Business Valuation Case Study: Patricia Laidler v. Hesco Bastion Environmental, Inc.
Business Valuation Court Case Analysis
Patricia Laidler v. Hesco Bastion Environmental, Inc., 2014 Del. Ch. (May 12, 2014)
The Delaware Chancery Court relied on a direct capitalization of cash flows (DCCF) analysis and rejected the market approach in determining the fair value of a minority shareholder’s ownership interest in Hesco Bastion USA, Inc. (Hesco). This case required a determination of the fair value of Hesco due to a merger with Hesco Bastion Environmental, Inc. (Environmental), an affiliated company. At the merger date, Patricia Laidler, (the Petitioner) was the sole minority shareholder in Hesco, holding a 10 percent ownership interest.
Hesco Bastion Ltd. (HBL), a company from the United Kingdom, designs and manufactures “Concertainer units,” a rapidly deployable barrier designed to be filled with sand and rock for the creation of mobile barriers used in storm and flood protection. The Concertainer units are stored accordion style, and once deployed, act as giant sandbags.
Hesco Bastion USA, Inc. was created for the purpose of licensing HBL’s intellectual property to non-military clients in the United States. Hesco assembled and sold the Concertainer units according to a licensing agreement with HBL.
The companies involved were related through common ownership. In this case, Hesco, HBL, Environment, and several other entities bearing the Hesco name operated under common control, with British entrepreneur James William Heselden retaining a controlling interest. In 2010, after Mr. Heselden’s passing, that controlling interest transferred to his estate (Estate of Heselden).
Operating in the flood barrier industry, Hesco’s customers consisted primarily of architecture and civil engineering firms, as well as government organizations. Natural disasters provided a substantial source of Hesco’s revenue, but those revenues fluctuated due to the unpredictable nature of those events.
Prior Transactions and the Merger
Patricia Laidler was the Managing Director of HBL until her termination in 2011. At that time Ms. Laidler owned a minority interest in Hesco and pursuant to a shareholder agreement, retained a contractual right to compel Hesco to repurchase her shares. Hesco sought an opinion from Willamette Management Association to value the minority stake in Hesco, opining that the fair market value was $180 per share. Ms. Laidler chose not to exercise her put right at that time.
In January of 2012, other minority shareholders tendered their shares in Hesco to Hesco Bastion Environmental, Inc. for $207.50 per share. However, Ms. Laidler continued to retain her ownership interest. On January 26, 2012, Hesco was merged into Environmental.
As mentioned, HBL, Hesco, Environmental and several other entities bearing the Hesco name operated under common control. At the merger date, 90 percent of Hesco was held by Environmental, who in turn was owned 100 percent by the Estate of Heselden. Because Environment held a 90 percent interest in Hesco, no stockholder vote was required to consummate the merger. Laidler, the remaining minority shareholder of Hesco, was offered $207.50 per share, which she declined. On May 23, 2013, Laidler filed a Verified Petition for Appraisal, pursuant to Delaware law.
Reliance on Merger Price
The Court declined to consider the merger price in determining fair value mainly because there was not an auction process for the merger. Instead, Hesco’s 90 percent controlling shareholder determined the price it would pay for Patricia Laidler’s minority interest. According to the Court, this did not result in an arms’ length transaction for Hesco.
In determining fair value a discounted cash flow analysis is often used. But that analysis requires financial projections, as prepared in the ordinary course of business. Because Hesco’s management did not prepare forward-looking financial projections, each financial expert instead relied upon historic financial results as the best representation of Hesco’s future operations.
Inconsistent revenues from natural disasters also impacted Hesco’s operations. Revenue in 2009 equaled $8.5 million, with $1.7 million resulting from one project. In 2010, the oil spill in the Gulf of Mexico provided $7 million in revenue to Hesco. During 2011, Hesco generated approximately $22.5 million in revenue largely due to a “500 year flood” that occurred in the western U.S. Those natural disasters played a role in the valuation of Hesco for at least one expert as revenue was “normalized” by backing out revenue related to certain projects.
Environmental’s expert developed value estimates using two separate market transaction methods. A comparable transaction analysis considered six companies acquired from 2007 through the valuation date and covered companies in small and middle markets, both public and private. According to Environmental’s financial expert, the comparable transaction analysis entailed qualitative adjustments because of differences in size, scale, business similarities and profitability.
The expert also developed a comparable company market analysis based on the guideline merged and acquired companies method but gave relatively little weight to this method due to the data points available and the comparability of the transactions. As a result of the differences between Hesco and those companies included in the analyses, the conclusions reached through the market approach were rejected by the Court.
Direct Capitalization of Cash Flow
Instead of the discounted cash flow method, the Court and both experts relied upon a direct capitalization of cash flow (DCCF) analysis in determining the fair value of Hesco. This method, also known as a capitalization of earnings, uses the economic benefits for a representative single period. That economic benefit is then converted to value through division by a capitalization rate.
According to the Court, “Though the DCF is more prominently employed in Delaware appraisal litigation, both parties’ experts opine that employing a DCF is not feasible here because Hesco’s management never made cash flow projections in the ordinary course of business.”
The economic benefit, or cash flow, was calculated differently by each expert. Ms. Laidler’s expert constructed cash flows by weighting Hesco’s 2010 and 2011 historical revenues 40 percent and 60 percent, respectively. To that figure, estimated profit margins and overhead were applied. The Respondent’s expert weighted “normalized” EBITDA figures for 2009, 2010 and 2011. Revenue for various projects had been removed as “non-recurring.” However, the Court did not agree with those adjustments.
The Court considered Hesco’s industry and the several “non-recurring” events that occurred in recent years. According to the Court, “(Hesco) is primarily in the business of providing asset protection in anticipation of natural disasters, so (Environmental’s) suggestion that all natural disasters are non-recurring, and therefore a poor predictor of future revenue streams, seems misplaced.”
The Court found that cash flows for 2009, 2010 and 2011, weighted equally, were the best predictor of Hesco’s future cash flows. The Court, after averaging cash flows for 2009 through 2011, estimated future cash flows at $7.48 million.
Capitalization Rates, Growth Rates, and Weighted Average Costs of Capital
Each financial expert used a build-up method to develop Hesco’s cost of capital and applied a weighted average cost of capital (WACC) in developing a capitalization rate. This cost of capital considered a return to both to the equity holders and the debt holders of Hesco. At the valuation date, Hesco’s capital structure was debt-free, but both experts agreed that if Hesco were to continue as a going concern it would require financing through borrowings.
The Court’s Conclusion
“In undertaking the statutory responsibility to ‘consider all relevant factors,’ (the court) often relies on market and income approaches to valuation … still, the Court may consider ‘proof of value by any techniques or methods which are generally considered acceptable in the financial community and otherwise admissible in court.’” The Court, basing its conclusion on the DCCF analysis, determined the fair value of Hesco at $364.24 per share.