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Developments in Statutory Appraisal: DFC Global, Dell and More

March 8, 2018

The Delaware courts have decided a number of statutory appraisal cases recently. Most prominently, the Delaware Supreme Court reversed two post-trial appraisal decisions of the Court of Chancery, in DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. Aug. 1, 2017), and Dell Inc. v. Magnetar Global Event Driven Master Fund Ltd., 177 A.3d 1 (Del. Dec. 14, 2017). The Court of Chancery in In re Appraisal of PetSmart, Inc., 2017 WL 2303599 (Del. Ch. May 26, 2017), determined that a transaction price generated through an arm’s-length auction process was reliable evidence of fair value and declined to place any weight on the parties’ competing discounted cash flow analyses. And in four recent decisions, In re Appraisal of SWS Group, Inc., 2017 WL 2334852 (Del. Ch. May 30, 2017), ACP Master, Ltd. v. Sprint Corp., 2017 WL 3421142 (Del. Ch. July 21, 2017), In re Appraisal of AOL Inc., 2018 WL 1037450 (Del. Ch. Feb. 23, 2018), and Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., 2018 WL 922139 (Del. Ch. Feb. 15, 2018), the Court of Chancery declined to rely on transaction price, but used a discounted cash flow analysis in three cases and pre-announcement market trading price in the last to reach valuation conclusions below the transaction price.

In DFC Global, the Court of Chancery had opined that, while the transaction was arm’s length and subject to a robust pre-signing market check, significant regulatory uncertainty undermined the reliability of the corporation’s cash flow forecasts (and hence of a valuation based on discounting those forecast cash flows), but also undermined the reliability of the transaction price and of a multiples-based valuation as indicators of fair value. The trial court had therefore placed equal weighting on transaction price, a discounted cash flow valuation that was above the deal price, and a comparable companies valuation that was below the deal price. See In re Appraisal of DFC Global Corp., 2016 WL 3753123 (Del. Ch. July 8, 2016).

On appeal, the Delaware Supreme Court reversed. Although the Supreme Court declined to establish a presumption in favor of the transaction price, it rejected the premise that the future uncertainty that rendered the cash flow forecasts unreliable also vitiated the transaction price and the multiples analysis as indicators of fair value. The Supreme Court also rejected the thesis, referenced in the trial court’s opinion, that the transaction price may have been unreliable because the buyer, a private equity firm, determined the price it was willing to pay by reference to achieving an internal rate of return and reaching a deal within its financing constraints; the Supreme Court held that a buyer’s focus on its internal rate of return has “no rational connection to whether the price it pays as a result of a competitive process is a fair one.” The Supreme Court concluded that the trial court had not adequately explained, in light of the record and the economic literature, the basis for its decision to assign equal weight to the three measures of value, and remanded for further proceedings.

Similarly, in Dell, the trial court had declined to place mathematical weight on the transaction price in a management-led buyout in which a special committee had elected to conduct a limited pre-signing market check followed by a post-signing go-shop process. See In re Appraisal of Dell Inc., 2016 WL 3186538 (Del. Ch. May 31, 2016). The trial court determined that the process included “sufficient pricing anomalies and dis-incentives to bid … to create the possibility that the sale process permitted an undervaluation of several dollars per share.” The trial court therefore placed exclusive weight on a discounted cash flow valuation that resulted in an appraisal value approximately 28% above the deal price. The trial court also focused on the fact that the private equity group that had participated in the buyout along with the company’s founder, Michael Dell, had determined its bid based in part on a leveraged buyout model, and that, at the value returned by the Court’s discounted cash flow valuation model, the internal rate of return under the LBO model would have been unacceptably low, and the corporation would not have been able to support the necessary levels of leverage.

On appeal, the Delaware Supreme Court reversed, holding that “the reasoning behind the trial court’s decision to give no weight to any market-based measure of fair value runs counter to its own factual findings.” The Supreme Court rejected the thesis that the corporation was obliged to show that the sale process is “the most reliable evidence of its going concern value in order for the resulting deal price to be granted any weight.” Rather, the Supreme Court wrote, the fact that the corporation attracted no bidders at the price determined by the trial court “is not a sign that the asset is stronger than believed—it is a sign that it is weaker.” The Supreme Court identified numerous factors suggesting that the transaction process was well designed to capture the highest available price for the company, and stated that those factors “suggest strong reliance upon the deal price and far less weight, if any, on the DCF analysis.” The Supreme Court remanded with the instruction that the trial court was at liberty to enter judgment at the deal price with no further proceedings or to follow another route, potentially including a weighing of multiple factors with an explanation “based on reasoning that is consistent with the record and with relevant, accepted financial principles.”

