Laurel Gonsalves v. Straight Arrow Publishers, Inc.

2002 Del. Ch. LEXIS 105

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Text Box: SYNOPSIS Straight Arrow Publishers (mainly in the business of producing Rolling Stone magazine) merged into another company. A minority shareholder dissented, giving rise to this statutory appraisal case. In the case, the parties agreed to the appointment of a neutral valuation expert. The expert issued his valuation report and the parties began their task of challenging the expert’s assumptions and conclusions in order to gain any advantage for their respective clients. The expert valued Straight Arrow using the capitalization of earnings method, and the court agreed that this method was appropriate. Unusual in the realm of valuation cases, the court sets out a point-by-point outline of the steps involved in a capitalization of earnings valuation. See 2002 Del. Ch. LEXIS at *8 (section II.A, “The Valuation Framework”). In a further aid to readers’ understanding, the court quoted language from an earlier opinion issued in the case which condensed the process into “four key decisions”: 1. The choice of an appropriate earnings measure (e.g., EBIT, EBITDA); 2. The selection of the historical time period on which the measure is based; 3. The determination of which adjustments, if any, should be made to the earnings measure to reflect items such as non-recurring expenses; and 4. The determination of an appropriate capitalization rate. 793 A.2d at 312, 319 (Del. Ch. 1998). The court used Straight Arrow’s earnings before interest and taxes for a five year period as the appropriate earnings measure and historical time period. This is standard practice and was not contested in the case. However, adjustments to the EBIT figures (3) and choice of capitalization rate were hotly contested (4). The court first looks at the choice of capitalization rate. The expert derived the capitalization rate by examining the price-earnings ratios of public companies reasonably similar to Straight Arrow, averaging those ratios, and then making adjustments to that average in order to compensate for dissimilarities between the comparable companies and Straight Arrow. That capitalization rate was then multiplied by Straight Arrow’s known earnings (derived from the weighted five-year average of past earnings) to determine the company’s overall value. The neutral expert compared Straight Arrow to other diversified publishing companies and concluded that the appropriate capitalization rate was 11.00. Not surprisingly, the parties’ experts disagreed and argued that the methodology should be altered. For example, Plaintiff suggested that, since Straight Arrow’s largest asset was Rolling Stone magazine, the capitalization rate should determined by primarily comparing Straight Arrow to other magazine-only publishers. The court disagreed, finding that Straight Arrow’s business, though substantially consumed by Rolling Stone operations, included other publishing and non-publishing endeavors that make comparisons to more diverse companies appropriate. Numerous other detailed exceptions were made to the stable of public companies the neutral expert used for comparison. These are listed in footnote 23 of the opinion. The court next addresses whether adjustments should be made to the earnings figures. The primary source of debate was how “deferred subscription income” (“DSI”) should be accounted for in the earnings analysis. DSI arises when a magazine’s subscribers purchase multi-year subscriptions. When this occurs, the income for total length of the subscription period is received in the current year. The neutral expert deferred recognition of the income that can be attributed to subscription payments for subsequent years and accordingly did not include that income in her earnings calculation. Plaintiffs argued that DSI should be accounted for on a cash basis—meaning that Straight Arrow would recognize the total subscription payment in the current year, thereby increasing the firm’s present value. The court ultimately rejects these arguments and does not adjust the EBIT value.