CLS BlueSky Blog posts that the Delaware Supreme Court’s recent decision in Dell–and the Delaware appraisal decisions awarding below deal-price in certain appraisal actions–may give cover to Dell Technologies (the Dell of the Dell decision) in its potential rollup of VMware. Dell already owns 82% of VMware stock, according to the post, and may seek to cash out the remaining shareholders. The post expresses concern about the effect of recent Delaware precedent on public stockholders, especially those who face a transaction like VMware, where the only real remedy may be appraisal.

We note the comment of Tom Vos, research associate at the Jan Ronse Institute, who has less concern for public shareholders. Arguing that Dell did not concern a controlling shareholder (as Dell would be of VMware), Vos suggests that Delaware courts would be stricter toward the buyer when that buyer is basically the only bidder.

If the VMware deal comes to pass and there is an appraisal action, we may yet see how the Delaware courts will handle application of the Dell decision to the situation of a controlling shareholder.

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.