Studies Show Merger SynergiesAre Optimistic

A factor behind many M&A deals is the expectation of an increase in value triggered by the combination of two firms into a new entity. In reality, this synergy takes a lot longer to materialize than you think—and often does not happen.

New studies: A pair of reports from PwC reinforce existing research findings that the acquiring firms simply do not realize the full value of the synergies they expect. One report, Capturing Synergies to Deliver Deal Value, lays out a framework for delivering deal value by identifying, managing, and executing on synergy opportunities. A synergy analysis needs to be done early on in the assessment of the target company—long before the deal is announced. The second report, PwC’s 2014 M&A Integration Survey Report, backs up the general belief that cost synergies are more achievable than revenue (growth) synergies. Two-thirds of buyers report favorable results for capturing cost synergies, but results from capturing revenue synergies are much worse, with just over half (54%) reporting a favorable result.

These findings reinforce the notion that expected revenue or growth synergies need to be viewed as more uncertain than cost synergies when doing projections. Also, they will take more time to achieve.

Because of this uncertainty, more risk is associated with revenue synergies, so the required return should be adjusted accordingly.

Studies Show Merger SynergiesAre Optimistic ........................................... page 1

Concerns With M&A Targets .................... page 2

No Easy Money in M&AShareholder Suits for Plaintiffs ................. page 2

Candy Crush Gets “Crushed”But Other IPOs Do Well ........................... page 2

Priorities for the Heathcare Industry ......... page 3

Hospitals Shift M&A Focus toOutpatient Facilities .................................. page 3

Plaintiffs’ Case Undermined byLack of Valuation Expert ........................... page 3

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©2013. No part of this newsletter may be reproduced or redistributed without the express written permission of the copyright holder. Although the information in this newsletter is believed to be reliable, we do not guarantee its accuracy, and such information may be condensed or incomplete. This newsletter is intended for information purposes only, and it is not

ABOUT VALUE MANAGEMENT INC. VMI the performance of more than 6,500 valuations. Appraisals are rendered for estate tax planning, litigation support, and many other situations requiring independent appraisal. Our

VMI’s clients and friends. Those interested

This publication is intended to provide accurate and authoritative information on the subject matter covered. It is distributed with the understanding that the publisher and distributors are not rendering legal, accounting or other professional services and assume no liability whatsoever in connection with its use.

(C) 2014 No part of this newsletter may be reproduced or redistributed without the express permission of the copyright holder. Although the information in this newsletter isbelieved to be reliable, we do not guarantee its accuracy, and such information may be condensed or incomplete. This newsletter is intended for information purposes only, and is

not intended as financial, investment, legal or consulting advice.

VMI HighlightsVMI is pleased to announce that David J. Peer, ASA, has joined VMI as a Senior Financial Analyst. David brings 8 years of experience with him to this position. Welcome, David!

Value Management Inc. was a sponsor at the ESOP Association’s Super Regional Board of Directors and Trustees Conference which took place on June 4th - 5th in Philadelphia, Pennsylvania.

Ed Wilusz led a “lunch and learn” at the Bar Association of Lehigh County on June 18th. His topic was, “The 5 Hottest Trends in Business Valuation for Estate Planners.”

If you are interested in having one of our experts give a presentation to your firm or at a conference, please contact Susan Wilusz at smw@valuemanagementinc.com or at 215.343.0500.

ValueManagementInc.

S U M M E R 2 0 1 4

The Business Valuation Specialist

the matter should be reviewed under entire fairness, the highest standard of review in corporate law, and should proceed to trial.

Range of valuations: Finding the case presented a “novel question of law” as to the applicable standard for review, the Chancery used the business judgment rule and granted the defendants summary judgment. In terms of the first requirement—the special committee requirement—there was no question as to its independence and empowerment, the Chancery stated. It was able to hire its own legal counsel, and it interviewed four potential financial advisors (“FA”) and ultimately retained one. The committee and the FA asked management for updated projections to reflect current thinking on the target’s prospects. The revised forecasts indicated a downward trend. The FA used various valuation tools, including the discounted cash flow (DCF) method and comparable company analyses to value the stock. Valuations based on the updated projections indicated a range of $15 to $45 per share. The DCF valuations generated a range of fair value of $22 to $38 per share; a premium paid analysis indicated a range of $22 to $45 per share. Ultimately, the parties settled on a “best and final”

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In This Issue

Pennsylvania Office: 2370 York Road, E2 • Jamison, PA 18929-1031

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offer of $25 per share. The FA opined the price was fair based on generally accepted valuation techniques. A majority of the minority shareholders approved the deal.

