Header graphic for print

Appraisal Rights Litigation Blog

Appraisal Rights and Institutional Investors’ Fiduciary Duties

Posted in Arbitrage, Distinct from Fiduciary Duty Claims

In this 2015 article from the Arizona Law Review, “Shareholder Litigation Without Class Actions,” Boston University Law School Professor David Webber imagines a “post-class-action landscape for shareholder litigation,” positing that the class action vehicle is becoming gutted by the courts and that mandatory arbitration provisions are undermining the class action device.  In this so-called post-class-action environment, the author considers what devices shareholders would have at their disposal to protect themselves.  He argues that “the decline of the transactional class action may be offset by, and may enhance, the rise of appraisal litigation, particularly of hedge fund participation in such litigation,” requiring a more active litigation strategy by fund managers than currently undertaken in furtherance of their fiduciary duties to their beneficiaries.

The article provides an interesting thought experiment and suggests that appraisal is a unique and narrow remedy that is highly individualized, as the right only accrues to the “no” voter and the resultant settlement or trial award does not benefit nonparticipating investors, unlike a class action.  For instance, unlike the typical fiduciary duty class action accompanying M&A deals, there are no additional disclosures to other shareholders.  In addition, as Professor Webber states on page 242, “[i]n the deal context, mandatory arbitration would make it impossible for plaintiffs to enjoin a shareholder meeting, which is the source of much of plaintiffs’ settlement leverage.  This could then shift the focus of institutional investors to appraisal proceedings.  Lately, such proceedings have attracted increased attention from investors, and the loss of a meaningful remedy under Revlon might force more institutions to seek out appraisal remedies, particularly in cases where institutional lead plaintiffs have had success in litigating transactional class actions in the past.”

In sum, if mandatory arbitration prohibits the injunction possibility, the institutional investor may be left solely with its appraisal rights.  And in an interesting twist, the author suggests that if appraisal rights are circumscribed by the legislature, the dissenter is in effect left with no choice but to pursue the strike-suit strategy, which in turn may be further limited by an arbitration provision.  In other words, if appraisal is the stockholder’s last hope, it should be left undisturbed and remain a robust tool.

Delaware Chancery Looks to Merger Price in BMC Software Ruling

Posted in Arbitrage, Discounted Cash Flow Analysis, Fair Value, Merger Price, Risk Premium, Synergies, Terminal Value

Vice Chancellor Glasscock issued his valuation decision this week in the BMC Software case, which we have previously blogged about concerning its threshold ruling rejecting any share-tracing requirements and thus allowing appraisal arbitrageurs to proceed with a valuation case. As we have previously reported, Merion Capital was seeking a 45% premium to the merger price, while BMC Software argued that the fair value was actually far below the merger price.

Merger Price Reflected Fair Value in This Deal

In rendering his decision, the Vice Chancellor once again looked to merger price as a measure of fair value, as he did in the Ancestry.com decision. Perhaps most interesting was his discussion of synergies toward the end of the opinion, in which he hypothesized that if Company B, holding a patent on the bow, found it advantageous to acquire Company A, a manufacturer of arrows, “synergies could result from the combination that would not have composed part of the going concern or the market value of Company A, pre-merger,” in which case Company B might value Company A more highly than the market ordinarily would. In this situation the court would be required to deduct any such synergistic value from the merger price. However, in this particular case, the acquisition was not strategic but financial, and while Respondent pointed to tax savings and other cost savings that it claims it would have realized as a private entity, the court refused to discount the merger price for any synergies.

The court further noted that receiving fair value is not necessarily the same as going concern value, and that any tax or other take-private savings may not be subject to exclusion from the awarded price as synergistic, but those savings could indeed be excludable from the going-concern value. The evidence in this case did not demonstrate any specific dollar-per-share value attributable to such savings, so the court refused to so discount the merger price. In a footnote, Vice Chancellor Glasscock said that the requirement to reduce from fair value any “non-speculative increases in value requiring a change in corporate form” was an “artifact of the policy decision to engraft ‘going concern’ valuation onto the explicit language of the appraisal statute itself,” citing Union Illinois.

