Dynasty Pty Ltd v Coombs

The Company

1. While the parties agreed on various facts, it is unnecessary to record many for the purposes of fixing a price of the plaintiff's shares.
2. Since 2012, the Company has owned and operated a business called "Raw C", which imports and sells beverages, oils and spreads derived from coconut plant to retailers which are primarily located across Australia. Approximately, at the date of valuation in June 2021, 76% of its revenue are coconut water, 19% of its revenue are coconut oils, with other beverages and spreads making up the rest of sales.
3. The business was founded in 2012 by Mr Mendelsohn and Mr Ghetto. Until 2019, both worked full-time in the business and were remunerated for their labour via their privately owned corporate entities rather than by way of salary.
4. On or around 28 June 2019, Mr Ghetto resigned as a company director and secretary of the Company and ceased working in the business. From that time, Mr Mendelsohn became the sole director and secretary, and he continues to work full-time (or 4 days a week) in the business. Mr Ghetto's role is now shared between Mr Mendelsohn, accounts management and an external accounting firm.
5. The Company's products are sourced from Vietnam, Philippines and Sri Lanka and the Company uses third-party logistics for warehousing its stock in Australia.
6. About 85% of the Company's sales are to Coles supermarkets (Wesfarmers Limited) and Woolworths Limited stores. The Company does not have written continuing contracts with those retailers and so there is no guarantee those retailers will purchase any specific quantity of Raw C products at any time. The two most relevant factors as to whether these retailers continue to purchase Raw C products are the competency of the management and end-consumers' demand for Raw C products. The Company must also bear the cost of the retailers' discounting of Raw C products. The balance of the Company's sales are to smaller retailers including Harris Farm, some IGAs and some fruit shops.
7. The Company leases business premises on a month-to-month periodic basis because the lease term has expired. The Company's workforce includes Mr Mendelsohn, 6 fulltime employees and 1 part-time employee.

Differences in valuations

1. There were several matters about which the experts agreed, including: 1. While the valuation was ordered to be determined at 29 June 2021, it was appropriate for the experts to take into account end of financial year material to 30 June 2021. 2. The experts used different valuation standards, which have different definitions: 1. Mr Mullins adopted the standard of "Fair Market Value"; and 2. Mr Groves adopted the standard of "Market Value". However, because neither applies discounts for lack of control or marketability, the assessments are comparable. 1. The reported financial performance of the Company in FY20 and FY21 based on the FY21 audited financial statements was: 1. Revenue of $21,319,744 in FY20 and $21,321,005 in FY21; 2. Gross profit of $1,824,790 in FY20 and $2,530,089 in FY21; and 3. Net profit of $143,074 in FY20 and $388,936 in FY21. 1. Some adjustments and normalisation adjustments to EBITDA ("Earnings before interest, tax, depreciation and amortisation Indication") were agreed as appropriate. 2. The classification of various liabilities and facilities were agreed.
2. The differences between the experts that must be determined are as follows.
3. First, and significantly, the Court is asked to determine whether an income-based valuation (per Mr Mullins) or market approach using comparable transactions (per Mr Groves) ought to be used. Related to this is the appropriate multiplier for the valuation process. Mr Mullins used a multiple based on the "First Principles" approach using actual inputs from the Company's financial records and industry data with minor discretionary adjustment in coming to a multiple of 4.40x. Mr Groves used sales of two businesses he considered "of a similar nature and/or risk profile" that he subjectively adjusted in coming to a multiple of 8.09x. While the multiplier has the greatest impact on the result, the determination of the most appropriate valuation method also determines the multiplier, because neither party submitted I ought to vary the discretionary adjustments made by the experts.
4. Secondly, the appropriate adjusted EBITDA for FY21 for the Company must be determined. The parties agreed that the EBITDA to be used was $592,731. In further submissions after the hearing, Mr Mendelsohn submitted that the agreed adjusted EBITDA was $743,802. While Mr Mullins had used the figure of $740,000 in his report, that was because of an uncertainty about a particular fee, which had been clarified during the hearing. Mr Mendelsohn accepted that Mr Mullins' calculation must therefore be amended using that updated adjusted EBITDA.
5. The plaintiff also accepted that the adjusted EBITDA was $743,802 but submitted that it needed to be further adjusted because Mr Mendelsohn's directors' fee in FY21 of $268,872 was too high. Mr Groves originally adjusted that fee down to $74,595 on the basis that Mr Mendelsohn's fee ought to have been calculated in his valuation at the rate payable to a junior sales executive or representative. In the joint report, Mr Groves changed his adjustment to allowing a fee of $178,253, which was based on Mr Mendelsohn receiving a pro rata fee for 4 days a week as a "Sales Business Manager". It is therefore necessary for me to determine whether it is appropriate to adjust the EBITDA by some sum because of Mr Mendelsohn's director's fee.

