Many readers of this blog understand the importance of asset and enterprise valuation at a number of stages of the bankruptcy process. Whether it be specific collateral (to address a secured creditor’s concerns) or enterprise value (to determine the viability of a Chapter 11 plan), or for purposes of a fraudulent transfer or an asset sale, the discipline and methodology of valuation forms a fundamental touchstone of business insolvency practice.
A recent Delaware Bankruptcy Court decision highlights the use of valuation in yet another context: The appointment of equity committees. In the Chapter 11 cases of Spansion, Inc. and its affiliates, Judge Kevin Carey reviewed the request of an ad hoc equity committee’s request for official sanction and appointment by the Office of the US Trustee. To evaluate the committee’s request, Judge Carey turned to case law holding that the appointment of an equity committee depends upon:
- the substantial likelihood of a distribution to equity holders after all creditors are paid; and
- equity holders’ inability to represent themselves without such an official committee.
Central to Judge Carey’s decision was a detailed analysis of the anticipated distribution to equity holders. Spansion’s disclosure statement, submitted with its proposed Chapter 11 plan, valued the debtors’ enterprise value at less than the amount of creditors’ claims and therefore left nothing for equity. The ad hoc equity committee (not surprisingly) believed enterprise value after payment was sufficient that equity holders should have a collective voice with respect to the proposed plan.
Both sides submitted extensive evidence in support of their positions. Unlike the debtors’ “full-blown” valuation, however, the ad hoc equity committee submitted a “sensitivity analysis” based on the debtors’ numbers and including an analysis of “precedent transactions,” comparable trading multiple analysis, and a discounted cash flow (DCF) analysis.
A substantial portion of Judge Carey’s 20-page decision denying the ad hoc equity committee’s request revolves around a careful weighing of the parties’ competing valuation evidence. The ad hoc equity committee’s valuation evidence ultimately faltered on four points:
- The future of the debtors’ market: For Judge Carey, the ad hoc equity committee’s analysis was not sensitive enough. It inferred growth estimates based on the broader semiconductor and memory markets rather than for the debtors’ smaller (and much less healthy) specific memory market.
- The estimated DCF terminal value: The ad hoc equity committee’s valuations assumed constant cash flow growth (a view not shared by the debtors), higher EBITDA multiples, and higher terminal values. By contrast, the debtors’ valuation assumed flat to negative growth, and a lower terminal value.
- Valuation of specific assets: The ad hoc equity committee claimed certain valuable assets – such as cash, litigiation claims held by the debtors, and net operating losses - were not accounted for in the debtors’ estimate of enterprise value. While acknowledging that cash ought to be included in enterprise value, Judge Carey nevertheless found that the ad hoc equity committee offered no support for its valuation of the litigation claims at issue. He found, further, that ambiguity surrounding the effect of the debtors’ net operating losses was not sufficiently resolved by the ad hoc equity committee to assign it any value for the committee’s analysis.
- Total amount of claims: The ad hoc equity committee’s claimed equity stake derived at least in part from its estimate of claims. However, Judge Carey found that the committee had neglected to include administrative claims and cash requirements necessary to exit from Chapter 11. The committee also had neglected to estimate the value of claims from as-yet-to-be-rejected contracts.
In the end, Judge Carey found that “[t]he only thing certain . . . is the uncertainty of the valuations” – and that, as a result, the ad hoc equity committee’s “uncertain” estimate had not established the “substantial likelihood” of distribution required for official appointment.
Judge Carey’s valuation analysis is instructive. Specifically, it highlights the evidentiary burden that can attend valuation fights in a bankruptcy case, as well as the thoroughness with which a court may investigate enterprise value.
Something to consider in a variety of bankruptcy contexts.