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Appraisal Rights Litigation Blog

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.

Many Roads Lead to Enterprise Value

Posted in Comparable Companies, Discounted Cash Flow Analysis, Fair Value, Precedent Transactions

A widely followed corner of the blog is our “Valuation Basics” series, where in earlier posts we have described many of the components of the discounted cash flow analysis, the income-based valuation methodology preferred by Delaware’s Court of Chancery.  (See here, here, and here).  Earlier this month we examined a market-based valuation approach — the comparable companies analysis  — that derives the subject company’s value based on the share price of analogous publicly traded companies.  Working knowledge of these and other valuation methodologies is essential for both appraisal professionals and professional investors, since as the Court of Chancery recently described in Merlin Partners LP v. AutoInfo, Inc., enterprise value can and will be determined in an appraisal proceeding a variety of ways, “depending on the case.”  Readers of our “Valuation Basics” series should check back in for the next post in that series, which will examine another market-based approach to valuation, the precedent transactions analysis.

Stockholders Seek 45% Premium in BMC Appraisal Case

Posted in Award Premium, Fair Value, Merger Price, Synergies

As reported in Law360, stockholder Merion Capital LP petitioned the Delaware Chancery Court this week for an award of $67 per share for its stock in BMC Software, Inc.  Such a demand would reflect a 45% premium to the merger price of $46.25.  Indeed, as Law360 reported, the parties’ arguments focused to a large degree on how much deference should be accorded, if any, to the sale process and resultant merger price it produced.  The court also asked the parties for supplemental briefing on any purported synergies that BMC claimed to have achieved in the merger, which synergies are excluded by the appraisal statute from the fair value determination.   Readers may recall that we previously posted about the BMC case back in January, when Vice Chancellor Glasscock issued his decision in this matter as well as the Ancestry.com case, reaffirming the validity of appraisal arbitrage for the first time since the court’s 2007 ruling in Transkaryotic.

We will continue to monitor this case and post the court’s decision when available.

Valuation Basics: Comparable Companies Analysis

Posted in Comparable Companies, Fair Value, Valuation Basics, Valuation Expert

Our “Valuation Basics” series has focused on the various components of a discounted cash flow analysis under the income approach, which seeks to value a company based on the present value of its projected cash flows.  This post and those to follow in this series will now move away from the income approach and instead examine two “market” approaches: (1) the comparable companies method; and (2) the precedent transactions method.  Under these approaches, we look at how the market values similar companies in order to determine the value of the subject company.

The purpose of a comparable companies analysis is to derive a value for the subject company based on the stock price of similar publicly traded companies.  Accordingly, the first order of business is to select publicly traded companies that are “comparable” to the subject company.  No two companies are truly identical, so an appraiser must use her judgment to select companies that have sufficiently similar characteristics to the subject company from which meaningful valuation data can be extracted.  The more similar the selected companies are to the subject company, the more weight the court is likely to place on a comparable companies valuation.

After selecting the applicable comparable companies, valuation multiples are derived for each of the comparable companies by dividing their respective enterprise values (“EV”) by appropriate financial metrics, such as revenue or EBITDA.  The comparable companies’ stock price on the valuation date is used to calculate their enterprise value.  So, for example, assume that Comparable Company A has a stock price on the valuation date that yields an enterprise value of $2 billion.  Assume further that Comparable Company A has reported revenue for the last twelve months (“LTM”) of $500 million.  Comparable Company A’s LTM EV/revenue multiple would be 4.0.

Next, the valuation multiples of the comparable companies should be adjusted to account for differences between the comparable companies and the subject company.  For example, if the comparable companies have a large amount of outstanding debt but the subject company is debt free, the valuation expert might adjust the valuation multiples to account for the subject company’s more attractive balance sheet.  In our example, if the median LTM EV/revenue multiple of Comparable Companies A, B, C, and D is 3.8, the appraiser might select an LTM EV/revenue multiple of 4.0 to apply to the subject company if there are factors warranting an upward adjustment based on the subject company’s superior performance.

