Valuation firm Willamette Management Associates has put out a pair of articles discussing the calculation and treatment of synergies in appraisal actions. At least in Delaware, the value of an appraisal petitioner’s shares is to be fixed as the fair value of the company less synergies. Synergies can thus become a significant battleground in an appraisal action – and can result in rulings below merger price.

For its part, Willamette reviews a number of the recent Delaware cases discussing synergies, as well as how relevant synergies will be when the “sales process” – now often described as “Dell compliance” – is considered. Synergistic value is subject to extensive expert debate, and, like any issue in valuation, is the source of competing expert opinions and briefing in effectively every case.

Recently, Vice Chancellor Slights refused to grant Carl Icahn and affiliates’ novel request for a company’s books and records in order to mount a proxy contest against Occidental for agreeing to an allegedly bad deal with Anadarko. The Vice Chancellor ruled that furthering a proxy contest was not a “proper purpose” to support the activist investors’ demand to inspect the corporation’s books and records under section 220 of the DGCL.

Icahn’s potential proxy fight comes after Occidental snatched Anadarko away from Chevron with a $76 per share topping bid. To finance the merger, Occidental engaged in two transactions that have since come under attack by Icahn: (1) a $10 billion raise through preferred stock to Berkshire at an allegedly high cost to Occidental shareholders and (2) the sale of Anadarko’s Africa assets at an allegedly fire sale price. After the Occidental-Anadarko merger was announced, Icahn made a $1.5 billion investment in Occidental stock and unveiled plans to replace the Occidental board of directors and change the company’s bylaws. The Icahn parties submitted a 220 demand for documents related to the Anadarko-Occidental merger in an attempt to secure consent from 20 percent of Occidental stockholders–the threshold required for an election challenge.

Investors have an important inspection right to obtain information under the control of the company. Under Section 220 of the DGCL, stockholders can inspect a company’s books and records provided they show a “proper purpose,” such as investigating corporate wrongdoing. The Icahn parties asked the Court to recognize a new “proper purpose” that would allow stockholders to communicate with other stockholders in furtherance of a bona fide proxy contest. The Court determined that a fishing expedition into the boardroom was not “necessary and essential” to advance the proxy contest here, because Occidental shareholders were already aware of the transactions Icahn called into question. However, the Court left open the door for stockholders to receive books and records from the company in aid of a proxy contest in the “right case.”

In the alternative to their novel argument, the Icahn parties proffered a need to investigate corporate wrongdoing. The Court did not find that alternative argument persuasive because the Icahn group did not meet its low burden in showing a “credible basis” of wrongdoing. According to Vice Chancellor Slights, the plaintiffs’ demand amounted to nothing more than a disagreement with the board’s exercise of its business judgment, which alone, without any allegation of conflict, disloyalty, or interest in the transaction, is not enough to provide a credible basis to infer mismanagement.

Inspection rights are one of many critical rights, including appraisal rights, speaking rights, and shareholder proposals, available to shareholders to influence corporate behavior. Investors have to state a proper purpose to exercise their inspection rights under section 220, and may not be allowed to view the documents requested in certain circumstances, such as possibly amid a proxy contest. On the other hand, investors can exercise their appraisal rights and obtain documents from the company and third parties through discovery without articulating a “proper purpose.”

Does the existence of the appraisal remedy, and its use, have an effect on arbitrage spreads? If the appraisal remedy results in lower arbitrage spreads, then one can conclude that shareholders writ large are benefiting from the appraisal remedy – the argument advanced by Professors Brian Broughman, Audra Boone, and Antonio Macias in their piece “Merger Negotiations in the Shadow of Judicial Appraisal,” published in The Journal of Law and Economics 62, no. 2 (May 2019): 281-319 (originally released in draft form in 2017, and covered here). Mechanistically, this part of the analysis is straightforward: If a stronger appraisal remedy (represented in the article by deals subject to an appraisal challenge) results in a greater “share” of merger consideration going to target company shareholders instead of arbitrage traders, then even shareholders who do not exercise appraisal are benefiting from a strong remedy. (Note that this argument is conceptually different from the argument that a strong appraisal remedy actually results in higher deal premia.)