The court also rejected Respondent’s request to deduct synergies based on take-private cost savings because they required a 23% internal rate of return in their business model to justify the acquisition, which raised the question of “whether the synergies present in a going-private sale represent a true premium to the alternatives of selling to a public company or remaining independent.” Thus, it was unclear whether any alleged going-private savings outweighed the buyer’s rate of return that was required “to justify the leverage presumably used to generate those savings.”

The Court’s DCF Exceeded Merger Price

The parties relied exclusively on their own DCF models, finding a comparable companies or precedent transactions analysis unreliable. Likewise, the court did its own DCF analysis and came up with a $48 per share price, exceeding the $46.25 merger price that it ultimately found to be fair value. The Vice Chancellor said that he was reluctant to use his own valuation and instead deferred to merger price, given the optimism inherent in the management projections; the raging debate within the academic community over the proper equity-risk premium to apply (thus undermining the reliability of his discount rate); and the difficulties in predicting the accurate terminal growth rate, which could be anywhere in between the floor of inflation and GDP (here, the court had picked the midpoint of those two measures in setting its own terminal rate). In this respect, the court’s DCF valuation, which exceeded merger price, was different from that in Ancestry.com, where the court’s own DCF came up just short of the merger price.

Sale Process

In examining the merger process itself, the court found the process to be robust insofar as there were two auctions conducted for several months each, and there were a total of five financial sponsors and eight strategic entities considering the acquisition. There was a go-shop clause, as a result of which the company contacted sixteen bidders — seven financial and nine strategic — which resulted in no alternative offers. And finally, in an arguable blurring of the line between fiduciary duty actions and appraisal rights (a subject on which we’ve posted several times before), the court explicitly looked to the settlement of the class action fiduciary duty litigation as an indication that the process was found to be free of any irregularities or fiduciary duty violations. In particular, the court found significant that the company’s activist investor, Elliot Associates, who had pressured the company to sell, was also forced to conclude that the auction itself was “a fair process.”

Other DCF Valuation Metrics

As to some of the basic valuation metrics (which were used to calculate the court’s own DCF that it ultimately refused to utilize in favor of the merger price):

  • The court adopted a supply-side equity risk premium, finding that it had already been done in Golden Telecom and Orchard Enterprises and is thus indicative of the “Court’s practice of the recent past.” The court found a preference for using forward-looking data as opposed to the historical or the supply-side approach, notwithstanding the continuing debate within academe concerning the more reliable method.
  • The court reaffirmed that inflation is generally the floor for a terminal value, and here, since there was no evidence to suggest that the growth rate should be limited to inflation, the court ultimately chose a growth rate at the midpoint of inflation and GDP, which was 3.25%.
  • The court found it appropriate to include a reasonable offset for the tax associated with repatriating offshore cash, rejecting Petitioner’s argument that the company’s plan to keep that money offshore indefinitely should translate to no offset at all. We have seen this same point argued (and now pending before the court) in the Dell appraisal case as well.
  • As is true of many tech companies, BMC had a sizable stock-based compensation (SBC) policy, which the court found was required to be accounted for, and further found reasonable to treat as an expense, particularly because this practice was expected to continue into the future. The court thus agreed with Respondent’s expert, who treated SBC as a cash expense, as opposed to Petitioner’s expert, who didn’t account for future SBC at all.

While the court seemed to take a jab at Petitioner for being “arbitrageurs who bought, not into an ongoing concern, but instead into this lawsuit,” nothing in this opinion referred back to or otherwise altered its prior ruling allowing appraisal arbitrage to proceed unfettered by a constraint such as the share-tracing requirement that BMC had asked the court to impose.

Can Appraisal Rights Be Available in an All-Stock Deal?

Posted in Appraisal-Eligible Deals

A frequently asked question involves the availability of appraisal rights when investors are being offered only stock in the acquiring corporation in exchange for their shares.

