Expert's "Invented" Enterprise Valuation Methodology Found Unreliable and Inadmissible
In re Nellson Nutraceutical, Inc., 356 B .R.364 (Bankr. D. Del. 2006) (Judge Christopher S. Sontchi)
At trial to determine the enterprise value of the Debtors, the Debtors’ expert tendered a valuation opinion based on a metric of EBITDA minus capital expenditures. Because this methodology is not generally accepted by experts in the field, and, moreover, was invented by the Debtors’ expert for use in this trial, the Court held that this method lacked reliability, and the Debtors’ expert’s testimony was therefore inadmissible under Federal Rule of Evidence 702.
The Debtors are a privately-held corporation whose ultimate equity owner was Freemont Investors VII, LLC. Exclusive of equity, the Debtors’ debt amounts to $365 million. Thus, for Freemont to recover in the bankruptcy, the value of the Debtors must exceed $365 million. At this trial, the agent for the Debtors’ first and second lien debt tranches, UBS AG, the Informal Committee of First Lien Holders, the Official Committee of Unsecured Creditors, and the Debtors each presented expert evidence on valuation of the Debtors’ enterprise. The experts for the each of the creditor constituencies agreed that the Debtors’ value is less than $365 million, while the Debtors’ expert placed the enterprise value at $404.5 million.Each of the creditor constituency experts used a discounted cash flow analysis to determine valuation, in addition to a precedent transaction or comparable transaction analysis, and a publicly traded company or comparable company analysis, and weighed each to provide an enterprise value for the Debtors. The Debtors’ expert substituted the DCF analysis for a methodology that he devised and termed “EBITDA minus capital expenditures,” and relied solely upon that valuation methodology.
The Court found that the Debtors’ expert was a qualified expert. The Court also found, however, that EBITDA minus cap ex was an unreliable method of calculating enterprise value and determined that his testimony relying on that method was therefore inadmissible. It was an unprecedented method that the expert invented for use at this trial. Applying the Supreme Court’s Daubert test and its progeny, the Court found that EBITDA minus cap ex (i) was an untested technique; (ii) had an undeterminable error rate; (iii) was a technique without any acceptance in the relevant community; and (iv) was a technique that, although related to the accepted methodology of EBITDA, was less reliable. Weighing those factors, the Court found the Debtors’ expert’s testimony to be unreliable and, therefore, inadmissible.
