Dell Inc. v. Magnetar Global Event Driven Master Fund Ltd.[1] is the Delaware Supreme Court’s latest word in just one species of mergers and acquisitions litigation that has been evolving quickly during the past several years in Delaware — stockholder appraisal petitions in merger transactions. In Dell, the Supreme Court reversed and remanded an earlier appraisal ruling of the Delaware Court of Chancery where that court had determined that the fair value of the stock of Dell Inc. was far in excess of the merger price paid to stockholders in Dell’s 2013 management-led buyout.

Once viewed as an afterthought in merger practice, appraisal has received increased attention during the past several years given the sharp rise of petitions filed under Delaware’s appraisal statute. That increase has been attributed largely to the emergence of appraisal arbitrage as an investment theme pursued by certain asset managers.

Space limitations preclude full treatment here of Delaware’s appraisal statute and its legislative history, the appraisal process, the rise of appraisal arbitrage, or the trajectory of Delaware’s appraisal jurisprudence over time. What this note provides is a brief overview of the Supreme Court’s ruling in Dell and some observations on appraisal in a post-Dell world.

In addition, as this article was being submitted for publication, the Court of Chancery issued its own latest appraisal ruling, Verition Partners Master Fund Ltd. v. Aruba Networks Inc.[2] The ruling is that court’s first public company appraisal ruling in the aftermath of the Supreme Court’s ruling in Dell, and this note also briefly reviews certain aspects of Aruba given the late-breaking development. Aruba reads as a response to, if not a rebuttal of, certain aspects of Dell. More interesting still is that it puts a klieg light on the rapid pace at which appraisal is evolving in Delaware.

In brief, Delaware’s appraisal statute entitles stockholders of an acquired company in certain transactions to forego receiving the offered consideration and to instead petition the Court of Chancery to have it determine the fair value of their stock, taking into account “all relevant factors” as mandated by the statute.[3] Statutory interest is added to the award. For some time, practitioners, academics and the judiciary have debated whether and under what circumstances the deal price in a merger transaction should be viewed as a determining factor or the determining factor of fair value for appraisal purposes.

Dell in the Court of Chancery

Dell’s appraisal proceeding arose when dissenting stockholders challenged whether the $13.75 per-share merger price (roughly $25 billion) CEO Michael Dell and Silver Lake Partners paid when partnering to acquire Dell in the MBO reflected the fair value of Dell. That price was a 37 percent premium to the company’s 90-day-average trading price. The transaction was approved by a 57 percent stockholder vote.

In ruling, the Court of Chancery declined to give any weight to the merger price as a determinant of fair value in appraisal.[4] The court based its decision on what it saw as shortcomings in the sales process, and concerns with the form of the transaction when viewed for appraisal purposes. Among other things, the court’s concerns revolved around: (1) a perceived valuation gap between Dell’s pre-deal stock trading price (which it noted anchored the bidding) and its intrinsic value; (2) limited presigning bidding competition among only a limited number of financial sponsors, each of which used the leveraged buyout pricing model in formulating its bid, and which model the court noted solves for achieving a targeted internal rate of return rather than discovering fair value; (3) a post-signing go-shop process of limited utility given Dell’s size and complexity; and (4) the fact that the form of transaction was an MBO, which the court viewed as undermining the probative value of the deal price for appraisal purposes given management’s informational advantages in such forms of transactions.

Instead of giving the deal price any credit, the court relied exclusively on a discounted cash flow analysis to peg fair value at $17.62 per share — or approximately 28 percent ($7 billion) more than the deal price. The ruling generated significant commentary, and was seen as a sharp break from what some regarded as a trend then emerging from a number of 2015 Court of Chancery appraisal rulings, where the court deferred to deal price when determining fair value in settings where the companies involved had been exposed to the market for sale purposes.

Dell in the Supreme Court

On appeal, the Supreme Court held that the lower court had erred and abused its discretion by not assigning any weight to the deal price based on the facts presented. The Supreme Court also took issue with the concerns upon which the lower court had grounded its analysis.