Once the appraiser has determined the correct valuation multiples, those multiples can be applied to the relevant financial metrics of the subject company to calculate the market value of invested capital of the subject company.  Using our example above, if the subject company had reported revenue of $750 million for the previous year, its market value of invested capital based on the LTM EV/revenue multiple of 4.0 would be $3 billion.  To derive the equity value of the subject company, the subject company’s interest-bearing debt should be subtracted.

Appraisal experts typically adjust a comparable companies valuation to account for the inherent minority trading discount reflected in the valuation multiples.  The stock price that is used to derive a comparable company’s enterprise value is based on transactions involving non-controlling ownership interests traded on the stock market.  Accordingly, the Delaware Court of Chancery has allowed appraisers to correct for this lack-of-control discount by adding a premium to the equity value derived from a comparable companies analysis.  While there is no set premium, the Delaware Court of Chancery has accepted as appropriate a premium of 30%.

In recent years, the Delaware Court of Chancery has become more exacting in its acceptance of comparable companies valuations in appraisal cases.   In cases where the court has rejected a comparable companies valuation proffered by a party’s expert, the court has often expressed its concern with the numerous subjective judgment calls made by the valuation expert in arriving at his comparable companies valuation.  Why did the expert choose some companies as comps but not others?  Why did the expert use certain multiples and not others?  Why did the expert adjust the selected multiple upward or downward rather than simply apply the mean or median multiple?  To address these concerns, valuation experts in appraisal cases should carefully describe in their expert reports not only the subjective judgment calls they made in conducting their comparable companies analysis, but also their principled basis for doing so.

In our next post in the Valuation Basics series, we will explain how the comparable transactions analysis differs from the comparable companies approach.

Settling Safeway Shareholders Achieve Substantial Premium Within Six Months of Closing

Posted in Award Premium, Distinct from Fiduciary Duty Claims, Merger Price

As reported in the Wall Street Journal, several investments funds who had exercised appraisal rights in connection with Albertsons’ acquisition of Safeway Inc. have now settled their appraisal case for a 26% premium over the merger price within just half a year after the deal closed.  The settlement, at $44 per share, netted $127 million more to the settling funds than the merger price of $34.92 would have given them.  While the deal resolves the claims of most dissenting stockholders, two other funds holding 3.7 million shares remain in the appraisal case, and the fiduciary duty class actions against Safeway remain pending as well.

Table Is Set in Dell Case for Another Look at Arbitrage

Posted in Arbitrage, Merger Vote, Waiver of Appraisal Rights

On Monday the Delaware Chancery Court heard challenges by Dell to the entitlement of various dissenting shareholders to pursue their appraisal claims.  Dell’s challenges included failures by shareholders to timely and accurately assert their appraisal rights, and a lack of continuous ownership of Dell stock based on purported changes in the nominal ownership of such stock.  The court has yet to rule on these arguments.  But perhaps the most closely watched challenge was the one not heard yesterday: namely, Dell’s challenge to T. Rowe Price’s appraisal claim based on the apparently recent revelation that T. Rowe voted “for” the merger, as we previously posted.  The court indicated that it would take up that issue after Dell proceeds with the targeted discovery that it advised the court it intends to pursue in respect of T. Rowe’s vote.

Also in the course of that hearing, Vice Chancellor Laster heard argument from an individual dissenting shareholder defending his entitlement to proceed and invoking historical case law to support his position.  As an amusing aside, the chancery judge commented that he appreciated hearing citations to court cases going back more than 10 years, validating the fact that appraisal rights are an historical phenomenon dating back to Delaware’s corporations law from the 19th century and were not simply invented in 2007 — when the Transkaryotic case was decided — as some people, particularly in New York, seem to believe.  This was a not-so-subtle swipe at the critics of appraisal arbitrage, who have derided the Delaware courts, and more recently the Delaware state assembly, for failing to limit or eliminate the emerging practice of appraisal arbitrage, as we have repeatedly posted about in recent months.