The Court of Chancery’s PetSmart decision, released several months before the Supreme Court’s decisions in DFC Global and Dell, sounded many of the same themes. In that case, the Court concluded that the petitioners had not carried “their burden of persuasion that a DCF analysis provides a reliable measure of fair value” on the facts of the case, due in large part to the speculative nature of the projections involved. Rather, the Court determined that the corporation had established that the merger “was the result of a proper transactional process comprised of a robust pre-signing auction in which adequately informed bidders were given every incentive to make their best offer in the midst of a well-functioning market.” In reaching that conclusion, the Court rejected the argument, also raised in DFC Global and Dell, that a buyer’s use of the leveraged buyout model to determine its offer price implied that the offer price would “rarely if ever produce fair value because the model is built to allow the funds to realize a certain rate of return that will always leave some portion of the company’s going concern value unrealized.” The Court finally noted that the petitioners’ valuation contention, based on a discounted cash flow model that valued the company at a 55% premium to deal price, “would be tantamount to declaring that a massive market failure occurred here that caused PetSmart to leave nearly $4.5 billion on the table.” Concluding that the transaction price was a reliable indicator of fair value under the circumstances of the case, the Court entered judgment at the $83 per share deal price, which judgment was not appealed by the petitioners.

The Court of Chancery also has ruled, in three cases decided since mid-2017, that a discounted cash flow analysis yielded a valuation below the transaction price. Two of those cases, SWS Group and Sprint, involved purchasers with significant degrees of control over the sale process; SWS was sold to a substantial creditor that possessed a contractual right to block competing bids, and the target company in the Sprint case, Clearwire Corporation, was sold to its majority stockholder. Hence, neither case involved a claim that the Court should determine that the transaction price was the fair value for appraisal purposes. Both transactions included significant synergistic elements. SWS has been affirmed on appeal in a summary order. An appeal of Sprint remains pending.

The latest discounted cash flow case, AOL, involved an arm’s-length acquisition of AOL by Verizon. AOL’s board had decided to approach potential buyers on a selective basis (rather than conduct a broad pre-signing market check), and several potential buyers had signed non-disclosure agreements and received access to due diligence materials. The Court did not criticize that decision about the structure of the sale process, but noted that once the merger agreement had been signed, AOL’s CEO (who was to be employed in the post-merger entity) made public statements expressing his commitment to the Verizon transaction. The Court also noted that the Verizon transaction was protected by a no-shop and unlimited three-day match rights, and that the time between signing and closing was relatively short. The Court therefore concluded that it could rely on the transaction price only as a check on the discounted cash flow analysis that it undertook. The result of the discounted cash flow analysis was $48.70 per share, a 2.6% discount to the $50.00 per share deal price.

Finally, in Aruba, the Court of Chancery observed that the Delaware Supreme Court’s rulings in Dell and DFC endorsed the efficient capital markets hypothesis, which suggests that prices produced by an efficient market are generally reliable indicators of value. Although the parties had not focused on market efficiency during trial, the Court concluded that the market for Aruba’s stock possessed the attributes consistent with an efficient market found in Dell and DFC. On that basis, the Court concluded that the market for Aruba’s stock was efficient and the unaffected trading price provided reliable evidence of fair value. The Court also considered the deal price less synergies approach for determining the fair value. The Court concluded that the HP-Aruba merger “looks like a run-of-the-mill, third-party deal,” and that the deal price likely included value attributable to expected synergies. The Court noted, however, that it was not possible based on the record to determine with confidence the amount of synergistic value included in the deal price. Thus, while the Court estimated the deal price less synergies to be $18.20, it found the unaffected trading price to be a more straightforward and reliable method for valuing Aruba. Finally, the Court rejected the petitioners’ discounted cash flow analysis because its significant divergence from market value indicators raised doubts as to its reliability, and rejected the respondent’s discounted cash flow analysis based on various methodological flaws. Accordingly, the Court found that the unaffected trading price ($17.13 per share), which was more than 30% below the deal price ($24.67 per share), was the best indicator of the fair value of Aruba’s stock. A motion for reargument of the Court of Chancery’s decision has been filed.