Referencing the efficient market theory hypothesis — which holds that the price produced by an efficient market is a reliable assessment of fair value — the Supreme Court concluded that the public market for Dell stock was efficient, thereby disputing the existence of a valuation gap the lower court had identified. The court also noted it was untroubled that bidders in the presigning phase were limited to financial buyers focused on achieving certain returns, and that there is no “rational connection” between a buyer’s status as a financial buyer and whether a deal price is fair, since both strategic and financial buyers ultimately seek a targeted return on equity. The court also noted that, during the go-shop period, 67 parties had been canvassed as to interest, including 20 strategic buyers, but that such parties either did not bid or had dropped from the process. While the Supreme Court acknowledged that some MBOs may suffer from negative attributes identified by the trial court, the Supreme Court determined as a factual matter that Dell’s special committee had mitigated the informational advantages sometimes found in such transactions, made sure that Michael Dell was available equally to all bidders, and obtained his agreement that he would vote his stock in proportion with unaffiliated stockholders.

Given these and other “objective indicia” confirming “the deal price’s reliability,” the Supreme Court ruled “the deal price deserved heavy, if not dispositive, weight” in appraisal. The court remanded the case, directing the lower court either to “enter judgment at the deal price ...,” or “weigh a variety of factors …” as long as such weighing is “consistent with the record and with relevant, accepted financial principles.”

The Supreme Court’s ruling in Dell relied heavily upon its August 2017 ruling in DFC Global Corp. v. Muirfield Value Partners,[5] where it had reversed a Court of Chancery appraisal decision involving DFC Global Corp. Notwithstanding that the lower court there had concluded that DFC had been sold in an “arm’s-length sale,” in a “robust” process that “lasted approximately two years and involved ... reaching out to dozens of [potential buyers]” and “did not involve ... conflicts of interest,”[6] the lower court had nevertheless discounted the deal price as a determinant of fair value and averaged the deal price with two other “imperfect” valuation methodologies (DCF and comparable company) to arrive at a fair value higher than the deal price. On appeal, the Supreme Court rejected the lower court’s reasoning for discounting the deal price in the face of questionable projections underpinning the DCF analysis the lower court partially relied upon, warmly embraced the efficient market theory hypothesis, and noted, among other things, that “second-guessing the value arrived upon by the collective views of many sophisticated parties with a real stake in the matter is hazardous.”

The Evolution of Appraisal Post-Dell: Aruba

It is too early to assess the full reach that Dell and DFC will have on appraisal in Delaware. That will become manifest through future appraisal cases and the playing out of issues that follow in their train. The Supreme Court’s rulings also will no doubt continue to be the subject of extensive ongoing analysis and commentary by practitioners, academics and pundits alike.

But time does not stand still for long in Delaware. As noted, late last week the Court of Chancery issued its ruling in Aruba, providing a first look at how the Court of Chancery is looking at appraisal in a post-Dell world. Again, there is far more to unpack from this latest ruling than there is space to do so here. Space also does not permit an assessment of what impact Aruba may have on the disposition of both Dell and DFC, which remain on remand to the Court of Chancery. But Aruba sets up an interesting dynamic as to what positions the parties in Dell and DFC may advance on remand, and how those actions ultimately may be resolved. And all of that may need to await any appeal of Aruba itself.

But in brief, Aruba arose when dissenting stockholders of Aruba challenged whether the $24.67 per-share merger price ($2.7 billion) Hewlett-Packard Co. paid when it acquired Aruba in 2015 reflected the fair value of Aruba. The price represented a 51 percent premium to Aruba’s closing price one day prior to announcement, and a 49 percent premium to Aruba’s 30-day average trading price. The transaction was approved by approximately 80 percent of Aruba’s outstanding shares. In the appraisal proceeding, the petitioners’ expert pegged fair value at $32.57 per share (32 percent higher than deal price); Aruba’s expert put it at $19.75 (20 percent lower) — for an overall 52 percent swing.

