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Delaware Chancery Court Adopts Dr. Zachary Nye's $171 Million Estimate In Re: El Paso Pipeline Partners L.P. Derivative Litigation

Vice Chancellor J. Travis Laster of the Delaware Court of Chancery found an affiliate of El Paso Corporation liable for $171 million in damages associated with the overpayment for a liquefied natural gas terminal in 2010. Vice Chancellor Laster's decision adopts Dr. Zachary Nye's calculation of the overpayment (i.e., $171 million) caused by the General Partner's breach of the LP Agreement. The judgment is one of the largest from the Delaware Court of Chancery, which is among the country's busiest venues for investor lawsuits. In his memorandum opinion, Judge Laster comments favorably on Dr. Zachary Nye's analysis:

Tudor and the defendant's expert did not account for any risk to Elba's cash flows. Dr. Zachary Nye, the plaintiff's expert, did. He separately estimated the present value of the guaranteed cash flows and the non-guaranteed cash flows. To reflect the credit risk associated with the former, he discounted them at the average yield to maturity of Shell's senior corporate bonds maturing in 2038 and 2040, or 5.581%.

For the non-guaranteed portion, Nye looked to an investment of comparable risk and term, i.e., an LNG import terminal connected to major U.S. natural gas markets. Although data was not available for thirteen of the fourteen North American LNG import terminals that were operational or under construction, he found an optimal comparable terminal in the Sabine Pass LNG terminal. It was owned and operated by Cheniere Energy Partners, L.P. ("CQP"), a master limited partnership with publicly traded debt and equity securities since 2007. The Sabine Pass terminal was CQP's sole asset from inception through 2010, making it a pure-play investment with historic risk exposure isolated to the supply and demand for U.S. LNG imports. Like Elba, the Sabine Pass terminal had sold its full capacity under a 20-year, firm commitment agreement. Like Elba, the counterparties were subsidiaries of more credit-worthy entities who had guaranteed the subsidiaries' performance. Using data from CQP's publicly traded securities, Nye calculated CQP's WACC to have been 11.876% in March 2010.

Because of the greater creditworthiness of the CQP guarantees, CQP's WACC understated the risk associated with Elba. To calculate the non-guaranteed risk implied by CQP's WACC, Nye turned to option theory. Using standard sources, Nye calculated that the cost of capital for a non-guaranteed investment in a U.S. LNG import terminal was 14.868%. Nye discounted Elba's non-guaranteed cash flows using this figure.

For his terminal value, Nye used a multiple of 9.1x EBITDA, derived from the Gulf LNG sale in February 2010 and from Parent's internal valuations of Gulf LNG and Elba, which used a 20-year terminal value of 9x EBITDA. Nye discounted his terminal value using a rate of 14.868%.

With these inputs, Nye calculated that the total enterprise value of Elba at the time of the Fall Dropdown was $1.551 billion. The value of 49% interest was $760 million. El Paso MLP paid at least $931 million for 49% of Elba in the Fall Dropdown. Accordingly, El Paso MLP suffered damages of $171 million from the Fall Dropdown.

As cross-checks, Nye compared his calculations with other indicators. In March 2010, Gulf LNG sold at an implied multiple of 9.1x 2010 EBITDA. Elba's 2010 EBITDA was $180 million, so that data point implied that the value of 49% of Elba was $803 million. In April 2010, Freeport LNG sold at an implied multiple of 8.2x 2010 EBITDA. Using that figure, Elba's implied value was $727 million. These data points framed Nye's calculation. Nye also conducted an event study based on the stock market reaction to the Fall Dropdown. The event study suggested a loss of value of approximately $285 million, implying an overpayment by El Paso MLP in that amount. This data point indicated that Nye's figure was conservative.

This decision adopts Nye's calculation of the overpayment. The General Partner breached the LP Agreement and caused $171 million in damages.