More evidence that certified business appraisers make better experts


R&R International v. Manzen, LLC, 2010 WL 3605234 (S.D. Fla.)(Sept. 12, 2010)

There’s been a lot of attention focused on the intangible asset valuation issues in the Uniloc decision last week. But, another recent case highlights some major flaws in business valuation testimony presented by an investment banker--an expert witness with extensive industry knowledge, but who applied non-standard valuation techniques.

In this new case, the plaintiff was relatively new to the beverage industry when, in 2008, it entered into a five-year contract to distribute the defendant’s “Xience” energy drinks in Florida and Georgia. Within months of the parties’ agreement, however, the defendant found another distributor, and the plaintiff sued for breach of contract, alleging over $8 million in damages based on its expert’s findings. Prior to trial, the defendant challenged the expert under the Daubert standard, claiming he was not qualified to testify and his opinions lacked reliability and replicability.

As to the first claim, the court found that the expert held no degree in finance, accounting, or economics. Nevertheless, as an investment banker, he had “substantial experience” in the beverage industry. Specifically, banks relied on his analysis of beverage companies—their financial statements and profit projections—to make lending decisions. This background qualified the expert to analyze lost profits, the court held—but ironically, his experience also became the benchmark by which the court ultimately tested his report’s reliability.

Expert relies on informal studies and sampling. To calculate damages, the expert began with the five-year contract term as the applicable lost profits period. Next, he predicted the plaintiff’s market share, growth rate, sales, and net profits as follows:

  1. Market share and growth rate. To determine the size of the applicable market in year 1 of his lost profits projections, the expert took the national per capita consumption of energy drinks from an industry publication, and multiplied this number (4.2 drinks per person) by the populations of Florida and Georgia, which he derived from marketing statistical reports. For years 2 through 5, the expert assumed the market would increase by 15.1%, based on a 2007 article in an industry publication. By year five, the plaintiff would hold a 4.5% market share, the expert said, based on his interviews with several “major” distributors of the defendant’s energy drink.
  2. Projected sales. To estimate the number of cases sold during year 1, the expert took the plaintiff’s six months of operating figures and increased them by 60%, based on an estimated rise in seasonal sales, for a total of 51,432 cases sold in year 1. For years 2 through 5, he projected sales of 150,000, 320,000, 510,000, and 706,150 cases, respectively, which culminated in a 4.5% market share.
  3. Net profits. During its six months in operation, the plaintiff grossed profits of $5.50 per case. Based on his interviews with distributors, the expert found their distribution costs ranged from $1.50 to $2.75 per case, depending on the market. Because the plaintiff was a non-union, non-urban distributor, the expert believed it would have an average distribution cost of $2.25 in the “build-out stage of the brand years 1 through 3 and $2.00 per case for years 4 and 5 to allow for efficiencies.” He then deducted some marketing costs, noting that, per the distribution agreement, the defendant had promised to contribute $9 for every $11 of cases (gross) the plaintiff purchased.

Finally, the plaintiff’s expert looked at the sales of several non-alcoholic beverage companies, noting that they had “commanded significant multiples . . . in recent years,” ranging from 4X to 11.5X revenue. Based on this data, he believed the plaintiff would have been worth over $11 million in 2010 but for the defendant’s breach of the distribution agreement.

Turns out, research was from Wikipedia. In assessing the reliability of the expert’s opinion, the court found that the plaintiff was a relatively new business, with little more than those six months of operating figures. This did not bar the plaintiff from claiming lost profits under applicable (Florida) law, the court held, so long as it presented reliable financial data from comparable “yardstick” companies. In this context, however, the expert’s report suffered numerous flaws and unsupported assumptions. In particular:

  • The industry studies he used to calculate market share were from Wikipedia, a source of “mixed” reliability, the court said. Moreover, he did not independently check the articles or attach copies to his report. Finally, the 2007 article on industry growth did not account for the subsequent economic downturn.
  • The expert’s report also failed to identify any of the “major” distributors he interviewed to calculate market share, such as their location, type of beverage distributed, length of operations, etc. Some were in the alcohol industry, and of the two non-alcoholic drink distributors, one had gone out of business. The expert did not obtain backup data from any of his contacts or tell them he was collecting information to use in litigation.
  • The report also did not explain how the expert developed the plaintiff’s sales figures, other than that the sales in year 5 would equal a 4.5% market share.
  • Aside from noting that the plaintiff was non-union and non-urban, the expert did not specifically explain how he reached his range of distribution costs.
  • In calculating marketing costs, the expert failed to include the plaintiff’s receipt of one free case for every four cases ordered. In his deposition, the expert said that free case giveaways were standard industry procedure, but at trial, he said it was not.
  • During his deposition, the expert admitted that in calculating an $11 million enterprise value under the market approach, he compared the plaintiff, a beverage distributor, to several national beverage companies.
  • During his Daubert testimony, the expert said he did not conduct any market or consumer surveys to determine the strength of the Xience brand. Instead, he had gone to grocery, gas, and convenience stores over the years to keep up with what was on the shelves—a method he admitted was “not scientific.”
  • The expert conceded that the only way to test or replicate his sampling would be to conduct the same informal telephone conversations with distributors.
  • The expert also admitted that—based on his prior role as an investment banker in the beverage industry and the materials used in his report—he could not have made a reliable recommendation whether to invest in the plaintiff.

This last admission was particularly significant, the court said. When an expert offers his years of experience in a particular industry spent evaluating the financial viability of certain businesses, but then “is unable to attest to the reliability of his own lost profits analysis, this court is hard-pressed to reach a different conclusion.”

The court also found the expert failed to employ any scientific or “otherwise reliable” method to calculate the plaintiff’s lost profits. “No indication exists that the [underlying] assumptions . . . have any validity at all,” the court said. The expert’s self-described sampling methods, his reliance on what appeared to be arbitrarily selected numbers, and his informal research methods “fatally undermine the reliability of his report and analysis,” the court ruled.

Finally, under the applicable “yardstick” test, the sampling choice lies at the “heart of an expert’s methodology.” His selection of several “sample” distributors based solely on “the limited universe of his personal contacts” without any specific comparison to the plaintiff substantially undermined his conclusions, the court held. The expert not only failed to compare apples to apples. “Instead, he compared apples with oranges, bananas, raspberries, and rotten apples [the one defunct company],” the court said, and struck his entire report and lost profits conclusions.


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