Giving readers their money’s worth, the Court of Chancery’s 129-page ruling in Aruba breaks down many issues raised by the Supreme Court’s rulings in Dell and DFC — particularly with respect to the Supreme Court’s embrace of, and reliance upon, the efficient market theory hypothesis in each of those earlier cases as a means determining fair value.

In Aruba, the parties sought to illustrate Aruba’s fair value by pointing to three valuation methodologies: Aruba’s unaffected market price, the deal price and a DCF analysis. The court analyzed each in detail.

Unaffected Market Price. Citing extensively to the Supreme Court’s holdings in Dell and DFC, the Court of Chancery noted that the Supreme Court had strongly endorsed the efficient capital market theory, which holds that market price is a reliable “proxy” of fair value when a company’s stock exhibits certain attributes.The court noted that, although there is a growing body of research that questions the bases of the theory, the petitioners had not put on expert testimony in that regard (although other future litigants might). But given the Supreme Court’s guidance in Dell and DFC, the Court of Chancery determined that Aruba possessed the attributes that the Supreme Court had identified there, and the Court of Chancery found that Aruba’s unaffected 30-day average market price of $17.13 per share was reliable evidence of fair value.

Deal Price. Again referencing the Supreme Court’s guidance in Dell and DFC, the court also determined that the deal price stockholders received in the merger was probative of fair value given Aruba’s merger with HP exhibited many of the same attributes and characteristics as were found by the Supreme Court to be present related to Dell. The court reached this conclusion notwithstanding that HP was the only bidder, given other potential strategic acquirers who were solicited as to their interest in Aruba passed on the opportunity, and financial sponsors were not solicited.

In addition, given the HP/Aruba deal involved two strategic parties and no financial sponsors (unlike in Dell and DFC), the Court of Chancery then adjusted the deal price downward to account for the significant revenue and cost synergies that supported the deal rationale given appraisal requires valuing the subject company as a going concern, “exclusive of any element of value arising from the accomplishment or expectation of the merger ….” Although there has not been many cases where the court has undertaken an adjustment based on synergies, the court determined that the deal-price-less-synergies calculation yielded an $18.20 per-share valuation.

DCF. The court also considered the DCF analyses provided by each of the petitioners’ and respondent’s valuation expert. After noting concerns with each of the reports, the court, again relying on the teaching in Dell and DFC, rejected using the reports at all as part of its process to determine fair value as there was nothing to suggest that the market price could not be relied upon as a proxy for determining fair value under the circumstances.

While the court determined that market price and deal price less synergies were probative of fair value, the court also identified potential shortcomings in relying on the deal-price-less-synergies approach that it thought could distort the outcome given it would be based on uncertainties and the judgements of a trial judge as opposed to the views of a broad collection of market participants. Hewing to the Supreme Court’s preference for market-based price discovery in situations where a company is widely traded and lacks a controlling stockholder, the Court of Chancery concluded that the best determinant of fair value was Aruba’s 30-day average unaffected market price of $17.13 per share — which price was 30 percent below the deal price, and even 13 percent below the fair-value assessment of Aruba's expert. In reaching that conclusion, the court noted that:
 

Some Observations

Dell, DFC and Aruba raise several themes for consideration.

Appraisal as a Remedy. Some have raised whether Dell and DFC (and now Aruba) essentially mark the end of appraisal. The rulings certainly raise basic questions as to the purpose and operation of statutory appraisal, where markets and deal processes have evolved significantly from when the statute was first enacted in 1899, and as appraisal has developed over time — and particularly recently. Although the rulings represent significant markers in the trajectory of appraisal jurisprudence, news of the demise of appraisal as a remedy appears premature. Similar to recent developments in fiduciary duty-based jurisprudence and disclosure-only settlements, the rulings can perhaps be better seen as a changing face of a constantly changing area of M&A litigation.

