BloombergOpinion

Finance

By Matt Levine

‎August‎ ‎1‎, ‎2018‎ ‎10‎:‎31‎ ‎AM

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Is appraisal dead?

Schematically, the way mergers and buyouts work is that some company’s stock is trading at $100, and some acquirer offers to buy it for $130, and the board says “that vastly undervalues us,” and there is a flurry of negotiation, and ultimately they agree on a price of $132.50. And then sometimes some shareholders will sue for “appraisal,” asking a Delaware court (most U.S. public companies are incorporated in Delaware) to find that the merger undervalued the company and that really it was worth $150. If they win, then the court can make the acquirer go back and pay them the appraised price, plus interest. But the court can appraise the company at whatever price it thinks is right—based on the standalone value of the company, excluding any synergies and changes that the acquirer plans to make—and if it concludes that actually the company was worth $130 or $120 or $100 or $50, then the holdout shareholders only get that amount, and would have been better off taking the merger consideration instead.

From first principles you might have one of two opposite assumptions about the appraisal price:

1. Most of the time, the company should be worth less than the merger price. After all the merger price is at a premium to the previous stock price ($100 in my example), and market efficiency suggests that the stock price is the best estimate of value. The merger price is generally the result of an auction process; if the acquirer gets the company for $132.50 then that means no one else was willing to pay more. And the merger price includes synergies and post-merger efficiencies, which are not supposed to be included in the appraisal price. So in normal circumstances the appraisal price should be $100 or $110 or $120, but not $132.50 and certainly not $150.

2. Most of the time, the company should be worth more than the merger price. After all shareholders don’t seek appraisal in every deal; it is risky and time-consuming. If they are seeking appraisal, it is because there was something wrong with the merger process. Maybe the chief executive officer was sandbagging the company, talking it down to try to drive down the price so he could buy it cheap. Maybe the auction process favored one bidder—the one working with the CEO—over others who might have paid a higher price. Maybe the deal value wasn’t driven by synergies but by the possibility of taking it away from public shareholders for cheap. 

If you took a random sample of deals, assumption 1 would probably be correct: Of course the average acquirer overpays. But appraisal cases aren’t a random sample, and it’s entirely possible that, among deals where the shareholders seek appraisal, the “actual” value of the company is often higher than the deal price.

Loosely speaking, for most of recent history, appraisals frequently came in higher than the deal price, and “appraisal arbitrage”—buying shares in merger targets and suing for appraisal—was a profitable hedge-fund strategy. But that has changed. In December 2017, the Delaware Supreme Court rejected Vice Chancellor Travis Laster’s valuation in the Dell appraisal case and concluded that, in an imperfect but more-or-less fair-ish looking merger process, the deal price was probably the best indication of fair value. And in February of this year, Vice Chancellor Laster one-upped the Supreme Court by finding, in the Aruba appraisal case, that actually the unaffected stock price—the price at which the stock was trading before the merger was announced—was the best indication of fair value. The entire merger premium, on this reasoning, represented the synergies of the deal and the risks that the buyer was taking on; the best estimate of the company’s standalone fair value is the stock price in the market.

This week a different Delaware Chancery Court judge—Chancellor Andre Bouchard—announced his decision in the appraisal of Solera Holdings Inc., a software company that was acquired by Vista Equity Partners in 2016. It’s another loss for appraisal arbitrage; the chancellor awarded the holdout shareholders a bit less than the deal price ($53.95 instead of $55.85):

The basic lesson of all these decisions is that, if you can prove that a deal was corrupt and that management did things to keep the price down, then you have a shot at making some money in appraisal; otherwise you don’t. But that is not how people thought it worked. The traditional view was that, if you could prove that a deal was corrupt and that management did things to keep the price down and favor one bidder, then you’d sue in a class-action lawsuit for breach of fiduciary duty. If you could prove you were right, then you’d get damages for every shareholder (not just the ones who held out for appraisal).

Appraisal was something different. In appraisal, you didn’t have to prove that the deal was corrupt. You just had to convince a judge that the company was worth more than the acquirer paid for it. Your evidence wasn’t secret nefarious emails between the buyer and the CEO. Your evidence was discounted cash flow valuations. Your argument wasn’t about fairness, but about value. That might be over. The Delaware courts just don’t want to do valuations anymore; they don’t want to substitute their view of value for the market’s. If you can’t prove that the market failed, that there was some form of corruption that prevented the company from getting a fair price, then don’t bother seeking appraisal just because you think the price is wrong. The courts are no longer interested.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net

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