Based on this Reuters piece summarizing the May 11 hearing and Dell’s brewing challenging to T. Rowe’s ability to proceed, it appears that T. Rowe may try to justify its entitlement to proceed by invoking the arbitrage cases to suggest that there were enough appraisal-eligible shares to allow it proceed, although it clearly faces an uphill battle.  Ordinarily, if a shareholder votes “for” the transaction, it’s game over for its appraisal claim.

A Painful Lesson in Failing to Perfect Appraisal Rights

Posted in Merger Vote, Notice of Demand for Appraisal, Record Date, Waiver of Appraisal Rights

As reported in USAToday, T. Rowe Price, the third largest shareholder in Dell, Inc., has been pursuing an appraisal case to recover more than the $13.75 per share merger price. However, it has now come to light that T. Rowe actually voted “for” the 2013 take-private deal by the company’s founder, thus threatening its ability to pursue appraisal. Indeed, one of the key steps in perfecting appraisal rights is voting against the proposed transaction, or at least abstaining from the vote, but in all events refraining from actively voting for the deal outright. Whether T. Rowe is permitted to continue in the case has not yet been decided by the Delaware chancery court.

“Shareholder Litigation That Works”

Posted in Arbitrage, Number of Appraisal Rights Filings, Record Date

Professors Korsmo and Myers have once again lauded the benefits of appraisal litigation and chastised its critics for pressuring the Delaware bar council to reconsider its recent decision not to limit or eliminate appraisal arbitrage.  In their latest piece, the authors reaffirm their findings that appraisal cases comprise that rare form of shareholder suit “where the merits actually matter.”  They suggest that the emergence of appraisal arbitrage specialists should be “reassuring, not shocking” to the deal community, as it evidences “beneficial specialization” that allows shareholders unfamiliar with the appraisal process to cash out, sometimes at a premium to the merger price, without being forced to accept an undervalued deal or to prosecute appraisal rights for themselves.

Deal Lawyers Lobby Delaware Bar to Reconsider Its Refusal to Limit or Eliminate Appraisal Arbitrage

Posted in Arbitrage, Number of Appraisal Rights Filings, Record Date

As we’ve previously posted, the Corporation Council of the Delaware bar had taken up the question of whether to ban or curtail appraisal arbitrage, and more recently decided to take no such action after determining that the practice had no discernable negative effects on mergers and acquisitions and, if anything, continued to protect shareholder value.  See our prior posts here and here.  In addition, as we recently noted here, Chief Justice Strine of the Delaware Supreme Court tends to agree with that position and believes that the concern over appraisal arbitrage is overblown.  As the Wall Street Journal reported this week, a group of law firms that typically represent parties to M&A deals strongly disagrees with the Council, and has sent a letter to the Council questioning its findings.  The headline-grabbing quote from the letter — that appraisal arbitrage is both “unseemly” and “rampant” — challenges the Council’s determination that there has been no recent uptick in frivolous or speculative appraisal litigation.  It is not apparent that the letter provides competing statistics to contest the Council’s findings, such as that in 2013, representative litigation occurred in more than 90% of public M&A, while only 17% of the appraisal-eligible transactions resulted in Delaware appraisal litigation.  Rather, the letter seems grounded on a policy rationale that the appraisal statute was not intended to enable those who purchase shares after the public announcement of a deal, or at least those who bought after the record date for the vote, to seek appraisal.  Given the Delaware courts’ finding to the contrary and their refusal to impose a share-tracing requirement that may impede appraisal rights of stockholders who purchased their shares after the vote, the letter-writers are taking their case to the legislature.

The current Delaware legislative session ends on June 30, so whatever changes, if any, are to be made to the appraisal remedy this year will need to take place before then.  We’ll keep you posted.