The answer is typically no.  The Delaware appraisal statute provides that appraisal rights are available in a wide range of statutorily permitted mergers.  8 Del. C. § 262(b).  However, in what is commonly referred to as the “market-out exception,” the statute further provides that appraisal rights are not available for stock that is “either (i) listed on a national securities exchange or (ii) held of record by more than 2,000 holders.”  8 Del. C. § 262(b)(1).  Of course, if this is where the story ended, the market-out exception would render appraisal rights unavailable in most cases.  But the Delaware legislature created another exception in the appraisal statute, which Delaware courts have labeled the “exception to the exception.”  The exception to the exception states that the market-out exception does not apply when the shareholders of the target corporation are required to accept consideration for their shares that is not (a) shares of stock in the surviving corporation, (b) shares of stock in any other corporation that are either listed on a national securities exchange or held of record by more than 2,000 holders, or (c) cash in lieu of fractional shares described in (a) or (b).  8 Del. C. § 262(b)(2).  Thus, the statute provides that when the holders of a nationally listed or widely held stock are offered cash consideration for their shares (other than cash in lieu of fractional shares), appraisal rights exist, but when they are offered only the stock of the acquirer or other nationally listed or widely held stock, there are no appraisal rights.

In Louisiana Municipal Police Employees’ Retirement System v. Crawford, 918 A.2d 1172 (Del. Ch. 2007), the Delaware Chancery Court addressed the interesting question of whether appraisal rights exist when the shareholders of the target company are offered only stock of the acquiring company, but the acquiring company also causes the target’s board to declare a special dividend immediately prior to the merger.  The acquiring company argued that appraisal rights were not available because the merger was technically an all-stock deal and the special dividend was not part of the merger consideration being offered by the acquirer.  The Chancery Court rejected that argument, however, finding that it elevated form over substance.  The payment of the special dividend was dependent on the shareholders of the target approving the merger.  Thus, the Court found, “[w]hen merger consideration includes partial cash and stock payments, shareholders are entitled to appraisal rights.  So long as payment of the special dividend remains conditioned upon shareholder approval of the merger, [shareholders of the target corporation] should not be denied their appraisal rights simply because their directors are willing to collude with a favored bidder to ‘launder’ a cash payment.”

In another interesting application of the appraisal statute, Krieger v. Wesco Financial Corp., 30 A.3d 54 (Del. Ch. 2011), the Chancery Court addressed whether appraisal rights exist when shareholders are given the option of receiving either cash or stock.  Shareholders who failed to make an election would receive cash.  The Chancery Court held that appraisal rights were not available in that instance because the shareholders had the option to elect to receive stock.  Even though they might ultimately receive cash, they were not required to accept cash.

Accordingly, whether or not an ostensibly all-stock deal is appraisal eligible requires an examination of all the forms of consideration being offered in the merger and any election features available to stockholders.

Mining for Gold in the Silver State: Nevada Appraisal Rights

Posted in Interest on Appraised Value, Merger Vote, Nevada Appraisal Rights

When the Delaware legislature recently struck down fee-shifting bylaws — those internal corporate laws that force losing plaintiffs to pay the company’s legal fees — it prompted a slew of commentary (e.g., here and here) suggesting Delaware may lose its place as the top venue to incorporate.  Nevada has been making a play to provide a Delaware-style business-friendly climate.  (See “Delaware’s loss of certainty could be Nevada’s gain.”)  Whether Nevada supplants Delaware as the leading corporate venue remains to be seen.  But it got us thinking — what does appraisal rights litigation (called “dissenters’ rights” in Nevada) look like for professional investors in Nevada corporations?  As it turns out, Nevada is not nearly as friendly a place as Delaware for professional investors whose shares are at risk of being cashed out for an amount below the going-concern value of their investment.

First and foremost, holders of securities in an exchange-listed Nevada corporation without a controlling shareholder (10% or greater) are not entitled to dissenters’ rights at all.  Nevada law allows for exceptions where the articles of incorporation provide otherwise or at least part of the merger consideration is not cash or shares of most kinds of corporate stock, but by default there are no appraisal rights.  In contrast, Delaware appraisal rights are generally available in a consolidation or merger for any series or class of stock.

