In two recent decisions, the Court of Chancery addressed the issue of disclosure of free cash flow estimates in connection with a merger. In Maric Capital Master Fund, Ltd. v. PLATO Learning, Inc., C.A. No. 5402-VCS (Del. Ch. May 13, 2010), the Court enjoined the challenged merger pending disclosure of free cash flow estimates. But in Steamfitters Local Union 447 v. Walter, C.A. No. 5492-CC (Del. Ch. June 21, 2010) (Transcript), the Court denied a motion to expedite, holding that disclosure of free cash flow estimates would not be material and distinguishing PLATO Learning.
In PLATO Learning, the plaintiff challenged the acquisition of PLATO Learning, Inc. (“PLATO”) by Thoma Bravo, LLC (“Thoma Bravo”) for $5.60 per share, in part because PLATO’s proxy statement omitted free cash flow estimates that PLATO had provided to its financial advisor, Craig-Hallum. The Court ordered the free cash flow estimates, which it found were “selectively” removed from the projections provided to PLATO’s stockholders, to be disclosed. In the Court’s view, “management’s best estimate of the future cash flow of a corporation that is proposed to be sold in a cash merger is clearly material information.” If stock value is based on expected future cash flows, “as is encouraged under sound corporate finance theory,” the Court reasoned that free cash flow estimates would allow the stockholders to determine if the price being offered in the transaction is fair compensation for the benefits they would receive if the corporation remained as a going concern.
The Court also required PLATO to make other corrective disclosures. PLATO’s proxy statement indicated that Craig-Hallum selected discount rates “based upon an analysis of PLATO’s … weighted average cost of capital,” and that Craig-Hallum used a range of 23%-27% when conducting its DCF analysis. However, Craig-Hallum’s calculations of the company’s weighted average cost of capital had generated discount rates of 22.5% and 22.6%, which were disclosed to the special committee. The proxy statement disclosed only the range of 23%-27% used by Craig-Hallum. In the litigation, Craig-Hallum provided various reasons why the higher range was used and disclosed, but there was no evidence that Craig-Hallum had explained these reasons to the special committee and no explanation had been provided to the stockholders. Thus, the Court ordered disclosure of the value that would be obtained by using the discount rates generated by the company’s weighted average cost of capital.
PLATO’s proxy statement also indicated that a factor the board and special committee considered in approving the transaction was “that Thoma Bravo did not negotiate terms of employment, including any compensation arrangements or equity participation in the surviving corporation, with [PLATO’s] management for the period after the merger closes.” The Court found that this “suggests that the decision whether to sell PLATO to Thoma Bravo was unaffected by any understandings between Thoma Bravo and the Company’s management about future economic arrangements.” In fact, PLATO’s CEO had “extended discussions” with Thoma Bravo regarding Thoma Bravo’s typical equity incentive package and its preference for keeping existing management after an acquisition. The Court ordered that the proxy statement clarify the extent of those discussions.
In Walter, the plaintiffs relied on PLATO Learning, among other cases, in arguing that free cash flow estimates were required to be disclosed. The transaction at issue was the acquisition of inVentiv Health, Inc. (“inVentiv”) by Thomas H. Lee Partners, L.P. for $26 per share. Goldman Sachs, inVentiv’s financial advisor, provided a fairness opinion based on projections of the company’s net revenue, net income, earnings per share and EBITDA estimates for five years. The Court held that, under the circumstances, free cash flow estimates would not be material. The Court distinguished PLATO Learning, where the estimates were presented to the financial advisor but were later excised from the proxy statement, and In re Netsmart Technologies, Inc. Shareholders Litigation, 924 A.2d 171 (Del. Ch. 2007), where the directors undertook to disclose free cash flow estimates but then disclosed stale estimates that were not meaningful. In Walter, no free cash flow estimates were provided to Goldman Sachs and the company did not disclose stale estimates.
Recognizing the potential inconsistency among the Court’s decisions, Chancellor Chandler suggested in Walter that he would certify an interlocutory appeal to the Delaware Supreme Court in an attempt to provide clarity on the issue of whether free cash flow estimates must always be disclosed. The plaintiffs, however, did not appeal.