The merger, the Chancery found, resulted in a 47% premium to the closing price preceding the offer. It noted that the FA considered the price fair in light of various analyses, “including a DCF analysis, which mirrors the valuation standard applicable in an appraisal case.” It pointed out that the plaintiffs did not produce a valuation from an expert that declared the merger price was unfair. They rationalized their omission by saying the defendants’ motion was not about the issue of fairness but about the business judgment rule. But, said the Chancery, the plaintiffs had to realize that to survive summary judgment they would have to show that the merger imposed terms that a rational fiduciary could not accept in good faith. Without a countervailing expert opinion, they “have not come close to meeting that burden.”

The Supreme Court affirmed the Chancery’s rulings on the applicable standard and on the summary judgment motion.

five lawsuits (the Dell Inc. buyout led to 26 suits, which distinguished this transaction as the most litigated deal in 2013);

• The “go-to court” for M&A litigation has been the Delaware Court of Chancery, which during the past four years has been followed by New York County, N.Y.; Santa Clara County, Calif.; and Harris County, Texas; and

• In 75% of the deals, there was a resolution before the deal closed. As to the resolution, 88% of the cases resulted in a settlement, 9% were withdrawn by the plaintiffs, and 3% ended in dismissal by the court.

Cornerstone Research points out that in 2013 shareholders settling their claims received monetary returns only 2% of the time. Many of the settlements are disclosure-only settlements, meaning the defendant merely agrees to provide more transactional information to the shareholders. Some courts, including judges in the Delaware Chancery, have voiced criticism about these settlements because they provide little value to the shareholders.

Candy Crush Gets “Crushed” But Other IPOs Do Well

The initial public offering market during the first quarter of 2014 was at its busiest since 2000. The quarter ended with almost double the number of IPOs from the first quarter of 2013. Biotech proved to be the winner, with over 25 deals, many with no or very small revenues. An improving economy, easier pre-IPO regulations from the JOBS Act, and increased investor interest in funding growth companies have contributed to the IPO pick-up.

King Digital Entertainment falls: Most IPO’s performed well post-offering, but the high-profile King Digital Entertainment, owner of popular online games Candy Crush and Farm Heroes, fell almost 20% in the first few days after its offering. Investors were probably skeptical of the company’s continued scorching growth rate. From 2012 to 2013, revenues increased from $164 million to $1.88 billion, and the company’s adjusted gross cash rose from $28 million to $825 million. While on the surface the market value of the company (close to $7 billion) as a multiple of adjusted EBITDA of nearly 8.5 is not expensive, it may be very expensive if growth slows because the company cannot develop new games. The revenue

growth was highlighted by high user participation—users play almost 1.1 billion Candy Crush games every day. That kind of participation will be hard to replicate in future games.

Best and worst performers: In spite of the late-March bio-pharma pullback in stock prices, some of the IPO market’s best performers in the first quarter were just such companies. IPOs from Ultragenyx, GlycoMimetics, and Auspex Pharmaceuticals were all up 100% or more over their IPO price, with Relevance Therapeutics not far behind, up over 90%. Six IPOs were also down more than 10%, with the worst per-formance from NephroGenex, down more than 30%.

The IPO pipeline looked promising for a busy second quarter, with over 100 companies having filed to go public, including GE’s financial unit, Sabre, which operates Travelocity, and the Chinese online sales company, JD.com.

Priorities For The Healthcare Industry

Healthcare executives have a trifecta of value-based priorities they say they must focus on for the rest of 2014. The 10th annual Healthcare Trends and Forecasts in 2014 survey from the Healthcare Intelligence Network reveals that: (1) population health management (cited by 56% of respondents); (2) care coordination (51%); and (3) integrated care delivery (42%) are the front-burner initiatives for healthcare organizations.