Moreover, an investor still needs to clear several hurdles to get an appraisal claim before a Nevada judge.  Indeed, the investor and the corporation need to exchange three separate notices before a dissenter’s petition is even filed in court.  Initially, investors wishing to dissent from a merger or other business combination subject to appraisal rights must first, before the merger vote, deliver a written notice.  Investors must also be sure not to vote their shares in favor of the merger or consolidation.

The shareholder’s notice prompts a response from the subject corporation, to which the investor must respond by (i) demanding payment, (ii) certifying that he or she was actually a beneficial owner, and (iii) surrendering his or her stock certificates as formal evidence of stock ownership.  The company is then required to tender payment to the shareholder of an amount that it considers to be the fair value of the shares.  The company is highly incentivized to follow this procedure — if it does not, only then may an investor file its action directly and, if the investor prevails, he or she is entitled to recover the expenses of the lawsuit.

Presumably, the corporation’s payment will be insufficient.  But even then, an investor cannot go directly to a judge.  Instead, the investor has to object in writing and make a demand for what he or she thinks is the fair value of the shares.  Only then, with the payment demand unsettled, will a petition be filed in court.  Also, it is the company — not the investor, as in Delaware — that files the petition, and the company can wait two months to do so.

Two other considerations bear mention.  First, unlike Delaware, Nevada does not provide for an interest rate floor on appraisal awards (Delaware appraisal awards accrue at 5% above the Fed’s discount rate and are compounded quarterly).  Nevada law instead says that a dissenter’s award will be for fair value “plus interest.”  Second, there are very few decisions interpreting Nevada’s dissenters’ statute, making litigation in Nevada much more unpredictable for investors and companies alike.

Accordingly, professional investors who utilize appraisal rights to maximize their investment returns will not cheer on Nevada to supplant Delaware as the seat of American corporate law.

Delaware Law Does Not Require All Stockholders to Settle on Same Terms as Non-Petitioning Dissenters

Posted in Fair Value, Non-Appearing Dissenters, Notice of Demand for Appraisal

In his second appraisal decision in as many months, Chancellor Bouchard faced the novel question of whether the Chancery Court can approve a settlement between the surviving company and certain non-appearing dissenters, who had never themselves filed or joined in an appraisal petition, if the terms of that settlement are unavailable to all of the dissenters who had perfected appraisal rights.  Under the Chancellor’s decision in Mannix v. PlasmaNet, Inc., the answer is yes.

Mannix was not a valuation decision but a procedural ruling.  The issue arose because Delaware’s appraisal statute is in certain ways similar to the class action device, in which one plaintiff serves as a representative in a lawsuit on behalf of all other similarly situated plaintiffs.  Specifically, the appraisal statute provides that one appraisal petition can serve as the “representative” appraisal action for all other dissenting shareholders, and that the fair value determination reached in that proceeding will be available to all dissenters who have perfected their appraisal rights even if they had not filed their own petition.  As the Chancellor is careful to note, however, there is “at least one notable distinction” between the procedures available in an appraisal proceeding and those in a class action: unlike in class actions, in which shareholders elect to “opt out” of the class to pursue individual claims, appraisal petitioners “opt in” to an appraisal proceeding before the litigation even begins by dissenting from the merger and perfecting their rights in the first place.

In Mannix, certain non-appearing dissenters – i.e., stockholders who neither filed their own petitions nor joined in another’s petition – had settled with the surviving Company and were now asking the Court for their appraisal claims to be released.  The settlement was conditioned on the non-appearing dissenters certifying that they were “accredited investors” under the federal securities laws, a necessary condition because the settlement consideration consisted of their receiving the surviving Company’s unregistered stock.  The Company made the same offer to the named appraisal petitioner (Mannix), who rejected it.

