On Monday, Law360 [$$] reported that the stockholders in the Clearwire appraisal action filed their opening brief in support of their appeal of the Chancery Court’s ruling, which found the fair value of Clearwire Corp. to be $2.13 per share, well below the $5 per share deal price paid by Sprint Nextel Corp. As reported in the article, on appeal, the stockholders argue that the “staggering discount” awarded by the Chancery Court is “virtually unprecedented.” We have previously posted on the Chancery decision here. We will continue to monitor the appeal and post on new developments as they arise.
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.
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.
Last month we wrote about the Lender Processing case, which ultimately awarded deal price and contained an instructive survey of recent appraisal law. For another view of this case, see the January 11, 2017 post on Harvard Corporate Governance.
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.
Vice Chancellor Glasscock issued his valuation decision this week in the BMC Software case, which we have previously blogged about concerning its threshold ruling rejecting any share-tracing requirements and thus allowing appraisal arbitrageurs to proceed with a valuation case. As we have previously reported, Merion Capital was seeking a 45% premium to the merger price, while BMC Software argued that the fair value was actually far below the merger price.
Merger Price Reflected Fair Value in This Deal
In rendering his decision, the Vice Chancellor once again looked to merger price as a measure of fair value, as he did in the Ancestry.com decision. Perhaps most interesting was his discussion of synergies toward the end of the opinion, in which he hypothesized that if Company B, holding a patent on the bow, found it advantageous to acquire Company A, a manufacturer of arrows, “synergies could result from the combination that would not have composed part of the going concern or the market value of Company A, pre-merger,” in which case Company B might value Company A more highly than the market ordinarily would. In this situation the court would be required to deduct any such synergistic value from the merger price. However, in this particular case, the acquisition was not strategic but financial, and while Respondent pointed to tax savings and other cost savings that it claims it would have realized as a private entity, the court refused to discount the merger price for any synergies.
The court further noted that receiving fair value is not necessarily the same as going concern value, and that any tax or other take-private savings may not be subject to exclusion from the awarded price as synergistic, but those savings could indeed be excludable from the going-concern value. The evidence in this case did not demonstrate any specific dollar-per-share value attributable to such savings, so the court refused to so discount the merger price. In a footnote, Vice Chancellor Glasscock said that the requirement to reduce from fair value any “non-speculative increases in value requiring a change in corporate form” was an “artifact of the policy decision to engraft ‘going concern’ valuation onto the explicit language of the appraisal statute itself,” citing Union Illinois.
The court also rejected Respondent’s request to deduct synergies based on take-private cost savings because they required a 23% internal rate of return in their business model to justify the acquisition, which raised the question of “whether the synergies present in a going-private sale represent a true premium to the alternatives of selling to a public company or remaining independent.” Thus, it was unclear whether any alleged going-private savings outweighed the buyer’s rate of return that was required “to justify the leverage presumably used to generate those savings.”
The Court’s DCF Exceeded Merger Price
The parties relied exclusively on their own DCF models, finding a comparable companies or precedent transactions analysis unreliable. Likewise, the court did its own DCF analysis and came up with a $48 per share price, exceeding the $46.25 merger price that it ultimately found to be fair value. The Vice Chancellor said that he was reluctant to use his own valuation and instead deferred to merger price, given the optimism inherent in the management projections; the raging debate within the academic community over the proper equity-risk premium to apply (thus undermining the reliability of his discount rate); and the difficulties in predicting the accurate terminal growth rate, which could be anywhere in between the floor of inflation and GDP (here, the court had picked the midpoint of those two measures in setting its own terminal rate). In this respect, the court’s DCF valuation, which exceeded merger price, was different from that in Ancestry.com, where the court’s own DCF came up just short of the merger price.
In examining the merger process itself, the court found the process to be robust insofar as there were two auctions conducted for several months each, and there were a total of five financial sponsors and eight strategic entities considering the acquisition. There was a go-shop clause, as a result of which the company contacted sixteen bidders — seven financial and nine strategic — which resulted in no alternative offers. And finally, in an arguable blurring of the line between fiduciary duty actions and appraisal rights (a subject on which we’ve posted several times before), the court explicitly looked to the settlement of the class action fiduciary duty litigation as an indication that the process was found to be free of any irregularities or fiduciary duty violations. In particular, the court found significant that the company’s activist investor, Elliot Associates, who had pressured the company to sell, was also forced to conclude that the auction itself was “a fair process.”
Other DCF Valuation Metrics
As to some of the basic valuation metrics (which were used to calculate the court’s own DCF that it ultimately refused to utilize in favor of the merger price):
- The court adopted a supply-side equity risk premium, finding that it had already been done in Golden Telecom and Orchard Enterprises and is thus indicative of the “Court’s practice of the recent past.” The court found a preference for using forward-looking data as opposed to the historical or the supply-side approach, notwithstanding the continuing debate within academe concerning the more reliable method.
