Managing Director in the Morristown, NJ office and is a member of the Expert Services practice. He focuses on issues related to valuation and credit analyses across a variety of contested matters.

Mr. Vitti can be contacted at (973) 775-8250 or by e-mail to michael.vitti@kroll.com.

The National Association of Certified Valuators and Analysts (NACVA) supports the users of business and intangible asset valuation services and financial forensic services, including damages determinations of all kinds and fraud detection and prevention, by training and certifying financial professionals in these disciplines.

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