Chancellor Bouchard rejected both of the petitioner’s challenges to the settlement.  The petitioner first argued that the Company could not condition a settlement on a dissenter’s status as an accredited investor, since not every non-appearing dissenter may qualify as accredited.  The Chancellor held that this argument was unsupported by any law or precedent and distinguished two earlier appraisal cases that had raised the specter of a “buy off,” whereby the named appraisal petitioner settles the proceedings to the benefit of himself and the Company, but to the detriment of all other non-appearing appraisal petitioners that he was in effect representing.  Chancellor Bouchard found that these concerns were not before him, where any purported “buy off” – if there even was one – was being undertaken by a non-appearing dissenter, and thus would have no effect whatsoever on Mannix’s ability to prosecute his own appraisal action on behalf of himself and any other non-appearing dissenters who remained.

The Chancellor drew another analogy to class action settlements, citing former Chancellor Allen for the proposition that “a defendant in a putative [i.e., pre-certification] class action is readily permitted under the law to settle a class claim with non-representative class members.”  Likewise, the surviving company in an appraisal proceeding is similarly able to settle directly with non-appearing dissenters.

In general, in making these references to the class action vehicle, the Chancellor made a point of showing how appraisal rights are also representative actions, albeit in different form, and that the statute in fact encouraged the notion of representation by requiring that only one appraisal petition be filed – whether by the surviving corporation itself or by a former stockholder – thereby entitling all former stockholders who perfected their appraisal rights to receive “fair value” even if they did not file a petition themselves.  Indeed, the court noted that the right to appraisal ceases if all interested persons failed to file a petition for appraisal within the statutory 120-day period following consummation of the transaction.

The Chancellor was also unmoved by the petitioner’s second argument, that settling non-appearing dissenters out of an appraisal case would “undercut the economics of the appraisal proceeding” by reducing the total shares at issue and, accordingly, the aggregate recovery available in the proceeding.  The court found that the petitioner happened to be the first shareholder to file an appraisal demand, and thus had already accepted the risk from day one that he might end up being the only one to so file, even though that risk never came to pass.  The Chancellor also observed that if he were to hold otherwise, it would give named appraisal petitioners a “hold-up right” to block any settlement, which was not envisioned by the appraisal statute.

The transaction is also notable for its incredibly small size: the total merger consideration for this deal after adjustments was just $114,000, or six-tenths of a penny for each of the 19,307,715 shares of outstanding PlasmaNet stock, and the named petitioner brought this action seeking appraisal of his 1,700 shares.

Without Fanfare, Chancellor Bouchard Hands Down First Appraisal Opinion

Posted in Award Premium, Discounted Cash Flow Analysis, Distinct from Fiduciary Duty Claims, Fair Value, Operative Reality, Short-Form Merger, Terminal Value

The Delaware Chancery Court’s recent opinion in Owen v. Cannon has garnered little notice or press coverage, but deserves attention not only because the hybrid fiduciary duty-appraisal decision is Chancellor Bouchard’s first foray into the appraisal space, but because it reinforces some basic appraisal tenets and yet also bucks what some have called a recent trend of merger price rulings.

The transaction arose from the interactions of the company’s three main principals: Nate Owen, the founder and president of the firm at the center of the lawsuit, Energy Services Group; his brother Bryn, who worked at ESG directly under Nate; and Lynn Cannon, who put up the capital for the Company.  Bryn and Cannon eventually forced Nate out of his job as president (with Cannon being his replacement), and cashed out in a short-form merger Nate’s significant minority stake in ESG for just under $20/share.  After applying a discounted cash flow analysis, and no other valuation methods, Chancellor Bouchard awarded Nate approximately $42 million for his 1.32 million shares of ESG, or just under $32/share.  The Chancellor’s $12/share premium is a departure from a recent slate of appraisal actions, including Ramtron and Ancestry.com, in which the Court of Chancery has rejected income- or market-based valuation methodologies while looking simply to the merger price as fair value.

