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Appraisal Rights Litigation Blog

Delaware Supreme Court Decides DFC Global Appeal**

Posted in Fair Value, Merger Price, Perpetuity Growth Rate, Supreme Court

Today the Delaware Supreme Court reversed and remanded the appraisal decision of the Chancery Court in the highly watched DFC Global case.  A more detailed post will follow, but we wanted to flag the ruling in the meantime.

The court declined DFC Global’s request to impose a presumption by “judicial gloss” that would peg fair value at the merger price in cases involving arm’s-length mergers.  The court found that such an approach would have no basis in the statutory text, which gives the Chancery Court discretion to determine fair value by taking into account “all relevant factors.”

The court did accept two other “case-specific” arguments by DFC Global.  First, the Supreme Court directed that on remand (i.e., when the trial court gets the case back from the Supreme Court), the Chancery Court — which in its valuation analysis had given equal weight to each of (i) the deal price, (ii) its DFC analysis, and (iii) a comparable companies analysis — should reconsider the weight it gave to the deal price in finding fair value based on certain factors in this case.  Second, the Supreme Court found that there was not adequate basis in the record in this case to support the Chancery Court’s increase in the perpetuity growth rate it assumed for DFC Global from 3.1% to 4.0% when it corrected an error that had been raised during reargument.

In addition, the Supreme Court denied the cross-appeal, by which the stockholders argued that the DCF analysis be given primary, if not sole, weight in the valuation analysis. The court found that giving weight to the comparable companies analysis in this case was within the Chancellor’s discretion.

We will continue to monitor the proceedings to follow in the Chancery Court.

**As previously noted, this law firm was counsel of record on one of the amici briefs filed in this case.

Breaking Down The Clearwire-Sprint Appraisal Ruling

Posted in Discounted Cash Flow Analysis, Distinct from Fiduciary Duty Claims, Fair Value, Merger Price, Perpetuity Growth Rate, Synergies

As we previously posted, the Chancery Court appraised the fair value of Clearwire Corp. to be $2.13 per share, substantially below the $5 per share merger price paid by Sprint Nextel Corp in July 2013.  This post will provide a more detailed breakdown of the ruling and the bases for Vice Chancellor Laster’s opinion.

I. The M&A Transaction(s)

The court examined not only the underlying acquisition of Clearwire by Sprint, but also the related transaction by which Softbank Corp. — Japan’s largest telecom company — planned to acquire Sprint, immediately upon Sprint’s acquisition of Clearwire.  The sale process in effect proceeded in two stages, the first leg of which culminated in December 2012, with Sprint agreeing to pay $2.97 per share for Clearwire.  But shareholder reaction to that initial deal was extremely negative and drew active opposition.  At the same time, DISH, Sprint’s competitor, proposed a tender offer at $3.30 per share, along with other financing terms as well as demands regarding board appointments and other governance rights.  This intervention by DISH disrupted the sale process, which thus entered into a new phase that ultimately culminated in Sprint paying $5 per share in June 2013.  In particular, DISH and Sprint engaged in a bidding war starting in April that involved Sprint raising its $2.97 offer to $3.40, DISH topping that offer at $4.40 per share, and Sprint again increasing its bid to $5 per share in June 2013.

II. The Court Found the Clearwire-Sprint Transaction to Be Entirely Fair

Before reaching the appraisal issue, the court analyzed whether a breach of fiduciary duty had occurred and whether the transaction was entirely fair to overcome any claim of breach.  Because the transaction involved self-dealing by a controlling shareholder — Sprint owned just over 50 percent of Clearwire heading into the negotiations — the applicable standard of judicial review was entire fairness, with Clearwire bearing the burden of persuasion of proving that the transaction was entirely fair.

The court was persuaded that Sprint and Softbank actually did engage in a series of acts that constituted unfair dealing.  However, the court was not persuaded that any of that unfair dealing had any impact on the ultimate $5 merger price that was reached in June 2013.  Indeed, once DISH intervened in the process, the court found that the landscape had changed “so substantially as to render immaterial the instances of unfair dealing that took place during the first phase” of the sale process.  Opinion, at 50.  The court thus found that despite Sprint and Softbank’s unfair dealing during the first phase of the transaction, the eventual $5 merger price and the process that culminated in it were entirely fair.