Income or market valuation?

1. Both experts referred to the International Valuation Standards 105 (IVS 105), which indicate that the three principal valuation approaches are: market approach, income approach and cost approach. Both experts accepted that the standards are not binding on Australian valuers, but provide useful guidelines, to which they referred in carrying out their valuations.
2. The IVS 105 states at 10.3: The goal in selecting valuation approaches and methods for an asset is to find the most appropriate method under the particular circumstances. No one method is suitable in every possible situation. The selection process should consider, at a minimum: (a) the appropriate basis(es) of value and premise(s) of value determined by the terms and purpose of the valuation assignment, (b) the respective strengths and weaknesses of the possible valuation approaches and methods, (c) the appropriateness of each method in view of the nature of the asset, and the approaches or methods used by participants in the relevant market, and (d) the availability of reliable information needed to apply the method(s).
3. The guidelines also recommend valuers use multiple methods, if possible, in order to provide a cross-check analysis.

Mr Mullins

1. At the outset, I note that Mr Mullins was an impressive witness and that provided me with confidence in his approach. He gave careful and reasoned answers to all questions. His report also provided academic and empirical industry material to support his approaches, having regard to finance theory where appropriate.
2. Mr Mullins' evidence was that he adopted an income-based approach because he was not able to identify appropriate comparable companies for a market-based approach. He also rejected a discounted cash flow method because he was not provided with financial projections for the Company.
3. He adopted a "continuing future maintainable earnings" (CFME) methodology to calculate the value of the business and adjusted the value for net debt or cash and surplus assets or liabilities to calculate the fair market value of the equity in the Company. Mr Mullins considered this an appropriate method because of the following factors, which Mr Groves also agreed meant the method was an acceptable valuation approach: 1. He was provided with historical financial information of the Company for five years prior to the valuation date; 2. He was asked to value the shares on a going concern basis and so assumed that the performance of FY21 was a reasonable indicator of the likely continued performance of the business; 3. Sales have been relatively stable and increasing from FY18 to FY21, and positive EBITDA from FY17 to FY21 allowed an assessment of FME (future maintainable earnings); and 4. The CFME method is "widely used and accepted as a method to value a business (in particular small to medium businesses)".
4. While not accepting that he was bound by the IVS, Mr Mullins appears to have considered that the "income-producing ability of [the Company] is the critical element affecting value from a participant perspective": IVS 105 at 40.2.
5. As noted above, the EBITDA for FY21 was agreed at $592,731. Mr Mullins then "normalised" the EBITDA by taking into account actual expenses and subsidies/grant income received to conclude a normalised FME of $740,000, reasoned from the following: 1. Past performance of the business and, in particular, the last two financial years in 2020 and 2021, where the growth appeared to have plateaued. 2. He was not provided with any evidence of material decline or improvement in financial operations of the business when preparing the report. Instead, his instructions were that the cost of goods in 2020 and 2021 were likely to remain constant at about 88%-90%. As noted above, because the uncertainty of one expense being clarified during the hearing, Mr Mendelsohn accepted that Mr Mullins' normalised figure needed to be adjusted.
6. Mr Mullins then allowed for the risk of not achieving the FME in determining a "weighted average cost of capital", which he calculated using the "First Principles" approach, which is a highly regarded formula to determine the "relationship between the value of a firm assuming stable growth and the firm's expected free cash flow": Professor Aswath Damodaran, "Valuation Multiples: First Principles", Stern School of Business (Damodaran). In applying this formula, the only discretionary aspect Mr Mullins subjectively determined was an "additional risk premium" of 13.5%, of which: 1. 12% was drawn from an industry report; and 2. 1.5% was based on Mr Mullins' subjective assessment of the Company's unique risk that it had no contracts with its major customers, Coles and Woolworths, which could not be replaced easily, and because the Company had "small market capitalisation compared to the market".
7. He determined the Company's likely growth rate was 2.5% per year, having regard to the relevant industry report, which estimated growth in the industry at 2.2%. Mr Mullins increased that likely growth of the Company to 2.5% to provide for the contingency that the Company may in fact increase its size.
8. He then carried out mathematical conversion exercises to determine an EBITDA multiple of 4.40x.
9. This led to an "enterprise value" of the Company of $740,000 x 4.40 = $3,256,000.
10. Once net debt and cash funding of $2,905,551 was deducted, the equity of the Company was $324,146, and the plaintiff's portion was therefore $162,073, according to Mr Mullins.
11. While Mr Groves maintained that he did not consider that the income producing ability of the Company was "the" critical element affecting the view of market participants to ground an income type of valuation, he accepted: 1. The income producing ability of the Company was a critical element; 2. The only asset the Company had was its income generated by purchasing products and on-selling them; and 3. Mr Mullins' reasons for adopting the income approach were reasonable.
12. In closing submissions, the plaintiff accepted that Mr Mullins' income approach was a valid methodology to use. The only criticisms of Mr Mullins were that: 1. The market approach was "preferable"; and 2. His overall valuation was commercially implausible, which would also mean I would prefer the market approach used by Mr Groves.
13. For the reasons developed further below in considering Mr Groves' approach, and as accepted by the parties, I consider that Mr Mullins' valuation was an appropriate valuation method. I further do not consider his valuation implausible in circumstances where there were many unattractive features of the business: 1. The Company's business model was concerned with making profit by importing, storing, and distributing products for less than it sells the products and its pre-tax profit margins were "slim", of at most 1.8% per annum. The experts accepted that very little needed to go wrong before the business would become unprofitable, for example, if there were difficulties in supply, the price of products, the cost of supply, the exchange rates, or loss of customers. 2. The Company did not demonstrate strong ability to meet current liabilities from current assets, and in fact had failed to do so for the last three years being considered. 3. The current net assets of the Company at the time of the valuation were only depreciated vehicles valued at $138,224. 4. There was also the risk that there are no written supply contracts with international suppliers, who could cease supplying for a number of reasons including crop failure, price increases, and political instability. 5. A similar risk was that there are no written contracts with the Company's major customers, Coles and Woolworths, which poses a significant risk that sales could reduce or cease, and that competitors' products could be sold and promoted instead.
14. I note that Mr Mullins carried out a cross-check valuation based on net tangible assets, which resulted in a valuation of $138,224. Mr Mullins explained that because that valuation was in reasonable proximity to the market value, even though lower, it gave him some comfort that his primary valuation was commercially sensible.