In his lengthy opinion, Chancellor Bouchard reaffirms a number of bedrock principles of the appraisal analysis:

  • The primacy of the DCF. According to Chancellor Bouchard, the discounted cash flow valuation methodology is the preferred manner in which to determine fair value because “it is the [valuation] approach that merits the greatest confidence within the financial community.”  Chancellor Bouchard’s view on the use of transaction price as proof of fair value was not tested in Owen, as both valuation experts in the case used a DCF exclusively and the Chancellor thus had no occasion to opine on the merits of merger price or any other metric to determine fair value.
  • Reliable management projections can be dispositive. Of course, a DCF is only as good as its inputs.  Much of the Chancellor’s exhaustive 80-page opinion was dedicated to whether or not he could rely on management projections created by Cannon in 2013 in connection with Nate’s buy-out.  Chancellor Bouchard determined that he could, in large part because Cannon created the projections when he was already trying to force Nate out of the company (meaning that the projections already had conservative assumptions baked in), and ESG submitted the projections to Citizens Bank to obtain a $25 million revolver (meaning that it would be a federal crime if the projections were false).  In contrast, the Chancellor applied well-settled Delaware law in rejecting defendants’ expert’s post hoc, litigation-driven projections in their entirety.
  • Tax treatment can mean real money. ESG was a subchapter S corporation, meaning that (unlike in a subchapter C corporation) ESG’s income was only taxed once, at the stockholder’s income rate.  Because Delaware law requires a shareholder in an appraisal to be paid “for that which has been taken from him,” and a “critical component” of what was taken from Nate was the “tax advantage” of owning shares in a subchapter S corporation, Chancellor Bouchard adopted Nate’s argument that the Court’s DCF should be tax affected to take into account ESG’s subchapter S status.  Under the hypothetical posed by the Chancellor in Owen, S Corp tax treatment means a nearly $14 boon to an investor for every $100 of income.
  • Absent identifiable risk of insolvency, inflation is the floor for a terminal growth rate, with a premium to inflation being appropriate for profitable companies. The DCF’s terminal growth rate — which is intended to capture a firm’s future growth rate while still recognizing that firms cannot over time grow materially in excess of the economy’s real growth — is a critical DCF input.  (We described one way to calculate terminal growth here, in an earlier post in our “Valuation Basics Series”).  Applying Delaware precedent, Chancellor Bouchard determined that it was appropriate to set the terminal growth rate at 3%, a “modest” 100 basis points premium over the Fed’s projected 2% inflation rate.  According to the Chancellor (quoting a 2010 Delaware Supreme Court decision), “the rate of inflation is the floor for a terminal value estimate for a solidly profitable company that does not have an identifiable risk of insolvency.”  Chancellor Bouchard, however, rejected Nate’s suggested 5% terminal growth rate (above nominal GDP growth) as too high for ESG, a company facing increasing competitive pressures whose years of rapid growth may have been behind it.

The Chancellor also found breaches of fiduciary duties, generally agreeing that, by Nate’s description, the merger was conducted in a “boom, done, Blitzkrieg style,” with Nate having been given notice (by sheriff’s service) on Friday, May 3, 2013 of a Monday, May 6, 2013 special meeting of shareholders to vote on the merger.  This was especially egregious as ESG had never before held a formal board meeting until Cannon and Bryn orchestrated two such last-minute meetings, the first one being to terminate Nate’s employment with ESG (which meeting Nate found out about while tending to a health issue for his wife).  The May 6 meeting was conducted despite Nate’s request for an adjournment, and the meeting was overseen by an armed guard who stood “at the door with a gun at his hip.”  Nevertheless, the damages award for the fiduciary duty claims equaled those decided by Chancellor Bouchard’s appraisal ruling.

Delaware Chancery Court (Reluctantly) Dismisses Appraisal Challenge Based on Re-titled Stock Certificates

Posted in Arbitrage, Consummation of Merger, Continuous Holder Requirement, Notice of Demand for Appraisal, Record Date

The Chancery Court granted summary judgment in favor of Dell against a number of stockholders who duly noticed their appraisal demands but whose stock certificates had been retitled before the effective date of the merger to their own custodians’ nominees. As is typical for an appraisal challenge, DTC certificated the dissenting stockholders’ shares into the name of its nominee, Cede. But the beneficial owners’ custodians then took the added step of directing DTC to retitle the shares to the name of their own nominees, which change took place prior to the consummation of the merger. The court ruled that this ostensive break in record ownership violated the continuous holder requirement and thus disqualified those beneficial owners from proceeding with their appraisal case.