Given this distinction between the two phases of the sale process, the court reviewed a series of missteps that would otherwise have rendered the transaction unfair, but because the deal price ultimately did not remain at $2.97 and increased to the revised $5 price, that any incidents that would have tainted the first phase of the transaction ultimately lost their relevance once Sprint increased the merger consideration to $5.

As the court summarized:

In a hypothetical world in which the Clearwire-Sprint merger closed at $2.97 per share, Sprint and Softbank’s interference with the stockholder vote on the Clearwire-Sprint merger would have warranted a finding of unfairness and an award of a fairer price.  Under those circumstances, the resulting award would not have approached $5.00 per share.  It likely would have anchored off of the Special Committee’s consistent demand of $3.15 per share, thereby giving credit to the contemporaneous judgment of Clearwire’s informed, independent fiduciaries. . . .  At $5.00 per share, the consideration received by the minority stockholders exceeded anything this court would have awarded as a remedy for unfair dealing.

Opinion, at 65.

III. The Court Disregarded the Merger Price That Followed a Bidding War and Included Massive Synergies

A. The Court Was Within Its Discretion to Select One Party’s Valuation Work

Having found the transaction to be entirely fair, the court then examined what the stock’s fair value should be to resolve the appraisal case.  The court relied on Delaware precedent providing a judge with discretion to select one of the party’s valuation models as its general framework, citing MG Bancorporation, Inc. v. LeBeau, 737 A.2d 513, 525-26 (Del. 1999).

The court found that with neither party having argued in favor of deal price, and with the record containing other reliable evidence of fair value, it did not consider at all the deal price but relied exclusively instead on a DCF analysis.  In doing its DCF analysis, the court found that the heart of the dispute — i.e., 90% of the difference in valuations as between the two sides — arose from the difference in the projections that each side’s valuation expert used.

B. The Court Found Projections Prepared by Clearwire Management in the Ordinary Course to Be the Most (and Only) Reliable Projections

The petitioners’ expert, Professor Gregg Jarrell, used the so-called Full Build Projections that were prepared by Sprint, while the respondent’s expert, Professor Bradford Cornell, used the so-called Single Customer Case projections that had been prepared by Clearwire’s management.  The court expressed a clear preference for the Single Customer Case projections, because they were prepared by the seller’s own management, and were done in the ordinary course of business.  The court found that the Single Customer Case projections accurately reflected Clearwire’s operative reality as of the merger date.  In contrast, the court held that the Full Build Projections were created by Sprint’s management team — not Clearwire’s — in order to convince Softbank to increase its offer and thereby top DISH’s offer price.  Accordingly, not only were the Full Build Projections created by someone other than management of the seller, but they were created by the buyer with the motivation of showing greater value in Clearwire in order to induce Softbank to bid higher.  Moreover, in examining the various assumptions underlying the Full Build Projections, the court found them to be without basis in the record and dependent on aggressive, “herculean” assumptions about future business with, and prices charged by, Clearwater, which were simply not a part of Clearwire’s operative reality.

In contrast, the court found that respondent’s use of Clearwire’s own Single Customer Case, which was prepared by Clearwire management in the ordinary course of business, was the more, and indeed only, reliable set of projections, as Clearwire’s management had significant experience in preparing long-term financial projections, and they regularly updated the Single Customer case, and even did so as recently as May 2013, within a month of the merger agreement.  While those projections did contemplate a significant increase in Sprint’s wholesale payments to Clearwire, the assumptions did not reflect the astronomical increases that the court found petitioners’ projections to rely on.  And in all events, the court found that Clearwire had tried for years to obtain additional customers, without success, and that there was no reason to believe that it would have had greater success in obtaining any additional customers in the years going forward.  Given its finding that the Single Customer Case was the most reliable set of projections reflecting Clearwire’s operative reality as of the merger date, the court adapted wholesale the respondent’s expert’s use of those projections in his DCF.

