Cede & Co. v. Technicolor, Inc.

1990 Del. Ch. LEXIS 259

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Text Box: SYNOPSIS In this case, the court faced a “battle of the experts” who presented widely varying valuations. Technicolor, the renowned Hollywood film processing company, found itself in dire financial straits in the early 80s after several poorly conceived ideas for new businesses (including one hour photo labs) and increased competition from Kodak had eroded its preeminent position in the film industry. Realizing the time had come to sell out, Technicolor agreed to merge with another company. A minority shareholder dissented, giving rise to this judicial appraisal proceeding. Two experts submitted valuation reports and testimony to the court, both employing the DCF method. One valuator concluded Technicolor was properly valued at $13.14 per share. Not surprisingly, the other valuator saw things differently, concluding that an entirely reasonable value would be $62.75 per share. Chancellor Allen was not mollified by this “distressingly wide difference” and “astonishing range.” At the outset, the court noted that since the experts were looking at the same historical data in making their cash flow projections, “[a] significant part of this difference is accounted for by the differing discount rates used in the DCF models. If one substitutes the higher discount rate used by respondent’s principal expert for the lower rate used by petitioner’s expert and makes no other adjustment to either DCF model the difference reduces from $49.61 a share to $20.86 a share.” Accordingly, the court devotes significant attention to the choice of discount rate. Respondent, in arriving at the low valuation, estimated Technicolor’s cost of capital by using the Capital Asset Pricing Model (CAPM). The petitioner’s expert used a simpler method: First, he determined two external discount rates: the weighted average cost of capital for the company acquiring Technicolor and the average cost of capital for all manufacturing companies. Next, he averaged the two discount rates. The court was unimpressed by the petitioner’s novel method and ultimately adopted the CAPM approach. The court, however, did make some significant adjustments to the inputs. First, the court concluded the beta coefficient of 1.7 chosen by the expert was too high for a “company with relatively stable cash flows.” The court opined that the beta was unduly affected by the volatility in Technicolor’s stock during the time period surrounding the merger announcement. It chose to apply the lower beta of 1.27 that was published immediately prior to the announcement. 1990 Del. Ch. at *97. Second, the court rejected the expert’s addition of a 4% premium because Technicolor was a small capitalization company (the rationale being that empirical studies have shown that small cap companies require such a premium). The court was not convinced and noted that, though Technicolor was technically a “small cap” company, it had many of the characteristics of large cap companies—such as its relatively old age and brand name identification.