Goodwill and FCC Licenses in Broadcast

Goodwill and FCC
Licenses in Broadcast
Transactions:
A Review of Deseret
Management Corporation
v. The United States
Kimberly M. Randolph, ASA – [email protected]
Lyndsay D. Foerster – [email protected]
Overview n n n
goodwill. As with any acquisition, the allocation of value
amongst the various asset categories has both tax and
In the July 2013 opinion issued by the Court of Federal Claims
financial reporting implications, which can be a sensitive issue
in Deseret Management Corporation v. The United States (the
for both the buyer and the seller. Most broadcast transactions
“Opinion”)1 reiterated the conclusions of existing tax court opinions
are structured as asset deals, meaning the transaction is
regarding goodwill in broadcast transactions and emphasized
taxable, triggering capital gains and other tax implications for
the importance of being able to qualitatively and quantitatively
the buyer and the seller. In a financial reporting context, the
ascribe value to goodwill. While the case itself was centered
allocation of value between amortizable and non-amortizable
around the like-kind provisions of Section 1031 (“§1031”) of the
intangible assets, particularly for public companies, can be
Internal Revenue Code of 1986, as amended (the “Code”), the
a more sensitive subject given the impact on earnings. As
Opinion provides some valuable insight into the tax court’s view
a result, the valuation methodologies and the underlying
of goodwill and the appropriate valuation methodology used to
assumptions used to assign value to the individual assets can
determine the level of goodwill in a broadcast transaction. Further,
have a meaningful impact on the financial performance of
given the increase in merger and acquisition (“M&A”) activity in the
the business.
broadcasting industry over the past several years, the allocation
of assets in broadcasting transactions is once again a concern for
broadcasters. This article will examine the valuation methodology
used to value Federal Communications Commission (“FCC”)
licenses and goodwill in broadcasting transactions and highlight
the key issues addressed in the Opinion regarding the exchange
of assets of radio station KZLA (the “KZLA Exchange”).
Background on KZLA Exchange n n n
KZLA-FM (“KZLA”) is an FM radio station licensed to Los
Angeles, California. On October 6, 2000, Deseret Management
Corporation, through its subsidiaries Bonneville International
Corporation and Bonneville Holding Company (collectively, the
“Sellers”) and Emmis Communications (the “Buyer”) executed
In a broadcasting transaction, the primary assets of the
an Asset Exchange Agreement (the “Agreement”), in which the
station (or the business) include tangible assets (i.e., tower,
parties agreed to exchange the assets of KZLA for those of
antenna, broadcast equipment), intangible assets (i.e., FCC
four stations in the St. Louis radio market. The transaction was
licenses, programming agreements, advertiser relationships,
structured as a like-kind exchange, as outlined in the provision of
retransmission consent agreements (television only), and
§1031 of the Code.
See Deseret Management Corporation v. U.S., No. 09-273T (Fed. Cl. July 31, 2013).
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Per §1031, the buyer is allowed to postpone paying tax on the
gain if the proceeds of the sale are reinvested in similar property,
Court’s Opinion Regarding Goodwill
in the KZLA Exchange n n n
as part of a qualifying like-kind exchange.2 “Like-kind” broadly
refers to property of the same nature, character, or class, with
In rendering its opinion, the court ultimately decided that there
certain exceptions as explicitly defined in §1031.3 Further, certain
were qualitative indications that KZLA may have possessed some
types of property are excluded from the “like-kind” definition,
degree of goodwill with respect to its audience, and relatedly,
including inventory, stocks, bonds, other securities or debt, and
its advertisers. As stated in the Opinion, “goodwill” is neither
partnership interests, among others.4 The issue at the heart of the
specifically referenced in §1031 of the Code, nor defined in any
KZLA Exchange was whether or not KZLA possessed goodwill.5
Treasury Regulation thereunder. The term is employed elsewhere
Deseret Management Corporation (the “Plaintiff”), claimed that
in the Code, most notably in Section 197, dealing with the
KZLA did not possess goodwill and therefore, under §1031, no
amortization of intangibles. The regulations under that Section
capital gains taxes were required to be paid. The United States
define “goodwill” as “the value of a trade or business attributable
(the “Defendant”), claimed that a portion of the value of KZLA
to the expectancy of continued customer patronage,” which
should be allocated to goodwill, in which case that amount should
expectancy may be due “to the name or reputation of a trade or
be taxed as capital gains.
