Restructuring

Contributed by Andrea Saavedra
If you’ve ever litigated valuation in bankruptcy, then you’re likely well versed in the three pillars of valuation analysis: discounted cash flow, comparable company, and comparable transaction. And you’re likely familiar with the kind of work that you’ll see from your expert in supporting your side’s theory of solvency (or insolvency).  At day’s end, however, barring any fraud on the market, the fair market value of an asset or business – i.e., the price a willing buyer, knowing all relevant information, paid to a willing seller in an efficient market – is likely to be the best indicator of value.  With these principles in mind, Judge Gropper’s recent decision in Eastman Kodak affirming (again) the US Trustee’s decision to deny the appointment of an official committee of equity holders should come as no surprise.
By way of background, shortly after Kodak commenced its chapter 11 case, a small group of equity holders petitioned the US Trustee to appoint an official committee to represent their interests.  Given that Kodak, at that time, did not estimate full recovery to its unsecured creditor constituency and was facing potential liquidation, the US Trustee denied the request, which was upheld by the bankruptcy court.  Nearly a year later and after a group of existing noteholders agreed to backstop a plan of reorganization that, among other things, provided for certain creditors to participate in a rights of offering of the reorganized Kodak’s common stock, certain individual equity holders renewed their request for representation, arguing, among other things, that the backstop parties’ interest in the reorganized business demonstrated that there could be some recovery to existing equity.
In considering their renewed request, Judge Gropper weighed the debtors’ estimates of recoveries under the plan against the estimates presented by the shareholders’ experts.  Noting that Kodak projected recoveries of only 4-5% for its general unsecured creditors (a position that was fully supported by the Creditors’ Committee and its financial advisors), Judge Gropper found that, “in order to demonstrate that there [was] even a remote possibility of a potential distribution to equity,” the moving shareholders would have to provide some evidence that Kodak understated its expected reorganization value by over $2 billion.
The shareholders’ patent expert asserted that, based on a discounted cash flow analysis, Kodak’s remaining patents had an “intrinsic” value of as high as $2.5 billion.  However, his licensing revenue projections were based on stale management presentations, and he had failed to take into account the debtor’s most recent projections of IP-related revenue at emergence.  Perhaps even more damaging was the fact that the expert did not seem to be aware that Kodak, at the commencement of its cases, had sold its digital imaging patent portfolio for less than half what had been anticipated, providing a real world check on even management’s expectations at that time.  Accordingly, Judge Gropper found that the expert’s prediction of future revenues was based on “overstated” and “outdated” income assumptions that were not based in “reality.”  Noting that expert opinion on the value of patent income streams must be based on “facts and data specific to the patents at issue,” he determined that the expert’s testimony, which was, at best, purely “speculative”, had to be excluded as entirely unreliable.
The shareholders had also separately retained a brand valuation expert.  She had concluded that Kodak’s brand value was in the range of $400 to $1 billion, utilizing a brand valuation technique known as “Relief from Royalty.”  However, she admitted at the hearing that: (i) brand value could not be a “separate item of value” in excess of the total equity of an enterprise, (ii) she was unfamiliar with Kodak’s current projections of value upon emergence, and (iii) she had not prepared her analysis in these cases with the same rigor she or a peer would normally apply to such a representation.  Therefore, Judge Gropper determined that her entire testimony had to be excluded as unreliable.  Consequently, absent evidence to the contrary, Judge Gropper found that, “[w]hatever value the Kodak brand may have after the sale of its camera business and its bankruptcy, it is embedded in total equity value, reasonably estimated at less than $500 million and resulting in a wholly insolvent debtor.”  Accordingly, he denied the shareholders’ request.
In chapter 11, where value is everything, valuation litigation cannot be taken lightly, particularly when there is market evidence contrary to a litigant’s position.  Mere speculation of value is insufficient, and courts, being asked to rule on substantive issues, require evidence.