ACA impact: Survey respondents were also asked how they expect the Affordable Care Act (ACA) to impact their businesses for the rest of 2014. Some representative responses: “Our customer base will expand greatly with implementation of physician ACO [accountable care organizations] and bundled payment programs,” says a home health/hospice provider. “Less reimbursement. We will have to be smarter and more efficient in how we deliver care and reduce costs,” says a hospital/health system.

One response underscores the uncertainty that surrounds health reform from the physician perspective. “Not sure. Lack of control on hospital service expansion will create even less competition in the marketplace, making physician led delivery networks even more difficult to develop and turn into successful enterprises,” says an independent practice association (IPA).

Hospitals Shift M&A Focusto Outpatient Facilities

Hospital M&A activity is expected to be strong this year, but hospitals are shifting their sights. Up to now, much of the focus has been on acquiring inpatient, acute-care hospitals, but these are no longer the “money makers” of a health system. Instead, large outpatient centers and other clinical integration groups have be-come bigger pieces in the M&A game, according to a new white paper from financial advisory firm Ponder & Co.

The report also reveals that: • There are still likely to be many large, nonprofit

transactions this year;• For-profit chains may be less aggressive with

M&As; and • Regional system mergers will increase.

Plaintiffs’ Case Underminedby Lack of Valuation Expert

Even when a case ostensibly is not about valuation, valuation issues often play a pivotal role, and failure to provide a valuation may undermine a party’s claim. This is one of the lessons gleaned from a Delaware shareholder suit that moved from the Delaware Court of Chancery to the state’s Supreme Court on a novel legal issue.

Going-private merger: The defendants owned 43.4% of the target company and proposed to take it private, offering $24 per share. The proposal built two stockholder-protective procedures into the merger structure: (1) It required the directors to appoint a special committee to negotiate and approve the merger; and (2) it required the approval of a majority of stockholders that had no affiliation with the controlling stockholder. Post-merger, a group of shareholders filed suit in the Delaware Court of Chancery alleging breach of fiduciary duty. The defendants argued that the up-front protective measures ensured that the controller merger replicated an arm’s-length transaction and adequately protected the interests of minority shareholders. In a pretrial motion, they asked the court to review the transaction under the business judgment rule and dismiss the suit for failure to present a genuine dispute of fact. The plaintiffs claimed that

Continued on next page...

Concerns With M&A TargetsWell over half (59%) of CFOs say that an overstated revenue forecast is the No. 1 valuation risk when assessing a prospective acquisition, reveals a survey from Deloitte. This is by far their greatest concern in terms of valuation, with understated expenses a distant second (14%). Other worries are: an overstated exit multiple or terminal value (12%), understated capital needs (6%), understated discount rate (2%), and “other” (6%).

“Target companies may be expected to view their cash flow projections optimistically, believing that recovery will likely drive market opportunities and growth,” explains Eric Pillmore, senior advisor to Deloitte LLP’s Center for Corporate Governance. “Yet how quickly, and how successfully, the post-transaction company may be able to exploit growth opportunities has become an open question under current circumstances,” he adds. Past disappointments and the write-downs taken during the financial crisis of 2007-2008 coupled with the weakness of the current U.S. economy may help explain why there is a “strong reinforcement for a cautionary view to M&A,” he says.

Big picture: Overall, failure to effectively integrate the target is the top concern (43%), and a changing regulatory and legislative environment is in the No. 2 spot (16%). An inaccurate target valuation is the third biggest concern of CFOs about M&As, with 14% citing this issue.

No Easy Money in M&A Shareholoder Suits

for PlaintiffsA recent report from Cornerstone Research examines trends in shareholder litigation related to mergers and acquisitions. Some highlights:

• For the fourth consecutive year, shareholders filed suit in more than 90% of M&A deals valued over $100 million;

• In 2013, 94% of M&A deals prompted challenges from shareholders;

• M&A deals attracted an average of more than

IssuesUpdates& Issues

Updates&

five lawsuits (the Dell Inc. buyout led to 26 suits, which distinguished this transaction as the most litigated deal in 2013);

• The “go-to court” for M&A litigation has been the Delaware Court of Chancery, which during the past four years has been followed by New York County, N.Y.; Santa Clara County, Calif.; and Harris County, Texas; and

• In 75% of the deals, there was a resolution before the deal closed. As to the resolution, 88% of the cases resulted in a settlement, 9% were withdrawn by the plaintiffs, and 3% ended in dismissal by the court.