C. The Court Found Reasonable a Perpetuity Growth Rate Set at the Midpoint of Inflation and GDP

The only other significant differential in the parties’ DCF analysis was the perpetuity growth rate.  The court agreed with the respondent’s expert’s (Cornell’s) use of a perpetuity growth rate at 3.35%, which represented the midpoint of inflation and GDP growth. The petitioners’ expert (Jarrell) used a perpetuity growth rate of 4.5%, which represented expected GDP growth.  To the extent that Jarrell’s justification for his use of GDP growth was based on Clearwire’s expected performance under the Full Build Projections, the court rejected that rationale, having rejected the notion that the Full Build Projections reflected the realistic future performance of Clearwater for the projection period.  Indeed, the court found Cornell’s choice of the midpoint between inflation and GDP to be more realistic — if anything, more generous for Clearwire — given the likelihood that Clearwire would require ongoing financing from Sprint in order to remain solvent under the Single Customer Case.

The court proceeded to discuss minor differences in some of the components of the discount rate, as well as the parties’ dispute over the value that should be added to the DCF based on Clearwire’s unused spectrum.  Once again, the court generally rejected Jarrell’s assumptions in these areas, although none of these issues had a significant impact on the valuation analysis.

IV. Conclusion

Based on these factors, the court adapted Cornell’s DCF valuation in its entirety, and awarded the petitioners fair value at $2.13 per share, the value that Cornell had arrived at.  In so holding, the court repeatedly cited the recent PetSmart decision to underscore the principle that Delaware Chancery prefers that the projections used in a DCF be derived from contemporaneous management projections that are prepared in the ordinary course of business.  Such projections are generally deemed more reliable as they are prepared by management — who has the best first-hand knowledge of the company’s operations — and they are generally not influenced by transactional dynamics or tainted by hindsight-driven litigation considerations.  But unlike PetSmart, here the court did not peg fair value at merger price given that a case could be made that the previously agreed-to price of $2.97 itself reflected fair value, and that the $5 price that followed the bidding war with DISH was loaded with synergies and was not predicated on valuation fundamentals that were materially different from those used to support the initial $2.97 price.


Delaware Gov. Signs Blockchain Bill – Possible Impact on Appraisal

Posted in Blockchain

As we have previously covered, Delaware has been considering whether to allow Delaware corporations (with Delaware being the site of the vast majority of appraisal litigation) to use blockchain platforms to issue and trade shares.  As of July 21, that has become the law with Delaware’s governor signing a bill allowing blockchain to be used for the maintenance of corporate records, including stock ledgers.  Blockchain is a concept of distributed ledger, as opposed to the centralized ledger system of DTCC.  From JD Supra: “One practical reason for using blockchain technology to track the transfer of corporate securities stems from a long-standing uncertainty surrounding the property rights of investors who ‘ultimately have no identifiable relationship with the corporate issuers of investment securities’ that they purportedly hold.”

Multiple decisions in the Dell case put the potential relevance of blockchain to appraisal in focus.  In July 2015, Vice Chancellor Laster reluctantly dismissed a subset of Dell shares seeking appraisal because, prior to the effective date, those stockholders’ stock certificates had been retitled.  As a brief recap, in that instance, DTCC (the holder of effectively all stock in the US) certificated shares into the name of its nominee, Cede & Co.  The petitioners’ custodians told DTCC to retitle the dissenting shares to the name of their own nominees – this retitling broke the record of ownership and thus denied these petitioners the right to appraisal.  Blockchain, which generally does involve “titling” in this sense, could avoid such a result.  The same is likely with regard to a second opinion, from May of 2016, involving the lead petitioner in Dell.  There, the lead petitioner instructed Cede (via its custodian) to vote in favor of the merger – but this was an error and the lead petitioner intended to vote against the merger.  While blockchain cannot protect against mistaken instructions, blockchain could reduce the number of steps between beneficial holder and the exercise of its vote.

