Chapter 14 Bankruptcy Valuation Hearings

• Jurisdiction: United States

Chapter 14: Bankruptcy Valuation Hearings

A. The Mirant Valuation Saga: Epic Battle of Experts¹¹⁰

Mirant Corp. filed for chapter 11 protection on July 14, 2003.¹¹¹ With claims in excess of $10 billion, it was the largest bankruptcy filing that year. In April 2005, a hearing for emergence from chapter 11 began in Fort Worth, Texas. The focus of the hearing was the assessment of Mirant's enterprise value to determine the new ownership structure at emergence.

The valuation hearing was a bitterly fought battle of experts representing the debtors, creditors, equity holders and certain convertible security-holders. At least 11 valuation analysts submitted expert reports, and many of the analysts testified at the hearing. There were numerous points of contention about the valuation methods employed by the various analysts. In fact, the analysts differed on nearly every aspect of the valuation approach. Some differences were minor, but other differences changed the value by hundreds of millions of dollars.

Generally, the analysts employed two methods to determine Mirant's enterprise value: a guideline publicly traded company (GPTC) valuation method and a discounted cash flow (DCF) valuation method.

Guideline Publicly Traded Company Method Valuation

In performing a guideline publicly traded company valuation, all of the analysts used earnings before interest taxes depreciation and amortization (EBITDA) pricing multiples, as EBITDA is a common financial metric in Mirant's industry. The calculation of EBITDA pricing multiples was hotly contested, as the analysts disagreed on how to calculate the two main components of the multiple: the guideline companies' enterprise value (the numerator) and their EBITDA (the denominator). With Mirant reporting EBITDA of approximately $1 billion, the pricing multiple used to value its operating assets had a huge impact on value.

Guideline Companies' Enterprise Value

One of the guideline companies, NRG Energy, had a note receivable asset worth more than $800 million. One analyst believed that the notes were nonoperating assets and reduced enterprise value by this amount, resulting in a lower pricing multiple. Other analysts argued that the notes were operating assets and should not be excluded from the enterprise value. This adjustment affected the median pricing multiple used to value Mirant. Specifically, reducing the NRG enterprise value by the notes receivable also reduced the Mirant enterprise value by more than $500 million.

Guideline Companies' EBITDA

Two of the issues that affected the calculation of the guideline companies' EBITDA had substantial impacts on Mirant's value: mark-to-market gains and losses, and income from unconsolidated investments. While all of the guideline companies comply with the financial accounting rules related to accounting for derivative instruments and hedging activities, only one guideline company detailed its gains and losses from marking-to-marketing its derivative contracts on gas and energy. Its EBITDA, using the numbers in its income statement, was reduced by more than $250 million because of the mark-to-market losses. Certain analysts reversed those losses, claiming that they were noncash losses, thereby reducing the pricing multiple. Other analysts disagreed, arguing that the remaining guideline companies did not detail similar gains/losses and, therefore, the analysts were inconsistent in their adjustments.

Another disputed issue was the inclusion of income from minority investments. It is common in the energy industry for companies to take minority ownership stakes in power-producing assets or to develop joint ventures, neither of which are consolidated in the operating income. Instead, income attributable to those investments is included in the income statement but below the operating income line as a separate item.

Certain analysts concluded that income from unconsolidated investments needed to be included in EBITDA because it was income from normal operations, and because it was also the way the guideline companies reported their EBITDA to analysts and investors. However, these analysts failed to include the unconsolidated debt associated with this income in the guideline companies' enterprise value. This inconsistent analysis results in a downward-biased pricing multiple, thereby reducing Mirant's enterprise value.

Timeliness of Information

The first round of analyst reports was submitted in February. Rebuttal reports followed in March. The hearing started in mid-April and concluded in late June. During this time period, Mirant continued to operate and forecasts were revised as actual information became available. The guideline companies sold divisions of their businesses, operating agreements expired, Form 10-Ks for the fiscal year ended December 2004 were issued, and then Form 10-Qs for the first quarter ended March were issued.

In addition, the guideline public companies and the security analysts revised their projections for the 2005 fiscal year and then issued their projections for the 2006 fiscal year. All this information had to be considered in the valuation calculations. As a result, throughout this period, the analysts had to continuously revise their valuation reports.

Some of the analysts believed that forward pricing multiples were the correct pricing multiples to use in valuing Mirant because the market is primarily concerned with future performance as an indicator of value. These analysts used one- and two-year forward pricing multiples to calculate a range of enterprise values for Mirant. Other analysts advocated the use of both forward and historical pricing multiples. These analysts concluded that both types are widely accepted in valuation literature and that the market considers both past and future performance when estimating value.

Discounted Cash Flow Valuation

The second method used to value Mirant was a discounted cash flow (DCF) valuation. Mirant provided a business plan with detailed financial projections covering a 10-year period, which mostly eliminated dispute among the analysts as to the expected cash flow. However, the other variables required to complete the DCF valuation varied greatly among the analysts.

Discount Rate

Cash flow in a DCF model is usually discounted at the company's weighted average cost of capital (WACC). As implied by its name, the WACC is derived as the weighted average of the company's cost of equity capital and cost of debt capital based on the company's capital structure. The Mirant after-tax cost of debt was generally agreed upon by the analysts to be around 5.4 percent, based on the Mirant business plan.

The...