business or any other factor.” See Treas. Reg. §1.197-2(b)(1). The
court asserted that there is no “black-and-white” distinction as to
In determining whether or not KZLA possessed goodwill at the
whether or not KZLA possessed goodwill, rather that the “truth is
time of the transaction, the testifying experts employed differing
more grey” and stated that an attempt to indirectly quantify the
methodologies and had opposing valuation opinions as to the
level of goodwill was necessary.
ultimate value or existence of goodwill.6 The Plaintiff argued that
the station possessed no goodwill and that the residual value
Depending on facts and circumstances, goodwill is often a
should be attributed to the station’s FCC license. The Plaintiff’s
material asset acquired in a broadcast transaction, particularly
expert did not attempt to directly value the FCC license of KZLA
in transactions of stations with substantial operating cash flow
(or its goodwill) and took a residual approach, assigning the
or a history of above average ratings performances. Goodwill
remaining value7 to the FCC license. The Defendant’s expert took
is typically a residual calculation, determined by the excess of
a direct approach to valuing the FCC license, with the difference
the purchase price over the assessed values of the identifiable
between the enterprise value and the identified tangible and
financial, tangible and intangible assets. The level of value
intangible assets (including the FCC license) allocated to goodwill.
attributable to goodwill in a broadcast transaction can vary
The Plaintiff’s approach resulted in no goodwill, whereas the
significantly across stations. Further, because there is no way
Defendant’s initial approach indicated the presence of goodwill.
to directly value goodwill independent of other assets, we
often rely on qualitative support to test the reasonableness of
Role of FCC License in
Broadcast Transactions n n n
nAn FCC license gives the owner the right to broadcast a
radio signal in an interference-protected area around the
transmitter site of the station. Without the rights to this
license, the owner of the station would have to find an
alternative means to distribute content to its audience.
Over the past few decades, a number of different
content-delivery platforms have been introduced and
gained popularity (cable, satellite radio and television, the
Internet, etc.), resulting in the content itself increasing
in value relative to the content-delivery platform as
a percentage of the total intangible gap.8 However,
particularly with radio stations, the FCC license continues
to be a primary intangible asset of the station.9
the level of calculated or residual goodwill.
Quantification of Goodwill
in the KZLA Exchange n n n
To quantify the amount of goodwill in the KZLA Exchange,
the court ultimately relied upon the approach used by the
Defendant, which relied on the residual approach to determine
the level of goodwill by directly valuing the FCC license through a
Greenfield Approach.10
However, the value of the FCC license as determined by the
Defendant’s expert was ultimately flawed as numerous errors
were found. The court identified issues with the expert’s selection
of a discount rate, various mathematical errors, and an incorrect
calculation of the tax amortization benefit. After the court
www.irs.gov.
Ibid.
Ibid.
5
We note that the Opinion also included a ruling as to whether assets placed in service were properly classified. However, this issue is not the subject of this article. The second issue in the
case involved the proper classification of certain assets under the depreciation rules provided by Sections 167 and 168 of the Code.
This issue is not addressed in this article.
6
Both parties agreed on the enterprise value of KZLA, the value of its tangible assets, and the value of its intangible assets (apart from the station’s FCC license and any goodwill).
7
In the case of KZLA, the experts (and the court) agreed on the enterprise value of KZLA, the value of its tangible assets, and the value of its intangible assets (apart from the station’s FCC
license and any goodwill). Therefore, the difference between the enterprise value and the tangible and intangible assets (including the FCC license) would be attributable to goodwill.
8
The intangible gap refers to the intangible assets and goodwill in a transaction or what remains of the purchase price after allocation to financial and tangible assets.
9
With television stations, the FCC license is also an important asset, however, network affiliation agreements and retransmission consent agreements also account for significant value.
