746
F. Supp. 251 (N.D.N.Y. 1990)
SYNOPSIS
Plaintiffs, former minority shareholders of Chenango Industries, Inc., brought suit against Great American Industries, Inc. (GAI), Chenango, and various officers and directors of those corporations challenging the legality of a joint proxy/prospectus issued by GAI and Chenango in connection with Chenango's 1979 merger into GAL The plaintiffs alleged that the proxy statement misrepresented and failed to disclose material facts regarding the financial condition of GAI and Chenango, and the integrity of, and the relationships between, the officers and directors of the two companies.
At trial, the district court found for the defendants, but the Second Circuit Court of Appeals reversed-finding that the proxy statement issued by defendants contained numerous material omissions and misrepresentations in violation of federal securities law. The case was remanded with instructions that "plaintiffs are entitled to recover damages equivalent to the benefit of the bargain they would have obtained had full disclosure been made. The determination of damages should include a valuation of Chenango's future earning power viewed prospectively from the date of the merger." 746 F. Supp. At 254.
The district court interpreted this directive and other case law as requiring a measure of damages that accounts for "the difference in the actual value of all that the plaintiffs should have received for their shares of Chenango and the actual value of what they received in exchange for their shares of Chenango stock" (GAI preferred stock).
In valuing Chenango, the court considered the testimony of five expert valuators and concluded that the method employed by the plaintiffs' expertthe capitalization of earnings method (using the Gordon Model)-provided the best estimate of the company's actual value. Capitalization of earnings requires two key inputs: (1) an estimation of Chenango's future cash flows as of the merger date and (2) a discount rate to reduce the value of those estimated cash flows to their present value on the merger date.
To estimate future cash flows, the court started with Chenango's earnings for 1979 as a baseline amount. Based on expert analysis, it was determined that this baseline cash flow could be expected to grow by 18% per year for the following five years and then level out at 7% per year thereafter. The discount rate of 21.4% was determined by using the Capital Asset Pricing Model (CAPM).
The court then discounted
the projected earnings for each year 1980-1984 (growing at 18%)
to present (1979) value. Next, the court discounted the projected
earnings post-1984 (growing at 7%) to present (1979) value. Having
performed these two calculations, the court simply added the present
value of the 1980-1984 and post-1984 earnings to arrive at a valuation
of Chenango.