The claim that a business valuation expert is making flawed comparisons can be devastating to the expert’s credibility and the client’s case. In Dieckman v. Regency GP LP, a class of limited partners of Regency Energy Partners (Regency) sued the general partner for breaching the partnership agreement’s implied covenant of good faith and fair dealing, as well as an express provision requiring that a merger be “fair and reasonable” to the partnership.
The plaintiff’s valuation expert estimated their damages at roughly $1.68 billion. But the Delaware Chancery Court rejected his conclusion in its entirety, finding his “apples-to-oranges” analysis unreliable. Here are the details.
Conflicting Views
Energy Transfer Equity (ETE) was a Delaware master limited partnership that held controlling interests in Regency and Energy Transfer Partners (ETP). Both Regency and ETP were also Delaware master limited partnerships whose units were traded on the New York Stock Exchange.
In 2015, Regency acquired ETP for approximately $10 billion in a unit-for-unit merger. In connection with the merger, Regency tasked its board’s conflicts committee with evaluating the fairness of the proposed transaction. However, a member of the conflicts committee had a conflict of interest: He also served on the board of an affiliated entity, which violated Regency’s limited partnership agreement.
The Chancellor agreed with the plaintiff that this conflict breached the implied covenant of good faith and fair dealing inherent in the partnership agreement. As a result, two safe harbors in the agreement — one for mergers approved by the conflicts committee and another for mergers approved by the unitholders — weren’t satisfied. Had they applied, the board’s good faith would have been presumed, precluding judicial review of the merger. Instead, judicial review was appropriate, and the defendants had the burden of proving the merger was fair and reasonable.
Give vs. Get
The court ruled in favor of the defendants, finding that:
- The defendants demonstrated that the merger was fair and reasonable to the partnership and its unitholders,
- The plaintiff failed to prove damages, and
- The plaintiff failed to prove that Regency’s general partner acted in bad faith or engaged in willful misconduct or fraud. Had the plaintiff succeeded, he would have voided a provision in the partnership agreement that shields the general partner from monetary damages.
Regarding damages, the gist of the opinion provided by the plaintiff’s expert was that Regency’s unitholders gave more than they got in the exchange of limited partnership units. Using a discounted cash flow analysis based on a dividend discount model, the expert valued the “give” (one Regency unit) at $29.06. He valued the “get” (0.4124 ETP units) at $23.83, based on its market price on the merger date ($57.78 × 0.4124). The difference was $5.23 per unit, for total damages topping $1.68 billion.
The Chancellor rejected the use of different valuation methods. The defendants’ expert’s apples-to-apples analyses (dividend discount model-to-dividend discount model and market-to-market) showed no damages.
The plaintiff’s expert argued that his comparison between the dividend discount model and the market price was valid based on a “valuation overhang” theory. According to that theory, ETE received greater incentive distribution rights (a greater share of incremental distributable cash flow) from ETP, giving ETE a financial incentive to favor ETP over Regency. This advantage stifled interest in Regency and made its market price an unreliable indicator of value. But the expert offered no empirical proof that ETE favored ETP, and the court said that the record showed otherwise.
Use Mixed Methods With Caution
The court didn’t rule out apples-to-oranges comparisons in all cases. Had there been evidence that one partnership received preferential treatment, the outcome might have been different. But there’s a clear preference for consistent apples-to-apples analysis.
TheKFORDgroup litigation team holds extensive knowledge and experience in expert witness engagements, forensic accounting, and business valuations. Our experts are trained and experienced in the litigation process. We can help guide the court to the right value in your next case. For more information, please call us at 210-340-8351.
Additional information included in this report was provided by PDI Global / Thomson Reuters © 2021