We have posted before about the amicus brief that a collection of law professors has asked to put before the Delaware Supreme Court as it hears the DFC Global appeal. On Friday, the Supreme Court granted their request and will consider their submission advocating that the chancery courts should defer to the merger price when reached as a result of a robust, pristine M&A auction. This ruling was made despite the opposition voiced by the DFC Global stockholders defending the lower court’s decision to award them a premium to the merger price. The Court found that the professors may be able to provide it with some “unique supplemental assistance” in this case, which involved a question of “general public importance.”
In a new post by the Harvard Law School Forum on Corporate Governance and Financial Regulation, Professor Albert Choi (Virginia Law School) and Professor Eric Talley (Columbia Law School) present their new working paper, which asks how best to measure “fair value” in an appraisal proceeding.
Applying principles of game theory and auction design, the authors show that as a general matter, setting the appraised value at merger price (using a so-called MP rule) “depress both acquisition prices and target shareholders’ expected welfare relative to both an optimal appraisal rule and several other plausible alternatives.” The authors argue that the MP rule is the functional equivalent of nullifying the appraisal right altogether.
Law360 has provided some Delaware Chancery Cases to Watch in 2017 [$$$], highlighting the DFC Global case, which we’ve blogged about previously. The Law360 commentary, like ours, notes that this will be an opportunity for the Delaware Supreme Court to weigh in on the factors relevant to appraisal and will be a closely watched decision.
We have blogged before about the purported “friend of the court” brief that a group of law professors would like to file with the Delaware Supreme Court, urging the Court to reverse the Chancery Court’s ruling awarding DFC Global stockholders a premium to the merger price.
The stockholders have now filed their own brief opposing the academics’ proposed submission. They deride the professors as “interlopers” pursuing an “academic fantasy” and attack the proposed amicus brief as a mere regurgitation of DFC Global’s argument that the Chancery Court should defer to the merger price as the sole indication of fair value when that transaction price was purportedly the product of a pristine, arm’s-length auction process.
In particular, the stockholders argue that the academics should not be heard because they have no direct interest in the outcome of the appeal; their arguments repeat what DFC Global already said in its appellate brief; and, they exaggerate the impact of the Chancery Court’s opinion on the M&A market, while attempting to insert new facts and assertions into the case that were not included in the record evidence adduced at trial.
The Supreme Court has not yet ruled on whether it will accept the amicus brief or not; we will continue to monitor this appeal for further filings and rulings.
The Federal Reserve’s recent rate hike, the second one in as many years, has increased the Fed’s discount rate — also known as its primary credit rate — by 0.25%, up to 1.25%. Effective as of December 15, this will increase the rate of statutory interest in appraisal cases to 6.25%, compounded quarterly, as the appraisal statute sets interest at 5% over the Federal Reserve discount rate.
We posted earlier this week about DFC Global’s appeal to the Delaware Supreme Court, challenging Chancellor Bouchard’s award to stockholders of a premium over merger price. Yesterday, a group of law and corporate finance professors from various universities moved the Supreme Court to allow them to file so-called amici curiae briefs as non-party “friends of the court” who opine on the case. As set forth in their proposed brief, these academics intend to urge the Supreme Court to defer to the transaction price when it was reached as a result of an arm’s-length auction process.
If the Supreme Court allows the professors to file their brief, then the stockholders have a chance to respond, as do other non-party friends of the court who believe that Chancellor Bouchard’s opinion was correctly decided and that merger price should not be deferred to or otherwise awarded presumptive or conclusive weight in appraisal cases.
Update: See Bloomberg’s January 4, 2017, coverage of the Professors’ brief here.
We’ve posted before about the DFC Global decision, in which Chancellor Bouchard awarded a 7% premium over merger price, and then further increased that uplift by 9 cents in a ruling on reconsideration. That ruling is now on appeal to the Delaware Supreme Court, and the appellant’s brief was submitted last week.
As reported in Law360, DFC Global has argued to the Supreme Court that the lower court’s decision “undermines confidence in Delaware appraisal actions.” The Delaware Supreme Court has not heard an appraisal case since its February 2015 ruling in CKx; their ruling in this case will be closely watched.
