A Manhattan judge last month awarded a dissenting shareholder over $2 million plus another $1 million for attorneys' fees and expenses in a battle of the experts featuring disputes over valuation methods, discounts, and consideration of future tax benefits arising from the merger. Matter of Harlem River Yard Ventures, Inc., Decision and Order, Index No. 602341/07 (Sup Ct NY County July 11, 2011).
In 1991, the New York State Department of Transportation as owner entered into a 99-year lease with Harlem River Yard Ventures, Inc. ("Ventures") to develop an industrial park on the site of the abandoned Penn Central rail yard at the southern tip of the Bronx bordered by the Harlem River, directly opposite Manhattan. Real estate developer Francesco Galesi of the Galesi Group is the majority and controlling owner of Ventures. The operator of the famous Hunts Point Market in the Bronx, organized as a cooperative association, took a 5% stake (later diluted to 4.6%).
Between 1997 and 2006, Ventures entered into long-term net sub-leases with Waste Management, Inc. for a waste transfer station; with News Corporation for a colorizing plant for the New York Post; and with Federal Express for a package transfer facility. A large portion of the approximately 100-acre site remains unused.
In March 2007, Galesi, who, along with other officers of Galesi Group controlled over 90% of Ventures' shares, merged Ventures into a new corporation called Harlem River Ventures II, Inc. ("Ventures II"), with the intention that Ventures II would elect to be taxed as a partnership under subchapter "S". The squeeze-out merger required Hunts Point Market, which, as a cooperative association could not own stock in an "S" corporation, to accept cash for its shares.
The merger plan offered Hunts Point Market approximately $480,000 for its shares based on a May 2006 appraisal. Hunts Point Market filed a notice of dissent under the dissenting shareholder statute, Section 623 of the Business Corporation Law, demanding payment of the "fair value" of its shares. Ventures responded with a new offer of approximately $900,000 which Hunts Point Market also rejected. In July 2007, Hunts Point Market filed a petition asking the court to determine the fair value of its shares (read petition here).
The valuation hearing turned mainly on the reports and testimony of the two, opposing expert appraisers whose conclusions of value were light-years apart. Hunts Point Market's appraiser contended that Ventures had a value of approximately $128 million and that its minority stake was valued at $7 million including $1 million for the post-merger value added to Ventures II from the conversion to a subchapter "S" corporation. Ventures' expert opined that the company's total value as of the March 12, 2007, valuation date was only $31 million.
Last month's decision by former Manhattan Supreme Court Justice (now Judicial Hearing Officer) Edward H. Lehner plows through the issues in workmanlike fashion, ultimately valuing Ventures at $61 million and Hunts Point Market's shares at $2.8 million. Here's a rundown of the key issues addressed in the decision:
- DCF vs. Capitalization Methods of Valuation. The two experts agreed on use of the income approach to value the subleases for the printing plant and waste transfer site subleases. But whereas the expert for Hunts Point Market used the DCF (discounted cash flow) method to value the reasonably expected future after-tax cash flows, Ventures' expert used the capitalization method based on the adjusted results for the years 2004-2006. The court opted for the former, stating that the DCF method "principally relies on actual rental obligations of the sublessees, who are nationally known companies who had expended considerable sums in erecting structures on the Property and had a consequent incentive to honor such obligations." (Decision pp. 11-14)
- Future Tax Benefits from Subchapter "S" Election. In 1982, BCL Section 623 was amended to allow consideration of postmerger factors including prospective tax benefits of the transaction. Ventures argued, and JHO Lehner agreed, that since Hunts Point Market as a cooperative association could never be a shareholder in the surviving corporation, any corporate tax benefit resulting from the "S" election should not be considered. "Since any benefit from a change in tax status is not a direct benefit from the merger," JHO Lehner explains, "it cannot be deemed to alter the then value of petitioner's shares as the 'very transaction' cannot be said to have had an economic impact on the value of the shares of [Ventures]." (Decision pp. 10-11)
- Minority and Marketability Discounts. JHO Lehner rejects any consideration of minority discount, quoting from Friedman v. Beway Realty Corp., 87 NY2d 161 (1995). He then addresses marketability discount, adopting a 22.5% discount as to the value of the operating assets only, about midway between the 10% and 30% marketability discounts used by Hunts Point Market's and Ventures' experts, respectively. (Decision pp. 8-10)
- Discount Rate. Calling it the "most significant dispute herein affecting value," the court was faced with widely disparate, proposed discount rates of 7.2% (Hunts Point Market's expert) and 10.3% (Ventures' expert), with both appraisers basing their figures on the Ibbotson guidelines but with major disagreement over industry risk and business size factors. The court concluded a discount rate of 8.5% based on "the relatively small size of the business, but with quality tenants who had invested significant sums in the construction of the structures to be occupied, and the unique nature of the business . . .." (Decision pp. 15-16)
- Waste Management, Inc. Shares Received by Galesi. Simultaneously with Ventures' entry into the sublease with Waste Management, Inc. in 1997, Galesi personally received shares in the latter (a publicly traded corporation) worth over $13 million. Galesi paid nothing for the shares, which Hunts Point Market argued was a misappropriation of corporate assets belonging to Ventures. JHO Lehner agreed with Hunts Point Market and therefore included the shares in valuing Ventures. (Decision pp. 5-8)
- Individual Asset Valuations. Page 15 of the decision presents a table summarizing and comparing the valuations offered by the opposing experts of the various, individual assets. At pages 16-21, JHO Lehner addresses a series of asset-specific disputes, including a management fee for the New York Post facility sublease; deduction for infrastructure expenses associated with the Federal Express sublease; valuation of the vacant portions of the site; and valuation of the waste transfer facility site based on tonnage projections. He also adopts the $2.5 million excess working capital number offered by Ventures' expert.
- Total Valuation. The court's tabulation of Ventures' total value is on page 23 of the decision. JHO Lehner values the operating assets at about $56 million including a 22.5% marketability discount, to which he adds $22 million non-operating assets for a total asset value of about $78 million. He then deducts about $17 million debt and infrastructure costs to conclude a total value of a little over $61 million.
Hunts Point Market's 4.6% stake accordingly is valued at $2.8 million, to which the court adds interest at 6% from the March 2007 valuation date on the difference between the $2.8 million and the $722,000 paid to Hunts Point Market at the time of the merger. The court also awards Hunts Point Market its attorneys' fees and expert's expenses totaling $1,150,000, based on the court's finding under BCL Section 623(h)(7) that the award "materially exceeds" the amount originally offered to Hunts Point Market. (Read here a copy of the final judgment entered on July 29, 2011, totaling about $3.8 million.)
Looking from the outside, I can't presume to know the complexities of the case or the strengths and weaknesses of the experts' valuations which necessarily included some inherently subjective judgment calls. To the cynically inclined, the fact that two highly qualified, independent experts can look at the same company data and reach opinions of value over 400% at variance, is a daunting reflection on the adversarial process. The court's $61 million conclusion of value, at almost twice Ventures' $31 million valuation and about half of Hunts Point Market's $128 million valuation, likewise feeds the commonly held perception that courts more often than not will "split the difference," thereby encouraging the parties and their experts to take extreme positions. I'm not saying that occurred here, but it does evoke the "Dr. Pangloss versus Mr. Scrooge" phenomenon about which others, including New York and Delaware judges, have written and lamented.