{"id":4093,"date":"2018-11-08T08:44:50","date_gmt":"2018-11-08T15:44:50","guid":{"rendered":"http:\/\/celebrated-metal.flywheelsites.com\/?p=4093"},"modified":"2022-02-17T16:02:48","modified_gmt":"2022-02-17T23:02:48","slug":"a-strategic-undervaluation-can-come-back-to-bite-you","status":"publish","type":"post","link":"https:\/\/analyticbusinessappraisers.com\/a-strategic-undervaluation-can-come-back-to-bite-you\/","title":{"rendered":"A Strategic Undervaluation Can Come Back To Bite You"},"content":{"rendered":"

Abstract: \u00a0\u00a0<\/b>Reusing discounted financial projections prepared for transfer tax purposes can backfire in a shareholder dispute. A recent opinion from the Delaware Court of Chancery shows the importance of allowing valuators to arrive at their own independent conclusions. This article discusses the case, in which a corporation mounted an unsuccessful defense against a valuation challenge. <\/span><\/p>\n

Fox v. CDX Holdings, Inc. (F\/K\/A Caris Life Sciences, Inc.), <\/span><\/i>Del. Ch. Ct. 2015<\/span><\/p>\n

A strategic undervaluation can come back to bite you<\/b><\/p>\n

Reusing discounted financial projections prepared for transfer tax purposes can quickly backfire in a shareholder dispute. A recent opinion from the Delaware Court of Chancery, <\/span>Fox v. CDX Holdings, Inc<\/span><\/i>., shows the importance of allowing valuators to arrive at their own independent conclusions. <\/span><\/p>\n

Option holders challenge valuation<\/b><\/p>\n

Caris Life Sciences (now known as CDX) was a privately held Delaware corporation. Through subsidiaries, it operated three business units \u2014 Caris Diagnostics, TargetNow and Carisome. Only Caris Diagnostics was profitable. To achieve the dual goals of securing financing for the other companies and generating a return for stockholders, the holding company sold Caris Diagnostics to Miraca Holdings using a \u201cspin\u201d merge structure to minimize taxes. <\/span><\/p>\n

It first transferred ownership of TargetNow and Carisome to a new subsidiary and then spun off that subsidiary to its stockholders. At that point, owning only Caris Diagnostics, Caris merged with a wholly owned subsidiary of Miraca.<\/span><\/p>\n

The merger canceled stock options that represented about 2.9% of CDX\u2019s stock. The option holders were entitled to receive for each share the amount by which the fair market value (FMV) of the share exceeded the exercise price. A class of option holders sued CDX, alleging that management had undervalued the spun-off entity that held TargetNow and Carisome.<\/span><\/p>\n

Court rejects transfer tax valuation<\/b><\/p>\n

The court found that CDX\u2019s management had selected a value for the spun-off entity that wasn\u2019t a \u201cgood faith determination\u201d of FMV. Rather, the figure was generated by the company\u2019s tax advisor using an intercompany tax transfer analysis designed to ensure the spinoff would result in zero corporate-level tax. The court found management provided \u201cfalsely low numbers\u201d to support the transfer tax valuation, which was <\/span>not<\/span><\/i> a fair market valuation.<\/span><\/p>\n

According to the court, the tax advisor\u2019s conclusion that the entity had a value of $65 million conflicted with the stockholder\u2019s subjective belief from earlier in the year that TargetNow alone was worth $150 million to $350 million. It also conflicted with views held by the company\u2019s founder, the private equity fund that held about 25% of Caris shares and the company\u2019s financial advisor. And it contrasted with higher values that an accounting firm had generated for the same businesses in a series of valuation reports prepared for other purposes in the same year as the merger.<\/span><\/p>\n

Moreover, at the time of the merger, Miraca questioned the tax advisor\u2019s valuation and insisted on a second opinion from the accounting firm that had previously valued the company for other purposes. The tax advisor and stockholder met with the accounting firm before it began work. It proceeded to prepare a valuation that largely (and admittedly) copied the tax advisor\u2019s analysis. Therefore, the second opinion was slightly lower than the transfer tax valuation.<\/span><\/p>\n

The court noted that previous Delaware decisions have criticized erroneous or seemingly motivated analyses by financial advisors. But the accounting firm\u2019s second opinion \u201creached a new low.\u201d The court observed, \u201cThe copy job was so blatant that the output matched [the tax advisor\u2019s], even when the inputs differed.\u201d The accounting firm also abandoned its previous valuation methodologies. And, when it didn\u2019t copy directly from the tax advisor\u2019s original report, the valuator made significant errors.<\/span><\/p>\n

Credibility counts<\/b><\/p>\n

The management of CDX tried to distance itself from the second opinion by conceding it was flawed and arguing that no one relied on it. But the court found that the report reflected on the integrity of the option valuation process, and it awarded approximately $16.3 million in damages. To avoid such costly mistakes, remind your clients about the importance of expert witness independence \u2014 both in reaching accurate figures and maintaining the client\u2019s credibility with the court.<\/span><\/p>\n

 <\/p>\n","protected":false},"excerpt":{"rendered":"

Abstract: \u00a0\u00a0Reusing discounted financial projections prepared for transfer tax purposes can backfire in a shareholder dispute. 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