The Delaware Supreme Court issued its opinion last week in Dell, Inc. v. Magnetar et al. (“SC Dell Opinion”), and although the end result was no real surprise, three things did jump out at me.
#1 The Concluding Paragraph: Fair Value Conclusion
Despite the sound economic and policy reasons supporting the use of the deal price as the fair value award on remand, we will not give in to the temptation to dictate that result. That said, we give the Vice Chancellor the discretion on remand to enter judgment at the deal price if he so chooses, with no further proceedings.
Reading between the lines a bit, they are basically saying to the lower Court- we aren’t going to do it, but you can and probably should. It immediately made me think of the opening paragraph in the Supreme Court’s opinion in DFC Global (“SC DFC Opinion):
In this appraisal proceeding involving a publicly traded payday lending firm purchased by a private equity firm, the respondent argues that we should establish, by judicial gloss, a presumption that in certain cases involving arm’s-length mergers, the price of the transaction giving rise to appraisal rights is the best estimate of fair value. We decline to engage in that act of creation, which in our view has no basis in the statutory text, which gives the Court of Chancery in the first instance the discretion to “determine the fair value of the shares” by taking into account “all relevant factors”.
Why don’t they just do it and be done with it? Even better, why not define, or at least attempt to define, the characteristics of a favorable process? A sort of check-list that Boards and their advisors can work from to minimize or even eliminate the possibility of appraisal litigation. There is far too much gray area already in appraisal litigation and this opinion, if anything, just adds to it.
#2 Financial Buyers Conclusion
The SC Dell Opinion indicates that the lower Court ran afoul of “accepted financial principles” including the idea that the rate of return that would, in J.P. Morgan’s words, “attract private equity buyers” is simply the rate that reflects the risk of completing a large merger. Clearly, I have been more than a little fixated on this point (see here, and here, and here), but I’m still not buying it. The only authoritative sources I have seen cited by the Supreme Court for this "accepted financial principle" are in footnotes 153 and 154 of the SC DFC Opinion.
Footnote 153 cites the Brealey Corporate Finance text (great book btw) in which they describe internal rate of return ("IRR") analysis as a tool frequently employed by CFOs in evaluating potential projects or investments. I agree that CFOs as well as many other people in the finance community consider IRR when evaluating investment decisions. However, I am not aware of any corporation that evaluates projects using a “standard” or “traditional” hurdle rate of 25-30 percent.
Footnote 154 cites an article in the Journal of Corporate Finance by Alexander S. Gorbenko & Andrey Malenko titled Strategic and Financial Bidders in Takeover Auctions. The footnote in the opinion indicates that Gorbenko & Malenko find that for a specific set of targets in auction-type situations, financial buyers place a higher value on the target than strategic buyers. This is true but what the footnote fails to note, and as I pointed out in a prior post, the subset of targets valued more by financial buyers consisted of mature, poorly performing targets with fewer investment opportunities. Given the various constituents that corporations have to answer to, it is not at all surprising that a financial buyer might see a diamond in the rough where a corporate buyer only sees a massive migraine.
#3 Fair Value ≥ Fair Market Value??
I think its fair to say that this sentence (citing SC DFC opinion) stood out more than anything else to me:
Fair Value entails at minimum a price some buyer is willing to pay – not a price at which no class of buyers in the market would pay.
Maybe I am reading this to literally but if not, when did this happen?
When did “Fair Market Value,” as defined in the IRS tax code or under GAAP, become the floor on the “Fair Value” determination in the Delaware Courts? Up until now, I had been under the impression that the Courts in Delaware were permitted to rely on a number of techniques in determining fair value, including reliance on the merger price itself (i.e., what an actual buyer was willing to pay), provided it was the result of a fair and robust process and did not include any shared synergies (see, for example, BMC Software, p. 31). However, I did not think there was a requirement that the fair value determination in Delaware satisfy a willing-buyer bright-line test.
The overall takeaways, for me anyway, are (a) that the Courts in Delaware are struggling, to some extent, with the dramatic rise in appraisal litigation over the past several years and (b) there is a need for better clarity on a number of process-related fronts. Exactly how, when, where, etc. is thankfully not something I have to figure out. But these are extremely intelligent and financially-sophisticated men and women that sit on the bench in both the Chancery and Supreme Courts in Delaware, so I am certain they will figure it out.
Note: All emphasis in this post is my own.