This ruling dismisses almost a million shares from the Dell appraisal case. Shares that were certificated in the name of Cede, without a further name change, are unaffected by this decision and the rest of the claims remain pending before the court. The ruling only affects those holders whose custodians changed the designee out of Cede’s name and into their own nominees’ names. Interestingly, the court found it irrelevant that the funds themselves were unaware of the retitling of their shares, a process which is undertaken by the custodian without the beneficial owner’s knowledge or consent. Thus, Vice Chancellor Laster found that once a shareholder chooses to hold its shares through intermediaries, it assumes the risk that the intermediaries might take an action against its interests.

Vice Chancellor Laster makes very clear that he felt constrained by Delaware case law to reach this result and that “were it up to me,” a better interpretation of the term “stockholder of record” in the appraisal statute would include the DTC participant list (i.e., the brokers and custodians, not just Cede). Under federal law, Cede is not the record holder, the DTC participants are deemed to be the holders, and the Vice Chancellor would have followed federal law if he did not think that Delaware law so clearly deems only Cede to be the owner of record. In fact, he directed much of his opinion to the Supreme Court itself and seems to want to be reversed. The legislature could conceivably take action first, and contemplating that very possibility, the Vice Chancellor also stated that he did not want to be overridden by the legislature and that there should not be a legislative cure to an issue of statutory construction.

The opinion provides a very detailed account of the process by which shares are held in fungible bulk and then re-certificated by DTC, and how Congress directed the SEC to immobilize share certificates through a depository system in response to the unworkable situation that had arisen under the former paper trading framework. The decision also lays out a comprehensive history of the record holder requirement, from 1899 to the present, in the course of which the court touched on appraisal arbitrage: on the one hand, the court said that including the DTC participants would bring greater clarity to the question of how particular stockholders may have voted. But at the same time, the Vice Chancellor made very clear that he did not thereby intend to undercut the practice of appraisal arbitrage, and as a policy matter he did not understand why critics of appraisal arbitrage oppose the transfer of appraisal rights when the commercial marketplace generally favors the transfer of property, including something as likely to result in an assignment of a litigation claim as a defaulted loan.

With Unreliable Management Projections and No Market-Based Models, Delaware Chancery Pegs Fair Value to Merger Price

Posted in Arbitrage, Discounted Cash Flow Analysis, Fair Value, Merger Price, Precedent Transactions, Synergies

Delaware’s latest appraisal decision in LongPath Capital v. Ramtron International Corp. adopted the merger price as its appraisal valuation, but stands apart from the other recent appraisal decisions that likewise fell back on transaction consideration. Here, the court’s lengthy opinion repeatedly lamented the lack of any remotely reliable means of valuation other than the merger price, and the court was careful to satisfy itself that the sales process leading up to the deal was “proper,” “thorough” and “effective,” though these terms remain without precise definition. Ramtron ostensibly joins Chancery’s recent decisions — including Ancestry.com and AutoInfo — in adopting the negotiated deal price as conclusive proof of value. But unlike those two cases, the court in Ramtron found that fair value ($3.07/share) was actually below the deal price ($3.10/share) when accounting for synergies between Ramtron, the semiconductor manufacturer being acquired, and Cypress Semiconductor, the hostile acquirer.

Part of the unique nature of this action was that in a deal valued at $110 million, the merger price represented a 71% premium to the pre-deal stock price. Moreover, the petitioner, who acquired its shares after the merger announcement (more about the arbitrage play later), bought only a small stake worth about $1.5 million. But the bulk of the court’s analysis focused on whether or not the management projections presented in the petitioner’s DCF analysis were reliable, as Delaware courts apply the commonsense rule that a DCF predicated on suspect projections is worthless in an appraisal. The petitioner’s projections were fatally flawed in many respects, though three of the nine flaws identified by the court stand out the most. First, the projections were prepared by new management, using a new methodology (the product-by-product buildup method) and covering a longer time period than earlier forecasts. Furthermore, the projections had not been prepared in the ordinary course of business. Second, Ramtron distorted its revenue figures by engaging in so-called channel stuffing, the practice of pushing excess inventory into distribution channels so that more revenue can be recognized sooner (indeed, the court repeatedly cited an e-mail in which a salesman said that the company will “for sure stuff channel”). Third, Ramtron management provided alternative projections to Ramtron’s bank, which they described as “more accurate” than those cited by the petitioner. Given these deficiencies, the court had no trouble casting aside management’s pre-merger projections and the petitioner’s DCF which relied on them.