10
The use of the Greenfield Approach to value the FCC license is also consistent with the ruling in Jefferson-Pilot, 98 T.C. at 450-55.
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adjusted for even one, let alone all, of the errors in the Defendant’s
Conclusion n n n
expert analysis, the analysis indicated a value of zero for
KZLA’s goodwill. Ultimately, the court concluded that the
The challenges surrounding the valuation of FCC licenses and
value of KZLA’s goodwill was zero, as originally reported post-
goodwill have been brought to the forefront given the increase
Transaction by the Plaintiff. However, the court confirmed that the
in M&A activity in the industry. However, the court’s opinion in
residual value methodology utilized by the Defendant is “the
Deseret Management Corporation v. The United States provides a
proper method of valuing goodwill.”
recent affirmation in the use of a “Greenfield” or direct methodology
to value FCC licenses and goodwill in broadcast transactions.
The Greenfield Approach n n n
nThe Greenfield Approach is a modified Income Approach,
whereby a hypothetical scenario that assumes a revenue
base of zero as the starting point, as though the
operations of the station would begin on the valuation
date. This approach effectively strips out any “goingconcern” value (or value from the existing advertisers),
as those revenues are excluded from the analysis.
nIn practice, the application of the Greenfield Approach can
prove challenging given the difficulty in ascertaining the
necessary assumptions, and the ultimate sensitivity
of the valuation analysis to those assumptions. The
analysis must consider key factors such as a station’s
market share (typically determined through a review of
the station’s historical audience shares and power
ratios, as well as metrics for stations with similar
signals in the market), operating costs, the capital
costs associated with putting the station on the air, and
determining the period over which a mature revenue
share could be achieved. These types of inputs or
assumptions can be difficult to determine, as they may
be materially different than the company’s current
operations and business plans. Also, finding market
benchmarking data to validate assumptions can be
challenging. Further, as with any Income Approach,
discount rates and long-term growth rate assumptions
add additional sensitivity to those inputs.11
nHowever, despite these challenges, the Greenfield
Approach continues to be the preferred methodology
of the U.S. tax courts, the Securities and Exchange
Commission (“SEC”), and the American Institute
of Certified Public Accountants (“AICPA”) in valuing
FCC licenses.
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Because the specific tangible assets, intangible assets, and
residual goodwill will vary by transaction due to station-specific
attributes, it is important for the acquirer, their auditors, and
valuation specialists to understand the valuation intricacies
involved in valuing the FCC licenses and other broadcast assets
so that the allocation of assets is properly accounted for in both a
tax and financial reporting context.
Kimberly M. Randolph, ASA is a Director in the Valuation & Financial
Opinions Group at Stout Risius Ross (SRR). She specializes in
enterprise valuations, purchase price allocations, intangible asset
valuations, goodwill impairment analyses, and option valuations,
for tax, financial reporting and corporate planning purposes.
In addition, Ms. Randolph has experience providing fairness
and solvency opinions for private transactions, mergers and
acquisitions, significant financing events (e.g. dividend recaps)
and other corporate transactions. Ms. Randolph can be reached at
+1.703.848.4952 or [email protected].
Lyndsay D. Foerster is a Vice President in the Valuation & Financial
Opinions Group at Stout Risius Ross (SRR). She has provided
transaction and valuation opinions for numerous purposes,
including
M&A
deals,
recapitalizations,
financial
reporting, shareholder succession planning, and other tax, litigation,
and corporate related matters. Ms. Foerster can be reached at
+1.646.807.4221 or [email protected].
This article is intended for general information purposes only and is not intended to provide,
and should not be used in lieu of, professional advice. The publisher assumes no liability
for readers’ use of the information herein and readers are encouraged to seek professional
assistance with regard to specific matters. Any conclusions or opinions are based on the
specific facts and circumstances of a particular matter and therefore may not apply in all
instances. All opinions expressed in these articles are those of the authors and do not
necessarily reflect the views of Stout Risius Ross, Inc. or Stout Risius Ross Advisors, LLC.
For a more detailed discussion of the Greenfield Approach, refer to Spectrum Licenses: Valuation Intricacies, SRR Journal, Spring 2011.
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