Cornerstone Research points out that in 2013 shareholders settling their claims received monetary returns only 2% of the time. Many of the settlements are disclosure-only settlements, meaning the defendant merely agrees to provide more transactional information to the shareholders. Some courts, including judges in the Delaware Chancery, have voiced criticism about these settlements because they provide little value to the shareholders.

Candy Crush Gets “Crushed” But Other IPOs Do Well

The initial public offering market during the first quarter of 2014 was at its busiest since 2000. The quarter ended with almost double the number of IPOs from the first quarter of 2013. Biotech proved to be the winner, with over 25 deals, many with no or very small revenues. An improving economy, easier pre-IPO regulations from the JOBS Act, and increased investor interest in funding growth companies have contributed to the IPO pick-up.

King Digital Entertainment falls: Most IPO’s performed well post-offering, but the high-profile King Digital Entertainment, owner of popular online games Candy Crush and Farm Heroes, fell almost 20% in the first few days after its offering. Investors were probably skeptical of the company’s continued scorching growth rate. From 2012 to 2013, revenues increased from $164 million to $1.88 billion, and the company’s adjusted gross cash rose from $28 million to $825 million. While on the surface the market value of the company (close to $7 billion) as a multiple of adjusted EBITDA of nearly 8.5 is not expensive, it may be very expensive if growth slows because the company cannot develop new games. The revenue

growth was highlighted by high user participation—users play almost 1.1 billion Candy Crush games every day. That kind of participation will be hard to replicate in future games.

Best and worst performers: In spite of the late-March bio-pharma pullback in stock prices, some of the IPO market’s best performers in the first quarter were just such companies. IPOs from Ultragenyx, GlycoMimetics, and Auspex Pharmaceuticals were all up 100% or more over their IPO price, with Relevance Therapeutics not far behind, up over 90%. Six IPOs were also down more than 10%, with the worst per-formance from NephroGenex, down more than 30%.

The IPO pipeline looked promising for a busy second quarter, with over 100 companies having filed to go public, including GE’s financial unit, Sabre, which operates Travelocity, and the Chinese online sales company, JD.com.

Priorities For The Healthcare Industry

Healthcare executives have a trifecta of value-based priorities they say they must focus on for the rest of 2014. The 10th annual Healthcare Trends and Forecasts in 2014 survey from the Healthcare Intelligence Network reveals that: (1) population health management (cited by 56% of respondents); (2) care coordination (51%); and (3) integrated care delivery (42%) are the front-burner initiatives for healthcare organizations.

ACA impact: Survey respondents were also asked how they expect the Affordable Care Act (ACA) to impact their businesses for the rest of 2014. Some representative responses: “Our customer base will expand greatly with implementation of physician ACO [accountable care organizations] and bundled payment programs,” says a home health/hospice provider. “Less reimbursement. We will have to be smarter and more efficient in how we deliver care and reduce costs,” says a hospital/health system.

One response underscores the uncertainty that surrounds health reform from the physician perspective. “Not sure. Lack of control on hospital service expansion will create even less competition in the marketplace, making physician led delivery networks even more difficult to develop and turn into successful enterprises,” says an independent practice association (IPA).

Hospitals Shift M&A Focusto Outpatient Facilities

Hospital M&A activity is expected to be strong this year, but hospitals are shifting their sights. Up to now, much of the focus has been on acquiring inpatient, acute-care hospitals, but these are no longer the “money makers” of a health system. Instead, large outpatient centers and other clinical integration groups have be-come bigger pieces in the M&A game, according to a new white paper from financial advisory firm Ponder & Co.

The report also reveals that: • There are still likely to be many large, nonprofit

transactions this year;• For-profit chains may be less aggressive with

M&As; and • Regional system mergers will increase.