While this market plumbing/market structure can seem esoteric, it can have real-world consequences.  In the recent Dole case, which concerned appraisal but was focused on breach of fiduciary duty claims, it ultimately turned out that millions of unexpected shares claimed on the settlement.  From JD Supra, regarding Dole: “The Chancery Court ruled that the additional merger considerations should be distributed to DTC, who would issue it to its over 800 participants, who would then issue it to the individual beneficial owners.  The Court warned that this process would likely result in incremental costs for beneficial owners, but noted that ‘these are [the] risks inherent in choosing to hold [equities] in street name.’”  At minimum, a blockchain ledger could have made administration easier than the Court’s selected remedy – kicking the issue back to DTCC

Blockchain may also present something of a victory for companies seeking to resist appraisal actions.  While appraisal arbitrage involves the idea of a “fungible bulk,” that may not rule the day with blockchain implementations.  With a distributed ledger, potentially, the shares of a beneficial holder could be traced to that holder in particular, instead of to a generalized mass of shares.

None of this is certain.  While the law allows for corporations to utilize blockchain, there is no guarantee they will necessarily do so [Law360 $$].  Developments in blockchain implementation in Delaware (and other places, such as Nevada and Arizona) may well turn out to be developments in appraisal rights as well.

Update:  the HLS Forum has covered blockchain and appraisal here.

CLS BlueSky: “Reality Check” on DFC Global By Profs. Korsmo and Myers

Posted in Appraisal Arbitrage, Fair Value, Merger Price, Supreme Court

Professors Korsmo and Myers, whom we have blogged about before, have a new post on CLS Blue Sky Blog, titled “A Reality Check on the Appeals of the DFC Global Appraisal Case.”  The Professors argue that the DFC Global appeal, which we’ve been covering, presents an attempt by deal advisors “to alter Delaware’s appraisal jurisprudence[,]” seeking to “undermine appraisal rights and shield opportunistic transactions from judicial scrutiny.”  Urging the Supreme Court not to “tie the Court of Chancery’s hands in future cases” – the Professors cite recent research showing that appraisal petitions are “more likely to be filed against mergers with perceived conflicts of interest, including going-private deals, minority squeeze outs, and acquisitions with low premiums, which makes them a potentially important governance mechanism.”

In Transaction Involving “Massive” Synergies, Chancery Court Finds Fair Value at Over 50% below Merger Price

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

Today the Delaware Chancery Court issued its ruling in the Clearwire case, which included claims for breach of fiduciary duty as well as appraisal arising from its acquisition by Sprint.  We’ll provide a more comprehensive breakdown of the decision in a later post.

In the meantime, as reported today by Reuters, Hedge fund stung by unusual ruling over Sprint-Clearwire deal, the ruling “stands out for a court that rarely finds fair value below deal price, let alone more than 50 percent below.”

Among other factors, the court found that neither side argued in favor of deal price, and so the court did not even consider it but looked only at the respective valuation analyses put forth by each side’s valuation expert.  Given the considerable synergies in this transaction, the court held that the deal price provided an “exaggerated picture” of Clearwire’s value.  The court also noted that the experts’ choice of projections drove 90% of the difference in their DCF valuations.

Law360: “The Misconception About SWS Appraisal Decision”

Posted in Award Premium, Merger Price

Law360 [$$] recently covered appraisal rights, presenting an analysis by attorneys at Fried Frank [pdf] discussing the SWS appraisal decision.  In their article, the Fried Frank lawyers note their view that it is a “misconception” that SWS heralds a new likelihood of below-merger-price appraisal decisions.  Reviewing the SWS decision and the appraisal jurisprudence, the authors note that in only three cases (since 2010), of many more, have the Delaware courts found below merger price and that each such case involved “unusual facts” – and opine that while some commentators view SWS as making below-merger-price cases more likely, they do not share that view.  Later last month, Fried Frank also posted a primer on “Appraisal Practice Points Post-SWS” [pdf] – following up on their prior article.

HLS Forum on Corp. Gov: “Delaware Appraisal at a Crossroads?”

Posted in Appraisal Arbitrage, Fair Value

The Harvard Law School Forum on Corporate Governance and Financial Regulation recently carried a post by Theodore Mirvis of Wachtell Lipton, “Delaware Appraisal at a Crossroads?”  This HLS Forum post discusses the recent DFC argument – which we’ve posted about – and lays out a variety of thoughts on future questions in appraisal and appraisal arbitrage.   For more on DFC, see our coverage here.

