Are A Debtor's Trading Prices Reliable Evidence Of Its Enterprise Value?
First published by ABI Journal, September 2011
Valuation disputes can be among the most critical issues addressed during the course of a bankruptcy case, at least in terms of economic impact to various bankruptcy participants. They arise in several contexts, including plan confirmation, adequateprotection requests, avoidance actions and the appointment of equity committees. Courts have generally recognized three accepted methodologies for valuing a debtor company: (1) the "discounted cash flow" (DCF) approach, which values a company based on the present value of projected future cash flows; (2) the "comparable company" approach, which values a company by reference to the trading prices of similar public companies; and (3) the "comparable transactions" approach, which values a company by reference to recent mergers and acquisitions involving similar companies.2
Problems with Valuation Methodologies
Courts may be reluctant to embrace any methodology outside this "trinity," and a number have looked askance at any sort of "novel" deviation from it.3 At the same time, courts and commentators have long acknowledged the many shortcomings of the accepted methodologies, even referring to the valuation exercise in its current form as "a guess compounded by an estimate."4 The DCF method, generally regarded as "the most commonly used and accepted method of valuing an enterprise,"5 presents an alluring façade of exactitude but can sometimes rest on a shifting foundation of assumptions and subjectivity. The slightest tweak in a debtor's assumed cost of debt, cost of equity or revenue growth rate can alter a calculated enterprise value by billions of dollars, particularly because so much of the debtor's value often comes from a "terminal value" up to 10 years in the future.6 Comparable companies and recent comparable transactions can be difficult to find. Each of these problems is magnified by the systemic biases the parties and their experts may have, in order to arrive at a particular value that could serve their economic interests.7 Judges are often placed in the difficult position of having to choose between two extreme polar valuations.
Traded Claims and Interests
All the while, in major cases, another rather obvious source of information about a debtor's enterprise value has largely been ignored: the trading prices of various claims against or equity interests in the debtor, including traded securities (e.g., stocks and bonds), bank debt and trade claims. Perhaps, seeing clearly insolvent chapter 11 debtors maintain positive stock prices, courts struggled with concerns that the trading prices of a debtor's securities are inherently unreliable.8 It is no longer the case that a debtor's stock comprises the only commonly traded interest. In large chapter 11 cases, bank loans,9 second-lien financings ,bonds and even trade claims10 may be freely traded in fairly liquid secondary markets. Unlike equity markets, which are more acce ssible to unsophisticated and potentially inattentive investors, distressed-debt markets tend to be dominated by professional investors. To take just one run-of-the-mill example of how liquid such markets are, consider the case of Blockbuster Inc. From its petition date of Sept. 23, 2010, to April 2011, its senior subordinated bonds traded 1,524 times for an aggregate volume of approximately $323 million.11 The range of values expressed by such trades can inform the court's view of whether value is likely to be available to unsecured debtholders. Actively traded instruments could be an efficient mechanism for price (value) discovery; while not dispositive, they can provide dozens of daily datapoints from sophisticated investors with "skin in the game."
Courts have recognized the valuediscovery benefits of markets in certain bankruptcy contexts. For example, in VFB LLC v. Campbell Soup Co., the Third Circuit resoundingly approved of market capitalization (number of...
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