Another court relies on the discounted cash flow analysis and not the simple multiple of gross profits for valuing distribution rights. Don’t worry, the DCA can result in acceptable numbers as well.

The old adage of taking a multiple of the gross profits earned by a beer distributor is the typical response you’ll receive in asking about the fair market value of the distribution rights for a given brand. We hear it a lot as a casual methodology employed between parties in negotiating value and potentially setting a price for the sale of a brand or as damages in lawsuits for improper termination of alcoholic beverage distribution rights. 

But this multiplier method has many faults. Chief among them, it is not an economically rigorous approach to setting price or value, it is not typical in other industries, nor is it an approach endorsed by business valuators. These failings make it subject to criticism as a dubious method in helping courts evaluate the value of a beer, wine, or spirits wholesaler’s losses in a lawsuit. Typicality or arguing that this is a “customary” method in an industry might be the basis for attempting to set a value that way in some state courts with less rigorous methods for assessing expert opinions or if litigants throw in the towel on demanding an actual basis for an expert opinion. But the federal evidentiary standards generally require greater rigor and a more reasoned approach in assessing the value of a wholesaler’s distribution rights in a given brand.

A typical method involving an actual reasoned analysis of the value of the intangible of the goodwill of a brand – the discounted cash flow analysis – receives endorsement over and over again in the federal system. You’ll recall the Tri County Wholesale Distributors v. Labatt USA Operating Co., Sixth Circuit opinion from 2016 where the Sixth Circuit blessed the discounted cash flow analysis for calculating the diminished value of a beer distributor’s business after Labatt USA beer changed hands and the new owner terminated the franchise held by two Ohio beer distributors. You’ll remember that case because it contained a short discussion of the nature of beer franchise statutes that many people cite to convey the exact nature of these laws:

“The distributors are the beneficiaries of an anticompetitive statute that deprives suppliers of their freedom to terminate contracts with distributors. Cf. Letter from C. Steven Baker, Director, Chicago Regional Office, Federal Trade Commission, to Illinois Senator Dan Cronin (Mar. 31, 1999) (“[A similar statute in Illinois] would shield the business of liquor distribution from market forces. . . . The likely result of such a static distribution system will be increased consumer prices. . . . We are unaware of any evidence establishing the need for this type of legislation.”). Under § 1333.85, suppliers may not “cancel or fail to renew a franchise or substantially change a sales area or territory without the prior consent of the other party  for other than just cause.” Any provision of a franchise agreement that waives or fails to comply with this requirement “is void and unenforceable.” § 1333.83.”

“The provision involved in this case, § 1333.85(D), provides an exception to this anticompetitive scheme when “a successor manufacturer acquires all or substantially all of the stock or assets of another manufacturer through merger or acquisition.” In that case, the supplier may end the franchise by repurchasing the distributor’s inventory of the product or brand and “compensat[ing] the distributor for the diminished value of the distributor’s business that is directly related to the sale of the product or brand terminated or not renewed by the successor manufacturer.” The distributors’ argument, in essence, is that the Takings Clauses of the federal and Ohio constitutions require Ohio to grant them the anticompetitive benefits of § 1333.85 without the exception provided by § 1333.85(D).”

That’s not an indictment, btw. There are many reasons to press for statutory or regulatory controls on the freedom to contract and behavior that otherwise impede purported open markets (think clean water and air, safe foods, secure banks) so the fact that something is characterized as “anticompetitive” is not a value judgment – even though it kind of felt that way in the opinion.

The Sixth Circuit went on to analyze different issues raised by the parties in looking to assail the underlying data utilized in calculating the value of the beer distributorships by each sides’ expert, but accepted and approved of the discounted cash flow methodology and raised no issue with the underlying merits of selecting that method in performing the calculations:

“Both parties argue that the district court used the wrong capital structure in calculating the discount rate used to determine the diminished value of the distributors’ businesses—that is to say, the value of the lost brands. To calculate the value of the lost brands in this case, the experts of both parties used discounted-cash-flow analysis. That procedure measures the present-day value of an asset based on the income it is expected to generate in the future, discounted to present-day value. Discounting allows for the final valuation to take into account the time value of money (money today is worth more than money tomorrow) and the uncertainty that exists about whether the projected future cash flow will actually materialize.”

No issues were decided based on a “multiplier” of simple gross profits. Nor should they be. It is not a rigorous analysis.

Recently, in valuing a wine distributorship, a district court has also endorsed the discounted cash flow analysis. You can read the opinion here in Ste. Michelle Wine Estates v. Tri County Wholesale Distributors. In this case, a winery terminated the distribution rights of an alcoholic beverage wholesaler under the same franchise law exception available in Ohio which provides for the payment of the diminished value resulting from the loss of the brands. Each party hired an expert to render an opinion regarding the diminished value. Each expert utilized the discounted cash flow analysis and DID NOT utilize the back-of-the-envelope multiple of gross sales methodology. Each side criticized the other side’s expert calculations based on what factors they chose to consider and what amounts they utilized in reaching their conclusions. It’s real money as the wine brand’s expert came up with $86,000 as the diminished value and the distributor’s expert assessed it at $325,345. The opinion is an interesting read for those looking to understand some potential objections to the underlying data and supporting numbers used in performing the discounted cash flow analysis. But because this is not a jury trial, the judge will be the finder of fact and the court essentially let each side know that its objections as to the underlying data and calculation methods utilized in assessing the discounted cash flow analysis on the diminished value of distribution rights for the brand would be taken into account during trial, and that the court would not be ruling on their particular objections and attempts to exclude the expert reports based on the data sets or calculation modifiers the expert used. 

The case is a good lesson for practicing attorneys in challenging assertions that the measure of damages will be some simple multiple of gross profits. It’s also a good lesson for practitioners and businesses that a DCA can have wildly different results (much the same way that arguing about the number for the multiple can) based on inputs and that a DCA can result in just as much value if not potentially more than the back of the envelope multiplier method.