Supreme Court Hears Arguments in DFC Global**

Posted in Fair Value, Merger Price, Perpetuity Growth Rate, Supreme Court

The Supreme Court heard argument yesterday from DFC Global and its dissenting stockholders. The court has not yet ruled, and nobody can predict how it will decide the case; the following questions and observations are just some of the points that different members of the full five-justice panel raised during argument:

  • The court asked DFC Global why they did not introduce an economics expert to corroborate the reliability of the merger price as the measure of the company’s fair value; the Chief Justice said that by not doing so, they didn’t offer much help to the Chancellor in his evaluation of the merger price and the process of wading through the respective valuation experts’ reports.
  • The court observed that DFC’s own expert gave 50% weight to the merger price, so it asked why the Chancellor’s one-third weighting of merger price isn’t entitled to deference.
  • The court observed that the statutory requirement that the chancery court consider “all relevant factors” in determining fair value is pretty “squishy,” suggesting that the trial court has the discretion to decide which factors to examine and what weight to give them.
  • The court asked both sides to describe the relationship between working capital and perpetuity growth rates and whether the calculation of the growth rate is necessarily based on working capital assumptions; e., does a higher level of working capital inevitably mean that a higher growth rate must be used?
  • The court observed that the appraisal statute requires the courts to focus on the fair value of the shares and that the pre-existing, unaffected market price would be highly informative of the stock’s fair value, but the jurisdictional definition of fair value looks beyond just the shares to the value of the company as a going concern.
  • One of the justices was “troubled” by the Chancellor’s equal weighting of the three chosen valuation sources – merger price, comparable companies analysis, and DFC – insofar as the support for such equal weighting seemed lacking in the record.
  • The court asked the stockholders why their valuation expert didn’t open up his own private equity shop if he really believed in the valuation delta between merger price and his own valuation, which came out nearly two times higher than the merger price.
  • The court further asked why none of the 40 people apparently contacted during the sale process bid higher, given that valuation gap; are the markets really that broken?
  • The court observed that on average, M&A buyers lose out and tend to overpay.

You can see the complete oral argument here (under the June 7, 2017, listing; DFC Global Corp. v. Muirfield Value Partners).

We will post again when the court issues its decision.

**As previously noted, this law firm was counsel of record on one of the amici briefs filed in this case.

SWS Group: The Breakdown

Posted in Beta, Comparable Companies, Discounted Cash Flow Analysis, Equity Risk Premium, Fair Value, Interest on Appraised Value, Merger Price, Perpetuity Growth Rate, Size Premium

Further to our prior post about Delaware’s two new appraisal decisions, SWS Group was a small, struggling bank holding company that merged on January 1, 2015 into one of its own substantial creditors, Hilltop Holdings.  Stockholders of SWS received a mix of cash and Hilltop stock worth $6.92 at closing.  Vice Chancellor Glasscock rejected the sale price as an unreliable indicator of fair value and performed his own DCF analysis, setting the fair value at $6.38, a price 7.8% below the merger price.

At trial, the petitioners persuaded the court that its critiques of the sale process were valid.  However, the stockholders failed to persuade the court that SWS was on the verge of a turnaround, as the court instead determined that SWS consistently underperformed management projections and, given its structural problems, a turnaround was simply unlikely.

Problems with SWS’s Projections and Performance

As was true in PetSmart, SWS had not historically performed long-term projections, but only created annual budgets that aggregated projections from individual business sectors.  Those single-year projections were then extrapolated into three-year “strategic plans” that assumed the annual budgets would be met.  The court found, however, that SWS never met those budgets between 2011 and 2014.  Also, despite straight-line growth assumptions in the management forecasts, SWS failed to hit its targets and continued to lose money on declining revenues.  The various problems facing the company led the court to embrace the respondents’ theory that SWS would continue to face an uphill climb given its relatively small size, which prevented it from scaling its substantial regulatory, technological, and back-office costs.