Mr Groves

1. The plaintiff's submission was that the market-based assessment was "preferable". Mr Groves used the market-based assessment because he considered that "Market Approaches, in particular the Comparable Transactions Method, are used by participants involved in the sale and purchase of companies similar to the Company as the primary valuation method".
2. The plaintiff accepted that for me to adopt the market approach, it would be necessary to accept Mr Groves ahead of Mr Mullins. I do not accept that Mr Groves' methodology is preferable for the following reasons.
3. First, despite his assertion in his report, Mr Groves conceded in cross-examination that the IVS principles did not require him to adopt the market approach. Instead, IVS 105 at 20.3 provides that "the market approach may be applied" where the following facts exist: (c) information on market transactions is available, but the comparable assets have significant differences to the subject asset, potentially requiring subjective adjustments. (d) Information on recent transactions is not reliable (ie hearsay, missing information, synergistic purchaser, not arm's length, distressed sale etc). Mr Groves said these factors existed. Mr Groves' valuation was based on two comparison transactions and significant subjective discounting. However, he did not follow the guideline that provides, when such circumstances exist, "a valuer should consider whether any other approaches can be applied and weighted to corroborate the value indication from the market approach".
4. Secondly, I consider Mr Groves' analysis very weak. He identified 3 other acquisitions of companies in the food product supply industry that he considered comparable merely because, as the plaintiff's counsel accepted, they sold discretionary food products in supermarkets in Australia. However, he rejected one comparable because of its size, without providing clear reasons for doing so.
5. For the reasons below, I do not consider those transactions comparable and there were problems with Mr Groves' use of each of them.

