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.

 

The purchaser of a company through merger often argues in a subsequent appraisal action that the price paid was too high and that the dissenting shareholder should be paid a lower amount. Tactically, it is important for the purchaser to impress the dissenting shareholder with down-side risk in pursuing the appraisal. The resulting inference of such a position is that the acquirer must have “overpaid” for the asset. To justify such a position, the acquirer may argue that his purchase price included a payment for so-called “synergies” that must be excluded from the going-concern value of the company. However, true “synergies” should be rarely acknowledged and quantified in appraisal proceedings.

The plain language of the appraisal statute sets the stage for the “synergies” argument because it requires the Court to determine the “fair value” of the shares “exclusive of any element of value arising from the accomplishment or expectation of the merger.” 8 Del. C.§ 262(h). What exactly does this mean, however? Consider the following hypothetical: Suppose a Company owns vast proven oil reserves, but lacks the capital necessary to drill wells and exploit the oil fields. If the Company markets itself, all potential bidders will bid for the property based upon their expected returns after making the capital investments necessary to exploit the oil reserves. Are these capital investments “synergies” because they constitute value that will be achieved only “through accomplishment of the merger? The answer should be “no.” If the Company sold the oil fields it would obtain offers that reflect the market value of the assets to purchasers who would use them. Shareholders who own the Company should share in the value of those reserves. On the other hand, what if the acquirer is willing to pay more for the Company because it is vertically integrating in an industry and will be able to extract greater value from the assets than would otherwise be possible? In that case, there is no reason to believe that the “synergy” created should be considered part of the going concern value on the date of the merger.

Although the above examples illustrate the complexity of the problem, many appraisal cases involve business opportunities that could have been pursued by the Company but had not yet reached fruition at the time of the merger. To deal with these situations, the Delaware courts have developed the concepts of “undue speculation” and “operative reality”. According to the Delaware Supreme Court in Weinberger v. UOP, Inc., 457 A.2d 701, 713 (Del 1983), the intent of the statute is to exclude only “speculative elements of value that may arise from the ‘accomplishment or expectation’ of the merger.” It is a “very narrow exception to the valuation process designed to eliminate use of pro forma data and projections of a speculative nature relating to completion of a merger.” In contrast, the “operative reality” of a company includes all “future prospects” that are ‘known or knowable” at the time of the merger –whether or not they have been achieved. MRI Radiology Assocs., P.A. v. Kessler, 898 A.2d 290, 315 (Del. Ch. 2006). The value of such “future prospects” rightly belong to the dissenting shareholder who would have presumably shared in their exploitation and realization had he been allowed to continue as a long-term owner in the concern.

In light of these principles, so-called “synergies” should be a narrow, rarely invoked exclusion to going concern value. When the acquirer is an insider or an investment professional, one should be very suspicious about alleged claims of synergies that are only first identified post-closing to downgrade the valuation analysis. Most claims of synergy will likely be nothing more than the financial exploitation of known or knowable prospects — like the oil fields in the example above. In the case of strategic buyers — who are either vertically or horizontally related to the Company — claims of synergy may be real. However, many analysts and lawyers believe that in order for synergy claims to be credible in an appraisal proceeding, they must be opportunities that the Company could never have identified or implemented on its own and should be quantified and disclosed to shareholders before they vote on the merger.