- The court reaffirmed that inflation is generally the floor for a terminal value, and here, since there was no evidence to suggest that the growth rate should be limited to inflation, the court ultimately chose a growth rate at the midpoint of inflation and GDP, which was 3.25%.
- The court found it appropriate to include a reasonable offset for the tax associated with repatriating offshore cash, rejecting Petitioner’s argument that the company’s plan to keep that money offshore indefinitely should translate to no offset at all. We have seen this same point argued (and now pending before the court) in the Dell appraisal case as well.
- As is true of many tech companies, BMC had a sizable stock-based compensation (SBC) policy, which the court found was required to be accounted for, and further found reasonable to treat as an expense, particularly because this practice was expected to continue into the future. The court thus agreed with Respondent’s expert, who treated SBC as a cash expense, as opposed to Petitioner’s expert, who didn’t account for future SBC at all.
While the court seemed to take a jab at Petitioner for being “arbitrageurs who bought, not into an ongoing concern, but instead into this lawsuit,” nothing in this opinion referred back to or otherwise altered its prior ruling allowing appraisal arbitrage to proceed unfettered by a constraint such as the share-tracing requirement that BMC had asked the court to impose.
Delaware’s latest appraisal decision in LongPath Capital v. Ramtron International Corp. adopted the merger price as its appraisal valuation, but stands apart from the other recent appraisal decisions that likewise fell back on transaction consideration. Here, the court’s lengthy opinion repeatedly lamented the lack of any remotely reliable means of valuation other than the merger price, and the court was careful to satisfy itself that the sales process leading up to the deal was “proper,” “thorough” and “effective,” though these terms remain without precise definition. Ramtron ostensibly joins Chancery’s recent decisions — including Ancestry.com and AutoInfo — in adopting the negotiated deal price as conclusive proof of value. But unlike those two cases, the court in Ramtron found that fair value ($3.07/share) was actually below the deal price ($3.10/share) when accounting for synergies between Ramtron, the semiconductor manufacturer being acquired, and Cypress Semiconductor, the hostile acquirer.
Part of the unique nature of this action was that in a deal valued at $110 million, the merger price represented a 71% premium to the pre-deal stock price. Moreover, the petitioner, who acquired its shares after the merger announcement (more about the arbitrage play later), bought only a small stake worth about $1.5 million. But the bulk of the court’s analysis focused on whether or not the management projections presented in the petitioner’s DCF analysis were reliable, as Delaware courts apply the commonsense rule that a DCF predicated on suspect projections is worthless in an appraisal. The petitioner’s projections were fatally flawed in many respects, though three of the nine flaws identified by the court stand out the most. First, the projections were prepared by new management, using a new methodology (the product-by-product buildup method) and covering a longer time period than earlier forecasts. Furthermore, the projections had not been prepared in the ordinary course of business. Second, Ramtron distorted its revenue figures by engaging in so-called channel stuffing, the practice of pushing excess inventory into distribution channels so that more revenue can be recognized sooner (indeed, the court repeatedly cited an e-mail in which a salesman said that the company will “for sure stuff channel”). Third, Ramtron management provided alternative projections to Ramtron’s bank, which they described as “more accurate” than those cited by the petitioner. Given these deficiencies, the court had no trouble casting aside management’s pre-merger projections and the petitioner’s DCF which relied on them.
Indeed, the court took both experts to task for what appeared to be litigation-driven valuations. The court criticized the respondent’s “eyebrow-raising DCF” which, notwithstanding its reliance on projections that the expert presumed were overly optimistic, somehow still returned a “fair” value two cents below the merger price.
In any event, the court also had little trouble rejecting the petitioner’s suggested “comparable transactions” methodology, a market-based analysis which ascertains going-concern value by identifying precedent transactions involving similar companies and deriving metrics from those deals (and which we will be examining in greater detail in our next “Valuation Basics” post). The petitioner’s expert was hamstrung by a lack of deals involving companies similar to Ramtron, and could only point to two, which were themselves drastically different from each other and which resulted in disparate multiples. Given this “dearth of data points,” the court found that it could not give any weight to a precedent transactions approach. The court was also influenced by the fact that the petitioner’s expert himself only attributed 20% of his valuation to the comparable transactions analysis.
That left merger price, which the court acknowledged “does not necessarily represent the fair value of a company” as that term is used in Delaware law. To demonstrate this truism, the court cited to the short-form merger, in which the controlling stockholder sets the merger price unilaterally, forcing minority stockholders out and leaving them to choose between taking the deal and exercising appraisal rights. According to the court, pegging fair value to the merger price in such a circumstance would render the appraisal remedy a nullity for the minority stockholder — all roads lead to a merger price that has not been independently vetted. In a situation like Ramtron, however, where the company was actively shopped for months and the acquirer raised its bid multiple times, merger price could be deferred to as conclusive (and critically, independent) proof of fair value.
