Minority Shares of Electronics Co. Business Valued in TN

F. John Walter v. The Nucleus, Inc.– Tennessee business valuation of minority shareholder’s stock in electronics company

This case was filed by minority stockholders of Tennelec after Tennelec and Nucleus, Inc., which owned just over 75 percent of the Tennelec stock, merged in December 1987.  Plaintiffs filed suit after rejecting both a cash offer of $802.50 per share and an offer of 10.916 shares of Nucleus stock for each share of Tennelec stock they held.  The sole issue in the appeal was whether the evidence preponderates against the Chancellor’s finding that the fair value of a share of Tennelec, Inc., as of December 18, 1987, was $802.50.  Plaintiffs claimed that the evidence showed that the Chancellor should have placed the value of each share of stock in excess of $3000, as testified by their expert witness.

Z. Christopher Mercer was employed by Nucleus to make an evaluation of the stock of both Tennelec, which had not paid a dividend since its inception, and Nucleus for two reasons. First, to determine the value of the stock for purposes of an employee benefit plan, and second, to determine the amount in dollars of Nucleus stock that should be offered to the minority stockholders.  The officials of Nucleus advised Mercer that they wanted to be fair with the minority stockholders and that he should arrive at the fair market value rather than the fair value as dictated by Tennessee statute.  The reason for this was that because of the fair market value methodology would yield a higher figure than fair value.  In his initial evaluation Mercer did not purport to follow the mandates of the rule of law in the Blasingame decision and did not use the most recent financial information available. He placed the value of the stock at $802.50, which was the amount offered initially.

Mercer evaluated the stock again, and took into account the effect of the stock market crash in October 1987. In this evaluation he used the most recent financial information available, which was as of November 30, 1987, and concluded the stock was worth $610. This evaluation also did not follow Blasingame.  Finally, he made a third report where he followed Blasingame and used the most recent figures available prior to the merger. This time he evaluated the stock at $520 per share and gave weights to other factors.

Richard I. Lazarus was employed by the Plaintiffs and evaluated the stock at $3029 per share, and also assigned weight to the various factors mentioned by the court.  Each party was critical of the other’s expert witness. The Plaintiffs’ position was that the earnings of Tennelec—which they contend had turned the corner economically—were not given sufficient consideration. They argued that Mercer should have used the more reasonable method employed by their expert who recognized the significant increase in earnings and took the last six months of figures available and projected earnings six months in advance, or at the least take the trailing 12 months of earnings rather than the four years Mercer used.

They also contended that Mercer did not give sufficient significance to a heavy backlog of orders of the company and did not recognize that earnings were depressed during prior years because Tennelec wrote off as expenses the costs incurred in starting up research and development for new business ventures rather than depreciating them over a period of time.  Further, he improperly capitalized revenues rather than earnings in arriving at his $608 evaluation. On the other hand, Nucleus was critical of Lazarus’ figures, as he used only the last six months available and projected six months in the future. He also, they said, added an additional 25% of value based upon information of other companies as gleaned from an industry publication.  Finally, he gave a control premium, although the stock held by the Plaintiffs only amounted to about 16% of the outstanding stock, 75% of which was held by Nucleus.

The court of appeals admitted that while it is true that the method employed by both experts was subject to some criticism, it was persuaded that the evidence did not preponderate against the finding of the Trial Court as to value.

Mercer opined that, referencing the mandates of Blasingame, the market value of Tennelec shares was $3,443,937.00 or $750.00 per share, and this evaluation was not challenged.  Mercer also said that the asset valuation of Tennelec, as of December 19, 1987, was $2,052,259 or $447 + per share. This valuation was challenged by the plaintiffs’ expert, but not convincingly, the appellate court said.  Asset value was determined from Tennelec’s financial statements, and Mercer’s report was based on those statements.  Lazarus, by contrast, speculated that, on the basis of assets held by comparable corporations, Tennelec’s assets were of a greater worth than its statements reflect. The court of appeals did not find this logic acceptable.

In apparent obedience to Blasingame, Mercer then established a valuation of earnings of $3,069,338.00, or $668+ per share. This evaluation involved a methodology of four-year averaged earnings combined with a capitalization of revenues. While Blasingame did not reference a capitalization of revenue, as Mercer did, the inclusion of that factor could not be protested by the plaintiffs since they profited by it.  Mercer attributed a weight of 10% to market value, 40% to asset values, and 50% to earnings value. These weightings for relative importance, mathematically, of each approach to evaluation when applied, resulted in a per-share value of $610.  While the court of appeals believed that earnings value should have been accorded a higher weight (about 70%), it did not feel the point was not crucial to the decision at hand.