Maggie Beer

1. Maggie Beer Products Pty Ltd had a revenue of $21.02 million and net profit after tax of approximately $960,000. It was acquired by Longtable Group Ltd for $17,385,000 on 16 April 2019. For that company, Mr Groves calculated an EBITDA multiple of 12.68.
2. However, in cross-examination, Mr Groves accepted that his EBITDA calculation was wrong or "fundamentally flawed". Therefore, Mr Groves' calculation of the appropriate multiplier for the Company using his Maggie Beer calculation was accepted as wrong.
3. Further, the Maggie Beer business is very different to the Company, as Maggie Beer is a manufacturing and distributing business, with significant assets and profit margins.
4. Mr Groves did not have regard to the publicly available material concerning the sale, including the fact that it was an "acquisition" rather than a sale. He conceded he had limited "oversight regarding the terms and structure" of the transaction.
5. Even though Mr Groves stated in his report the transaction was "not … directly comparable" and was "somewhat useful as a guide", he concluded it was relevant because the business had a "similar risk profile" to the Company. However, as he conceded in cross-examination, he did not attempt to assess the risk profile of either company to determine if they were similar.
6. The transaction was also more than 2 years earlier than the valuation date. As counsel for the plaintiff conceded, Mr Groves did not explain how the market approach could satisfy the aim of ensuring the valuation took account of the "mood of the market" (see Damodaran) if the comparable transaction was not around the same time.
7. Therefore, I do not consider that Mr Groves ought to have had regard to the Maggie Beer transaction as a "comparable" for the purposes of the valuation that he carried out in the way that he did.

Capilano Honey

1. Capilano Honey Limited was purchased for $225.91 million and had an EBITDA of approximately $16.17 million. For that company, Mr Groves calculated an EBITDA multiple of 12.99x, and then applied an "assumed size discount" of 20%, resulting in a hypothetical multiplier of 10.39x.
2. Again, Mr Groves stated in his report that the transaction was "not … directly comparable" and was only "somewhat useful as a guide". However, there were reasons why the transaction did not provide a useful guide, primarily because it was insufficiently comparable.
3. Mr Groves conceded that he had insufficient information; he did not have regard to publicly available information, such as a Capilano company announcement regarding cash consideration, but accepted he should have done so. The full extent of the information he relied on in determining that Capilano Honey was an appropriate comparator was from a document: Top 10 Australia Deals The top 10 Australian deals were dominated by acquisitions of our iconic brand assets in the packaged foods and meats industry. Demand for our larger assets from international acquirers remained strong, with 5 of our top 10 deals involving an international acquirer. This compares to only 23% of total Australian deals being purchased by inbound equity. … 10 Target: Capilano Honey Limited Target industry: Packaged Foods and Meats Acquirer: ROC Capital & Wattle Hill Private Equity Acquirer Country: Australia Deal Value (A$m): 210 Closed Date: 5/12/2018 EV/EBITDA: 12.99x Iconic Honey producer sold to private equity: Capilano started in 1953 by brothers Tim and Bert Smith. Now, the company is Australia's largest honey producer and an iconic Australian brand. A consortium of ROC Capital Pty Ltd and Wattle Hill Capital (specialising in China focused agricultural exports) entered into a scheme of implementation to acquire the Company from Wroxby Pty Ltd (operated by billionaire Andrew Forest and Kerry Stokes) and others including Bega Cheese Limited. The strategic acquisition will see the expansion of the household Australian brand expand into China. Capilano first listed on the ASX in 2012, and delisted in December 2018.
4. That document was focusing on the "Top 10 Australian Deals" and therefore had excluded any other transactions that might have been useful comparators. The fact that they were the "top" deals also indicated that the transactions concerned large and "iconic brands" when there was no suggestion that the Company was similar.
5. The business profiles were starkly different, for example, because Capilano Honey was listed on the ASX and it produced, packed and sold honey products in Australia and overseas. Mr Groves did not have regard to the financial statements for Capilano, which revealed it generated income in FY18 of $138.5 million.
6. Mr Groves concluded that Capilano had a similar risk profile to the Company, but accepted in cross-examination that he did not carry out any assessment to reach that conclusion.
7. Mr Groves determined that to attempt to make the transaction more comparable, it was appropriate to adjust the multiplier by discounting it by 20% for "size", without, explaining how that figure was determined. For example, there is no reference to the difference in revenue or net profit.
8. Mr Groves further discounted the multiplier with a discretionary discount of 30%, again not explaining his reasoning or justifying such a large discount with reference to literature or valuation practice.
9. With such large discretionary discounts, it does not appear that the transaction could be considered comparable. I accept Mr Mullins' concern indicated in the Joint Report: "the need to apply discounts of this magnitude implies that the transactions are not 'comparable' to Natural Raw C".