The court was not troubled by the fact that Cypress’s acquisition process was initiated by a hostile offer, or the fact that no other company made a bid for Ramtron. According to Vice Chancellor Parsons, there was no evidence that the hostile offer prevented other companies from bidding on Ramtron — there were six signed NDAs in total — and impediments to a higher bid for Ramtron were a result of the company’s operative reality, not any purported shortcomings in the deal process itself. Having found a fair merger process, the court concluded that the merger price was the best, if not the only, evidence of fair value. Simply put, “if Ramtron could have commanded a higher value, it would have.” Indeed, the court expressed its skepticism over the petitioner’s expert’s valuation of $4.96, as compared to its unaffected stock price of $1.81, suggesting that “the market left an amount on the table exceeding Ramtron’s unaffected market capitalization.” The court could not accept that such a significant market failure occurred here.
Coming back to the arbitrage issue, the Vice Chancellor makes a point of noting that LongPath only began acquiring Ramtron shares a month after the merger was announced. We’ve discussed the practice of appraisal arbitrage extensively, noting the arguments for (here) and against (here). The Court of Chancery has been reluctant to limit the practice thus far (here), and Vice Chancellor Parsons continues that pattern here, consistent with the Corporation Counsel of the Delaware Bar’s own refusal to recommend to the legislature that it limit or eliminate the arbitrage practice altogether, as we’ve previously posted here and here.
As reported in Law360, stockholder Merion Capital LP petitioned the Delaware Chancery Court this week for an award of $67 per share for its stock in BMC Software, Inc. Such a demand would reflect a 45% premium to the merger price of $46.25. Indeed, as Law360 reported, the parties’ arguments focused to a large degree on how much deference should be accorded, if any, to the sale process and resultant merger price it produced. The court also asked the parties for supplemental briefing on any purported synergies that BMC claimed to have achieved in the merger, which synergies are excluded by the appraisal statute from the fair value determination. Readers may recall that we previously posted about the BMC case back in January, when Vice Chancellor Glasscock issued his decision in this matter as well as the Ancestry.com case, reaffirming the validity of appraisal arbitrage for the first time since the court’s 2007 ruling in Transkaryotic.
We will continue to monitor this case and post the court’s decision when available.
Last week the Delaware Supreme Court’s en banc hearing in the CKx case resulted in a simple affirmance, without opinion, of the Chancery Court’s 2013 decision that the merger price in this particular case was the best proxy for the fair value of petitioners’ stock. In CKx, the Chancery Court had rejected the valuation methodologies presented by both sides and yet also failed to consider any other valuation approach, pointing instead to the price paid by the acquirer as the most reliable indicator of fair value given its finding that the merger price was the product of a fulsome and robust auction process. The Supreme Court also rejected the company’s request to set fair value below the merger price after taking out supposed synergistic gains that the acquirer had planned to capture from the merger entity (to which post-merger synergies dissenting stockholders are not entitled by statute). Likewise, the Supreme Court rejected the company’s cross-appeal challenging the full award of statutory interest at 5.75%, affirming Chancery’s ruling that it had no authority under the appraisal statute to permit the respondent to compel the petitioners to accept a partial pre-payment of the award that would cut off the accrual of interest.
As reported by Reuters, if you read the Supreme Court order in CKx as setting the market price as a floor in appraisal litigation, rather than a ceiling, and after taking the statutory interest award into account, the decision may ultimately incentivize appraisal arbitrage for big investors.
**Note: this law firm is of counsel to the appellant-petitioner shareholders in CKx.
The Delaware Supreme Court has scheduled the case of Huff Fund Investment Partnership v. CKx Inc. for en banc review in February 2015.
The Chancery Court rejected the valuation methods proposed by the parties and deferred to the merger price as the only reliable indicator of value. The Chancery Court likewise rejected the shareholders’ argument for an upward adjustment to the merger price as well as the company’s argument for a downward adjustment.
On appeal, the parties are asking the Supreme Court to consider whether the Chancery Court erred by:
- deferring exclusively to the merger price, in lieu of performing any valuation analysis, to determine the stock’s fair value.
- rejecting both of the DCF valuations presented by the shareholders as well as the company.
- rejecting the shareholders’ other valuation methodologies; namely, their expert’s (a) guideline publicly-traded companies analysis and (b) precedent transactions valuation.
- refusing to attribute any value to a corporate acquisition that materialized after the merger price was agreed upon but prior to the time the merger was consummated.
- refusing to decrease the merger price by certain claimed synergies and other cost-savings that the acquirer expected to achieve.
- refusing to allow the company to make a partial payment to the shareholders to stop the running of statutory interest prior to the entry of final judgment.
The Supreme Court seldom reviews appraisal cases en banc. In fact, the seminal cases of Weinberger v. UOP, Inc. (1983) and M.G. Bancorporation, Inc. v. Le Beau (1999) are the only other en banc appraisal cases of which we are aware.
**Note: this law firm is of counsel to the appellant-petitioner shareholders in CKx.