Today Vice Chancellor Laster issued a new appraisal ruling, Merion Capital LP v Lender Processing Services, pegging the appraised fair value to the merger price.
The court found no reason to depart from merger price given the apparently reliable sale process and reliable projections. The court performed its own DCF valuation, which came out 4% above the merger price. Vice Chancellor Laster found that his own valuation’s proximity to merger price gave him comfort as to the reliability of merger price and thus chose not to vary from it in determining fair value.
The court rejected the respondent’s synergies argument — intended to set fair value below the merger price — for being raised too late and unsupported by any evidence. The decision also includes a thorough and instructive survey of recent appraisal case law.
In Farmers & Merchants Bancorp, an appraisal case involving a small closely-held community bank that was sold in a stock-for-stock deal valued at $83 per share, Chancellor Bouchard disregarded merger price, as well as the “wildly divergent valuations” of both sides’ experts. He arrived at an independent valuation of $91.90 per share based on his own discounted net income analysis (which is similar to a discounted cash flow but does not adjust net income for non-cash income and expenses and does not consider cash outflows for capital goods).
The court rejected the merger price as a reliable indicator of fair value because the merger was not the product of an auction and was not conditioned on obtaining the approval of a majority of the minority shareholders. Rather, the sale was driven by the same family that controlled both the target and the acquiror; even though the target formed a special committee to negotiate on behalf of the minority stockholders, the court was not confident that the negotiations were truly arms-length.
Likewise, the court rejected the comparable transaction analysis that the petitioner’s expert put forth. The petitioner’s expert calculated the median P/E ratio from the eight most comparable companies out of a pool of 160 community bank acquisitions that had taken place over the prior two years. The court found that the eight selected banks were good comparables but rejected the analysis because the expert failed to adjust for synergies that were potentially incorporated into the merger price of those banks, despite strong evidence from several witnesses that community bank mergers typically do include synergies. As to the respondent’s expert, the court rejected its comparable transaction multiples because the choice of selected comparables was suspect – it excluded 15 regional banks that would have raised the average P/E ratio significantly – and found that its guideline public company valuation was unreliable since most community banks were not publicly traded, and even the publicly traded shares were less liquid than non-community banks.
In light of these facts, the court gave no weight to the merger price or either expert’s analysis, relying entirely on its own discounted net income analysis, which projected a stream of income using a single year of earnings and applied a long-term growth rate, while using a discount rate calculated under CAPM. In determining the equity risk premium, the court chose the long-term supply-side as opposed to the historical premium, citing then-Vice Chancellor Strine’s ruling in Golden Telecom that the professional and academic valuation literature favored that approach.
Finally, the court adopted the respondent expert’s 3.0% terminal growth rate over the 4.375% rate suggested by the petitioner. Citing Owen v. Cannon, the court recognized that Delaware precedent favored a perpetuity growth rate that is a premium, such as 100 basis points, over inflation. The court also found that the 3.0% rate was consistent with the annual growth rate projected in the target’s strategic plan, which reflected its limited growth potential in a county with a declining population and stagnant economy. That rate likewise comported with the perpetual growth rates used to value mature companies in several recent cases.
It remains to be seen how much precedential value a decision like this will have on the public M&A that is more commonly the subject of Delaware appraisals, but once again the court has rejected merger price and undertaken a truly independent valuation.
We posted recently about attempts by M&A buyers to include a closing condition in the merger agreement that would relieve the buyer from closing if a triggering percentage of appraisal rights are exercised. As an illustration of such a condition, CBOE Holdings — which owns the Chicago Board Options Exchange — succeeded in including a so-called blow provision in its merger agreement to acquire another exchange operator, Bats Global Markets. Under that merger agreement, the deal blows up if more than 20% of the target’s outstanding shares seek appraisal.
The very existence of a blow provision may cause some stockholders to hesitate in seeking appraisal, fearing that their dissenting vote might push the appraisal class over the 20% hurdle. Some casual observers find that only about 10% or less of the outstanding share population ultimately seeks appraisal. Accordingly, a lower blow provision, on the order of 10% or 15%, could pose a very real challenge to appraisal and would test the resolve of stockholders who are unsatisfied with the deal price but concerned about blowing up the deal altogether. That may be true, for instance, where dissenters feel that the target is being sold at the right time but at the wrong price.