November 2013

As one Delaware judge put it long ago, the Delaware courts conducting an appraisal proceeding have long ago “rejected placing absolute confidence in the market price for a share of stock.” Kleinwort Benson Ltd. v. Silgan Corp., No. 11107, 1995 Del. Ch. LEXIS 75 (Del. Ch. June 15, 1995) (Chandler, V.C.). For one thing, a publicly traded stock price is solely a measure of the value of a minority position and market price therefore reflects only the value of a single share. Delaware courts thus adjust the market value to compensate for that so-called inherent minority discount.

Furthermore, even if a court wanted to look at a company’s most recent stock price preceding the merger date as a factor in determining enterprise value, that price may already be impacted by short-term news and noise. Indeed, short-term economic and political realities — such as short-term unemployment rates, lending rates and monetary policy — may have an outsized impact on the stock market while having no necessary correlation to the underlying fundamentals of a company or its industry. That markets overreact is implied in the so-called “bounce back” period used to calculate damages under the Private Securities Litigation Reform Act, which determines damages by using the mean trading price during the 90-day period following the dissemination of corrective information rather than the trading price on just the first day.

But even beyond these considerations, the Delaware courts have identified as recently as last week another factor making a public stock price far less reliable in the valuation exercise; namely, the downward pressure a stock price will experience over time as a result of a prolonged sale process. Where a company is on the sales block for an extended time, even the mean stock price measured over a prolonged period of time will not provide the court with sufficient insight into the company’s long-term growth potential to provide a basis for the valuation exercise to be built upon. Thus, evidence that the “stock price may have undervalued the company due to the company’s inability to make acquisitions while it was up for sale” led one court to recently reject the stock’s trading price as an indicator of fair value. Huff Fund Investment Partnership d/b/a Musashi II Ltd. v. CKx, Inc., Case No. 6844-VCG (Nov. 1, 2013).

A stockholder pursuing appraisal rights is entitled to the present value of the long-term going concern value of her stock, often with the expectation that holding onto that stock over the long term is likely to realize more value than what can be achieved in a near-term sale in the existing economic environment. Courts are therefore careful to rise above immediate or even long-term market conditions and are predisposed to give little weight to the stock trading price as a proxy for whatever longer-term value that stock might represent. This is especially so where there is no reliable evidence that the stock trades in an efficient market that would permit a court to even consider whether the stock price is reflective of fair value. Moreover, in any event, Delaware law requires courts to undertake an independent evaluation of the stock’s fair value at the time of a transaction, and courts therefore cannot place too much weight on trading price as a substitute for engaging in their own independent analysis of fair value.