A new article from authors at Analysis Group seeks to challenge the methodology of the Boone et al. piece. In “Appraisal Challenges and Benefits to Target Shareholders Through Narrowing Arbitrage Spread” (summary available here; article here), the authors argue that there were both data issues and sampling issues with the original analysis, which showed a 6 percent lower post-announcement arbitrage spread for deals subject to appraisal challenge. As to data, the challenger-article argues that there are significant outliers in the Boone et al. data set, and that those outliers drive much of the result. Highlighting instances where arbitrage spreads of 50 percent or even 100 percent appeared (and specifically referring to one instance where the data set recorded the spread as 52.46 percent when the actual spread should have been 9.35 percent), the challenger-article purports to resolve the issue by using medians instead of means to compare arbitrage spreads.

The challenger-article than moves on to a critique based on supposed “sampling bias” – putting forth three factors it contends the Boone et al. article did not sufficiently contend with: (1) time period, (2) deal consideration, and (3) state of incorporation.

  1. For time period, the challenger-article breaks the data set down into three periods: “Pre-Crisis,” set as January 2004 to November 2007; “Financial Crisis,” from December 2007 to June 2009; and “Post-Crisis,” from July 2009 to April 2017 (when the Boone study data set terminates). The challenger-article points out that a significantly larger set of the deals subject to an appraisal challenge occurred in the “Post-Crisis” period, compared with deals not subject to an appraisal challenge. In turn, the challenger-article notes that the entire set of deals Post-Crisis exhibited lower arbitrage spreads than did the other time periods.
  2. For deal consideration, the authors note that none of the all-stock deals, which exhibited the highest arbitrage spreads, were subject to an appraisal challenge.
  3. For state of incorporation, the challenger-article noted that none of the non-Delaware deals were subject to an appraisal challenge, and thus all of the “subject-to-appraisal” deals in the analysis were Delaware deals.

Without reviewing the data set and the quantitative work behind the Boone et al. and challenger-article analyses, we cannot speak to which has the better argument. But we do note that there is a certain path dependence aspect to each of the sampling critiques above. For example, with respect to time period, it is no secret that appraisal rights litigation picked up significantly post-financial crisis, reaching very high levels in the 2010s. Is it possible that the growing number of appraisal cases, and thus the threat to mergers of a possible appraisal, helped narrow arbitrage spreads?

Similarly, as to stock versus cash deals, it’s difficult to know whether the threat of appraisal caused certain deals that otherwise would have had a cash component to shift to all-stock.

Separately, while the pre-2017 data set contained no (public) deals outside Delaware with an appraisal challenge, this has not necessarily remained the case. There is a growing cognizance of the appraisal remedy in other U.S. jurisdictions, and there are cases – ongoing now – outside Delaware, and more are certainly anticipated.

Also, other variables could be tested. For example, appraisal arbitrage cases generally occur in mergers with larger public floats – perhaps the size of merger is a relevant variable to consider.

Appraisal challenges also may occur more frequently in deals that include an interested party as one of the buyers. This may also be a variable to interrogate – if appraisal challenges generally occur in deals that are more likely to close, then the challenger-article may have a point: The arbitrage spreads on such deals may be lower apart from the impact of the appraisal remedy.

We will continue to cover developments in the discussion of if and how the appraisal remedy benefits shareholders writ large. Further, as we noted at the top of this piece, the methodology challenges issued by the challenger-article here go only to a small subset of the potential benefits of the appraisal remedy to shareholders. And of course, the entire debate here is cabined by the data at issue. As time goes on, more appraisal cases are filed, and more data made available, perhaps the conclusions will become clearer.

In this paper, published in 2015 in Investment Management and Financial Innovations, the authors examined multiple valuation methods for a specific data set: in this case, Slovakian mining companies. Comparing multiple valuation methods, including a discounted cash flow, economic value, and iterative approach, the authors note that the DCF yielded the lowest valuation, whereas the other methods yielded higher amounts (though the iterative method did so with much higher volatility, represented by high standard deviations).

While Delaware public appraisal arbitrage cases have focused on DCFs as the valuation method of relevance, it’s important to note that other valuation methods exist – and in fact are used in a variety of contexts. Setting aside the paper noted, other valuation techniques include the comparable company analysis and precedent transactions.