Plaintiffs’ Case Underminedby Lack of Valuation Expert

Even when a case ostensibly is not about valuation, valuation issues often play a pivotal role, and failure to provide a valuation may undermine a party’s claim. This is one of the lessons gleaned from a Delaware shareholder suit that moved from the Delaware Court of Chancery to the state’s Supreme Court on a novel legal issue.

Going-private merger: The defendants owned 43.4% of the target company and proposed to take it private, offering $24 per share. The proposal built two stockholder-protective procedures into the merger structure: (1) It required the directors to appoint a special committee to negotiate and approve the merger; and (2) it required the approval of a majority of stockholders that had no affiliation with the controlling stockholder. Post-merger, a group of shareholders filed suit in the Delaware Court of Chancery alleging breach of fiduciary duty. The defendants argued that the up-front protective measures ensured that the controller merger replicated an arm’s-length transaction and adequately protected the interests of minority shareholders. In a pretrial motion, they asked the court to review the transaction under the business judgment rule and dismiss the suit for failure to present a genuine dispute of fact. The plaintiffs claimed that

Continued on next page...

Concerns With M&A TargetsWell over half (59%) of CFOs say that an overstated revenue forecast is the No. 1 valuation risk when assessing a prospective acquisition, reveals a survey from Deloitte. This is by far their greatest concern in terms of valuation, with understated expenses a distant second (14%). Other worries are: an overstated exit multiple or terminal value (12%), understated capital needs (6%), understated discount rate (2%), and “other” (6%).

“Target companies may be expected to view their cash flow projections optimistically, believing that recovery will likely drive market opportunities and growth,” explains Eric Pillmore, senior advisor to Deloitte LLP’s Center for Corporate Governance. “Yet how quickly, and how successfully, the post-transaction company may be able to exploit growth opportunities has become an open question under current circumstances,” he adds. Past disappointments and the write-downs taken during the financial crisis of 2007-2008 coupled with the weakness of the current U.S. economy may help explain why there is a “strong reinforcement for a cautionary view to M&A,” he says.

Big picture: Overall, failure to effectively integrate the target is the top concern (43%), and a changing regulatory and legislative environment is in the No. 2 spot (16%). An inaccurate target valuation is the third biggest concern of CFOs about M&As, with 14% citing this issue.

No Easy Money in M&A Shareholoder Suits

for PlaintiffsA recent report from Cornerstone Research examines trends in shareholder litigation related to mergers and acquisitions. Some highlights:

• For the fourth consecutive year, shareholders filed suit in more than 90% of M&A deals valued over $100 million;

• In 2013, 94% of M&A deals prompted challenges from shareholders;

• M&A deals attracted an average of more than

IssuesUpdates& Issues

Updates&

Studies Show Merger SynergiesAre Optimistic

A factor behind many M&A deals is the expectation of an increase in value triggered by the combination of two firms into a new entity. In reality, this synergy takes a lot longer to materialize than you think—and often does not happen.

New studies: A pair of reports from PwC reinforce existing research findings that the acquiring firms simply do not realize the full value of the synergies they expect. One report, Capturing Synergies to Deliver Deal Value, lays out a framework for delivering deal value by identifying, managing, and executing on synergy opportunities. A synergy analysis needs to be done early on in the assessment of the target company—long before the deal is announced. The second report, PwC’s 2014 M&A Integration Survey Report, backs up the general belief that cost synergies are more achievable than revenue (growth) synergies. Two-thirds of buyers report favorable results for capturing cost synergies, but results from capturing revenue synergies are much worse, with just over half (54%) reporting a favorable result.

These findings reinforce the notion that expected revenue or growth synergies need to be viewed as more uncertain than cost synergies when doing projections. Also, they will take more time to achieve.

Because of this uncertainty, more risk is associated with revenue synergies, so the required return should be adjusted accordingly.