Hilltop’s Influence on the Sale Process Rendered Merger Price Unreliable

Even before SWS launched its sale process, Hilltop was interested in buying the company (unbeknownst to SWS).  Also, since Hilltop had observer status on SWS’s board, it had unique access to SWS’s board meetings and management not available to others.  The court found that Hilltop’s acquisition theses were driven by synergies, as it viewed its acquisition of SWS as resulting mainly in cost savings by reduction of overhead.  A Special Committee was formed after Hilltop made its initial offer in January 2014, and the court found that even though the committee engaged legal and financial advisors, the management projections that evolved in the sale process were still overly optimistic and unrealistic about SWS’s projected growth.  Only two other bidders emerged, one of which was found not to be credible and the other continued to bid through March 2014 despite apparent pressure by Hilltop to proceed with its deal.  Finally, in response to Hilltop’s unilateral March 31, 2014 deadline, the board decided to accept its offer, which at that time was valued at $7.75, consisting of 75% Hilltop stock and 25% cash.  As of closing on January 1, 2015, the value dropped to $6.92 per share based on a reduction in Hilltop’s own stock price.

Another factor making the deal price unreliable was that Hilltop was a creditor of SWS pursuant to a Credit Agreement.  That agreement contained a covenant prohibiting SWS from undergoing a “Fundamental Change,” which was defined to include the sale of SWS.  The agreement thus conferred upon Hilltop a veto right over any competing offers, which right Hilltop refused to waive during the sale process.

Valuation Model & DCF Inputs

The court undertook its own DCF analysis, on which it relied exclusively.  The court refused to put any weight on petitioners’ comparable companies analysis, finding that the comp set diverged too much from SWS in terms of size, business lines, and performance to be meaningful.  The court held that SWS’s unique structure, size, and business model – particularly its composition of a broker-dealer business alongside its banking line – rendered the stockholders’ selected peers not truly comparable.

In performing its DCF valuation, the court used the existing three-year projection period in the management projections, rejecting the stockholders’ argument that SWS had not yet reached a “steady state” and that an additional two years was needed to normalize SWS’s financial performance.  The court found that SWS’s declining revenues in the period leading up to the merger deprived it of any basis to assume (unprecedented) straight-line growth beyond the existing three-year projection period.  In addition, the court found that the exercise of warrants three months prior to the merger pursuant to the Credit Agreement, which resulted in a change to SWS’s capital structure by cancelling debt in exchange for new shares, was part of SWS’s “operative reality” for purposes of the fair-value determination.  This ruling differed from other cases, such as BMC Software and Gearreald, where changes to the company’s balance sheet resulting from actions by the company solely in expectation of the merger – like the company paying off its debt – was not considered to be within the company’s operative reality.

As to the other DCF inputs, the court adopted the respondents’ perpetuity growth rate of 3.35%, which was the midpoint between the long-term inflation rate of 2.3%, and the long-term economic growth rate of 4.4%.  In selecting the appropriate equity risk premium, the court observed that whether to use supply-side or historical ERP should be determined on a case-by-case basis. Nevertheless, it found supply-side ERP appropriate as the “default” method in recent Delaware chancery cases, unless a party provided a compelling reason to use historical ERP.  With regard to beta, the court found fault with both side’s approach.  The respondents’ expert looked at two years of SWS weekly stock returns, which measurement period included a “merger froth” and too much volatility to be reliable.  The petitioners’ expert, in contrast, surveyed multiple betas and used a blended median; even though the court found that this approach relied on comparable companies that were not truly comparable, it nevertheless adopted this beta – despite its apparent drawbacks – as the one more closely in line with the record evidence.  Finally, to determine size premium, the court took the midpoint of both side’s decile (which was 3.46%), finding that using market capitalization is generally appropriate for public companies (the respondents’ approach), and yet SWS’s capital structure, including its substantial in-the-money warrants and the outsized influence of its major creditor, made it more like a private company and not susceptible to a market cap approach (the petitioners’ argument).


In reaching its final determination of $6.38, the court said that a sub-merger price award was not surprising here given the synergistic nature of the transaction.  Also, given the award of statutory interest, which runs from the January 1, 2015 consummation date, it appears that the petitioners will ultimately recover more than the merger price after all.