Indeed, the paper covers only a selection of potential valuation methods. Many more exist, including those mentioned, such as:

Discounted Cash Flow Analysis (DCF); Comparable transactions method; Comparable Market Multiples method; Market Valuation; Economic Value Added Approach; Free Cash Flow to Equity; Dividend Discount Model; Net Asset Valuation; Relative Valuation.

Since choice of valuation method can determine the outcome of the valuation, both investors and appraisal practitioners need to be aware of how their particular case may play out under a variety of possible valuation methods, and which one or ones may be appropriate for the specific situation.

When considering how to structure a deal – consider appraisal. That’s one of the takeaways from a detailed M&A presentation by lawyers at Morgan Lewis. As we’ve covered before, the existence of appraisal rights, how they may be exercised, and what percentage of shareholders may exercise appraisal rights are considerations for deal lawyers and, of course, the buyer itself. Whether that concern takes the form of simply considering appraisal in the overall process, or even structuring an entire deal in such a way that avoid appraisal rights, the fact is that appraisal must be part of M&A considerations.

The Texas Court of Appeals recently held that shareholders exercising their appraisal rights under Section 10.354(a) of the Texas Business Organizations Code are not entitled to a jury trial, because appraisal is specially created and controlled by statute. Pursuant to section 10.361(e) of the Code, the court determines which owners have perfected their appraisal rights and appoints an appraiser to determine the fair value of their ownership interest. If an objection to the report filed by the appraiser is raised, the court then must hold a hearing to determine the fair value under section 10.363(b). In Kruse v. Henderson Texas Bancshares, Inc., 2019 WL 4125966 (Tex. App. Aug. 30, 2019), the Court of Appeals reasoned that the term “hearing” suggests that the legislature intended to designate the court as the fact finder. We have previously posted about Texas appraisal rights here.

In a 3-2 vote, the SEC recently agreed to propose stricter voting requirements on shareholder proposals. The proposed rule would raise the threshold of shareholder support required to resubmit proposals previously voted down by shareholders. While SEC Chairman Jay Clayton proclaimed that the changes will help weed out unconstructive shareholder proposals, SEC Commissioner Robert J. Jackson Jr. expressed his concern that the proposals would “shield CEOs from accountability to investors.” Making shareholder proposals is one of the tools, including inspection rights and speaking rights, available to minority investors who seek to enforce corporate governance. Recent shareholder proposals have run the gamut from good corporate governance concerns and social consciousness concerns to introducing appraisal rights.

On Nov. 5, 2019, PLI hosted a roundtable on Delaware developments at the 50th Annual Institute on Securities Regulation, where the speakers discussed recent Delaware appraisal decisions. The panel consisted of Patricia O. Vella, Lawrence A. Hamermesh, Lisa A. Schmidt, and the Honorable Collins J. Seitz Jr. Webinar registration can be accessed here.

Law360 has published this analysis of the advantages and disadvantages of various structuring options when dealing with a British Virgin Islands acquisition. Notable to appraisal is the diversity of appraisal rights/dissenters; rights offered (or not offered) in the various structuring options. For example, if using a “merger” of “tender offer,” the article details that appraisal rights are available, except in certain specific instances. But if using a “scheme of arrangement” – a form of court-supervised combination – appraisal rights are only available if allowed by the court.

Consideration of appraisal rights in deciding what kind of legal process a company will engage in to effectuate its merger is not new. We have seen similar issues with Cayman appraisal, and in the U.S., the 2018 Dr. Pepper decision suggested the possibility of more U.S. companies using a reverse triangular merger to avoid appraisal rights (though some commentators argued this would not occur).

Appraisal rights/dissenters’ rights and choosing the correct form of acquisition arrangement are intimately connected – apparently in the BVI as well.

Legal news site Law360 provides this analysis [$$$] of what has occurred in Delaware law in the third quarter of 2019, including developments in appraisal. As the Delaware courts have grappled with the trio of Delaware Supreme Court decisions impacting appraisal – DFC Global, Dell, and Aruba – the decisions coming from the Chancery courts – some currently being appealed* – continue to both define what factors courts will consider in appraisal proceedings and blur the line between appraisal (at least in instances of appraisal arbitrage) and fiduciary duty litigation, where actual wrongdoing is required.

*Lowenstein Sandler is counsel to petitioners in certain cases mentioned in the Law360 piece.