Studies Show Merger SynergiesAre Optimistic ........................................... page 1

Concerns With M&A Targets .................... page 2

No Easy Money in M&AShareholder Suits for Plaintiffs ................. page 2

Candy Crush Gets “Crushed”But Other IPOs Do Well ........................... page 2

Priorities for the Heathcare Industry ......... page 3

Hospitals Shift M&A Focus toOutpatient Facilities .................................. page 3

Plaintiffs’ Case Undermined byLack of Valuation Expert ........................... page 3

PRSRT FIRST CLASSU.S. POSTAGE

PAIDHAVERTOWN, PA

PERMIT # 45

ValueManagement Inc. The Business Valuation Specialist

2370 York Road, E2 Jamison, PA 18929-1031

Address Service Requested

©2013. No part of this newsletter may be reproduced or redistributed without the express written permission of the copyright holder. Although the information in this newsletter is believed to be reliable, we do not guarantee its accuracy, and such information may be condensed or incomplete. This newsletter is intended for information purposes only, and it is not

ABOUT VALUE MANAGEMENT INC. VMI the performance of more than 6,500 valuations. Appraisals are rendered for estate tax planning, litigation support, and many other situations requiring independent appraisal. Our

VMI’s clients and friends. Those interested

This publication is intended to provide accurate and authoritative information on the subject matter covered. It is distributed with the understanding that the publisher and distributors are not rendering legal, accounting or other professional services and assume no liability whatsoever in connection with its use.

(C) 2014 No part of this newsletter may be reproduced or redistributed without the express permission of the copyright holder. Although the information in this newsletter isbelieved to be reliable, we do not guarantee its accuracy, and such information may be condensed or incomplete. This newsletter is intended for information purposes only, and is

not intended as financial, investment, legal or consulting advice.

VMI HighlightsVMI is pleased to announce that David J. Peer, ASA, has joined VMI as a Senior Financial Analyst. David brings 8 years of experience with him to this position. Welcome, David!

Value Management Inc. was a sponsor at the ESOP Association’s Super Regional Board of Directors and Trustees Conference which took place on June 4th - 5th in Philadelphia, Pennsylvania.

Ed Wilusz led a “lunch and learn” at the Bar Association of Lehigh County on June 18th. His topic was, “The 5 Hottest Trends in Business Valuation for Estate Planners.”

If you are interested in having one of our experts give a presentation to your firm or at a conference, please contact Susan Wilusz at smw@valuemanagementinc.com or at 215.343.0500.

ValueManagementInc.

S U M M E R 2 0 1 4

The Business Valuation Specialist

the matter should be reviewed under entire fairness, the highest standard of review in corporate law, and should proceed to trial.

Range of valuations: Finding the case presented a “novel question of law” as to the applicable standard for review, the Chancery used the business judgment rule and granted the defendants summary judgment. In terms of the first requirement—the special committee requirement—there was no question as to its independence and empowerment, the Chancery stated. It was able to hire its own legal counsel, and it interviewed four potential financial advisors (“FA”) and ultimately retained one. The committee and the FA asked management for updated projections to reflect current thinking on the target’s prospects. The revised forecasts indicated a downward trend. The FA used various valuation tools, including the discounted cash flow (DCF) method and comparable company analyses to value the stock. Valuations based on the updated projections indicated a range of $15 to $45 per share. The DCF valuations generated a range of fair value of $22 to $38 per share; a premium paid analysis indicated a range of $22 to $45 per share. Ultimately, the parties settled on a “best and final”

IssuesUpdates&

In This Issue

Pennsylvania Office: 2370 York Road, E2 • Jamison, PA 18929-1031

(215) 343-0500

New York Office:310 E. 46th St., Suite 19M • NY, NY 10017

(646) 454-1414www.valuemanagementinc.com

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offer of $25 per share. The FA opined the price was fair based on generally accepted valuation techniques. A majority of the minority shareholders approved the deal.

The merger, the Chancery found, resulted in a 47% premium to the closing price preceding the offer. It noted that the FA considered the price fair in light of various analyses, “including a DCF analysis, which mirrors the valuation standard applicable in an appraisal case.” It pointed out that the plaintiffs did not produce a valuation from an expert that declared the merger price was unfair. They rationalized their omission by saying the defendants’ motion was not about the issue of fairness but about the business judgment rule. But, said the Chancery, the plaintiffs had to realize that to survive summary judgment they would have to show that the merger imposed terms that a rational fiduciary could not accept in good faith. Without a countervailing expert opinion, they “have not come close to meeting that burden.”

The Supreme Court affirmed the Chancery’s rulings on the applicable standard and on the summary judgment motion.