Lion Drinks

1. Lion Drinks & Dairy Ltd had an EBITDA of approximately $62.2 million and was purchased for $534 million. Mr Groves calculated the EBITDA multiple as 8.59x. However, he then applied a size discount of 25% and a "marketability and synergy discount" of 30% because the purchaser was also in the food industry. This led to a hypothetical multiplier of 4.81x.
2. As submitted by Mr Mendelsohn, that transaction was arguably more comparable than the other two because Lion Drinks sold fruit juice, similar to coconut drinks, and the multiplier arrived at was more similar to that determined by Mr Mullins.
3. However, Mr Groves determined that the transaction was not sufficiently comparable to factor into his calculations because it was "too large … even following my hypothetical assumed discounts". He does not explain why he could not have applied further discounts if his primary criteria for comparability was simply the sale of discretionary food products in Australian supermarkets.

Assessment of Mr Groves' analysis

1. I do not consider the transactions Mr Groves relied upon were appropriately comparable to provide a cogent basis for assessing a market value of the Company.
2. Mr Groves accepted he had "limited oversight regarding the terms and structure of each transaction". He eventually accepted in cross-examination that his research into the financial position and performance of the companies was inadequate, and he ought to have had regard to other information.
3. While he accepted that there was no factual basis for his assumptions he used in his valuation, but nevertheless doggedly refused to accept that they were not truly comparable. He maintained they were "of some use", without explaining how they could be used in light of the problems with his approach, which he accepted.
4. I note that he made various mistakes in his first report and varied his valuation down by millions of dollars in the joint report. Overall he did not appear careful with his reports or his evidence.
5. I consider his valuation on a market basis untenable, and I reject the submission that it ought to form the basis of my determination of the price.

Should EBITDA be adjusted for Mr Mendelsohn's director's fee?

1. As noted above, the parties disagree on whether it is appropriate to adjust the EBITDA because Mr Mendelsohn's director's fee was too large.
2. I do not consider it appropriate to adjust that fee for the following reasons.
3. First, both experts volunteered that they had no expertise in determining salaries or remuneration. Therefore, it is unclear on what basis Mr Groves considered he ought to make an adjustment in the way he did. Mr Mullins' evidence was that the only necessary enquiry was whether the fee was a business expense and whether it was likely to continue. He sought and received instructions to that effect and, on that basis, included the fee in his calculations. I consider that an appropriate approach.
4. Secondly, Mr Groves accepted that he had no instructions about the role that Mr Mendelsohn in fact carried out in the Company. There is also no evidence that he sought instructions, despite asserting in his report that he had made all appropriate enquiries. It is not apparent how he therefore originally concluded that Mr Mendelsohn ought to be paid as the most junior sales representative, or later, a Business manager.
5. Thirdly, when Mr Ghetto was involved in the Company, both directors were paid a little over $170,000 each. Mr Mendelsohn's fee of $268,872 in FY21 included a bonus of $45,000 and fell within the range an independent human resources company had advised the Company was appropriate.
6. Mr Groves' approach to Mr Mendelsohn's director's fee is questionable and comes close to him crossing the line between being an independent expert and an advocate for his client.
7. I do not consider there is a sound basis for adjusting the EBITDA by reducing the amount attributed to Mr Mendelsohn's fee.

Conclusion

1. I consider that Mr Mullins' income approach based primarily on the Company's financial material is preferable. I do not consider there was evidence of comparable transactions to support a market valuation, and further there was no evidence of an accurate analysis. Mr Groves provided no challenge in terms of Mr Mullins' application of the income method.
2. Using the adjusted EBITDA figure that was agreed after the hearing and Mr Mullins' calculations, the valuation is as follows: 1. EBITDA is agreed at $592,731. 2. Adjusted EBITDA is agreed at $743,802. 3. The "enterprise value" of the Company is obtained by using Mr Mullins' selected multiple: 4.4 x $747,701 = $3,272,729. 4. The "equity value" of the whole Company requires a deduction from the enterprise value of the agreed debt and surplus liabilities of $2,931,854 = $340,875. 5. The plaintiff's shares are 50% of the total equity and are therefore valued at $170,437.50.

Orders

1. I make the following orders: 1. For the purposes of Order 1 made on 9 March 2022 by Black J, the purchase price is fixed at $170,437.50. 2. The plaintiff is to pay the defendants' costs as agreed or assessed. 3. Grant leave to any party to approach my Associate by email within 7 days of the date of this judgment, should an alternative costs order be sought. 1. That email must provide any evidence relied on together with submissions of no more than 3 pages and be copied to the other party. 2. That other party has leave to provide in response any evidence and submissions of no more than 3 pages within 7 days after receipt of the original material contemplated in order 3(a). 3. The party that made the application has leave to provide reply submissions of no more than 1 page within 2 days after receipt of the response contemplated in order 3(b).

DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 30 September 2022