Indeed, the court took both experts to task for what appeared to be litigation-driven valuations. The court criticized the respondent’s “eyebrow-raising DCF” which, notwithstanding its reliance on projections that the expert presumed were overly optimistic, somehow still returned a “fair” value two cents below the merger price.

In any event, the court also had little trouble rejecting the petitioner’s suggested “comparable transactions” methodology, a market-based analysis which ascertains going-concern value by identifying precedent transactions involving similar companies and deriving metrics from those deals (and which we will be examining in greater detail in our next “Valuation Basics” post). The petitioner’s expert was hamstrung by a lack of deals involving companies similar to Ramtron, and could only point to two, which were themselves drastically different from each other and which resulted in disparate multiples. Given this “dearth of data points,” the court found that it could not give any weight to a precedent transactions approach. The court was also influenced by the fact that the petitioner’s expert himself only attributed 20% of his valuation to the comparable transactions analysis.

That left merger price, which the court acknowledged “does not necessarily represent the fair value of a company” as that term is used in Delaware law. To demonstrate this truism, the court cited to the short-form merger, in which the controlling stockholder sets the merger price unilaterally, forcing minority stockholders out and leaving them to choose between taking the deal and exercising appraisal rights. According to the court, pegging fair value to the merger price in such a circumstance would render the appraisal remedy a nullity for the minority stockholder — all roads lead to a merger price that has not been independently vetted. In a situation like Ramtron, however, where the company was actively shopped for months and the acquirer raised its bid multiple times, merger price could be deferred to as conclusive (and critically, independent) proof of fair value.

The court was not troubled by the fact that Cypress’s acquisition process was initiated by a hostile offer, or the fact that no other company made a bid for Ramtron. According to Vice Chancellor Parsons, there was no evidence that the hostile offer prevented other companies from bidding on Ramtron — there were six signed NDAs in total — and impediments to a higher bid for Ramtron were a result of the company’s operative reality, not any purported shortcomings in the deal process itself. Having found a fair merger process, the court concluded that the merger price was the best, if not the only, evidence of fair value. Simply put, “if Ramtron could have commanded a higher value, it would have.” Indeed, the court expressed its skepticism over the petitioner’s expert’s valuation of $4.96, as compared to its unaffected stock price of $1.81, suggesting that “the market left an amount on the table exceeding Ramtron’s unaffected market capitalization.” The court could not accept that such a significant market failure occurred here.

Coming back to the arbitrage issue, the Vice Chancellor makes a point of noting that LongPath only began acquiring Ramtron shares a month after the merger was announced. We’ve discussed the practice of appraisal arbitrage extensively, noting the arguments for (here) and against (here). The Court of Chancery has been reluctant to limit the practice thus far (here), and Vice Chancellor Parsons continues that pattern here, consistent with the Corporation Counsel of the Delaware Bar’s own refusal to recommend to the legislature that it limit or eliminate the arbitrage practice altogether, as we’ve previously posted here and here.

AOL Stockholders Seek Increased Returns Through Appraisal

Posted in Dollar Amount of Appraisal Rights Filings, Number of Appraisal Rights Filings

As reported in the Wall Street Journal, stockholders owning about 5 percent of AOL, Inc., are seeking greater returns than the $50/share buyout price paid by Verizon Communications by pursuing appraisal of their shares.  The deal was valued at $4.4 billion.  As reported in the article, this appraisal case is yet another example of how the appraisal mechanism has evolved from a “little-used remedy” to a “bona fide investing strategy.”  Thus, as the Wall Street Journal reports, a record 40 appraisal cases were brought in 2014, and another 28 have been filed already in 2015 having a face value of about $1.8 billion.