Appraisal actions will continue where companies that do not have publicly traded equity securities are involved, where controllers are involved, and where public transactions are involved (including MBOs) and petitioners dispute whether the efficient market theory hypothesis is applicable given the facts at hand, or whether the sales process was deficient in some manner when measured against precedents. That said, Dell, DFC, Aruba (and other appraisal rulings in 2017) have narrowed the target zone of potential transactions where appraisal may be successfully prosecuted.

Nonpresumption Presumption. As it did in DFC and in prior cases, the Supreme Court in Dell specifically declined to adopt a per se presumption in favor of deal price for appraisal purposes, even in a fully shopped deal setting, noting such a ruling would contravene Delaware’s statutory mandate in appraisal. Nevertheless, the court’s ruling that “the deal price deserved heavy, if not dispositive, weight” and that “far less weight, if any,” should be given to the DCF analysis in a setting where the sale process was considered "robust” appears to create a presumption in everything but name only. That view also appears to be supported based on the analysis and outcome in Aruba. But case-specific facts and circumstances will remain the touchstone for how future appraisal actions will be treated rather than bright-line approaches.

Efficient Market Theory. Also as it did in DFC, the court in Dell warmly embraced the efficient market theory hypothesis, noting the pre-transaction trading price of Dell’s stock was “a possible proxy for fair value” because the market for Dell’s stock was efficient. In Aruba, the Court of Chancery closely followed the Supreme Court’s reliance on the theory, although it not too subtly reminded that the emphasis on stock price in Dell (and DFC) can be seen as at odds with certain Delaware precedents holding that stock price may be unreliable for various reasons. The Court of Chancery also raised the prospect that future litigants may well seek to challenge the market efficiency theory based on a “significant and growing body of literature that raises question about the assumptions undergirding the traditional [efficient capital markets hypothesis] model, which suggest a need for greater nuance.”

But the extent to which the efficient market theory will be viewed applicable will again be based on case-specific facts and circumstances presented in future actions. Dell and DFC were already pointing toward this being an area that might see greater use of expert testimony in future appraisal proceedings. Aruba essentially ensures it. In that regard, it had been reported previously that petitioners in Dell had spent upward of $4 million in the appraisal proceeding just to establish that the market for Dell’s stock was not efficient. Notwithstanding the court’s ruling in Aruba, the court was careful to caution that “this decision is not interpreting Dell and DFC to hold that unaffected market price is now the standard for fair value in appraisal.”

Sale Processes. According to the Delaware Supreme Court, when “a robust sale process [has] ... occurred, the Court of Chancery should be chary about imposing the hazards that always come when a law-trained judge is forced to make a point of estimate of fair value based on widely divergent partisan expert testimony.” Post-Dell, deals with the cleanest sales processes will have the best chance of earning deal-price deference. Beyond assessing market efficiency, that will put the full litany of sale process features under the microscope to determine how robust the process and whether the probative value of deal price can be undermined, including whether (1) directors were engaged and had the benefit of independent advisers; (2) the process was adequately designed to foster — or at least seek out — competition at important junctures; (3) a controller was involved or other conflict elements were present undermining process neutrality; (4) the special committee (if present) was independent, experienced, adequately authorized and had independent advisers; (5) if an MBO or even an LBO, appropriate procedural safeguards were in place to address management’s perceived conflicts and informational advantages; (6) there was an effective post-signing market check or go-shop process; (7) deal terms are neutral or preclusive; and (8) the negotiation record is strong or weak.

Future petitioners will no doubt assess on a granular level how each feature stacks up against Dell, DFC and other precedents. That also raises what result will follow if certain process elements are less exemplary than others, and whether the Delaware courts might weight findings or take an all-or-nothing approach, and whether process quality will need to be higher in appraisal settings than that typically required for fiduciary duty purposes. In Dell, the Supreme Court suggested that the lower court should take merger price into account in other cases at least to some extent, even where merger price may not be the “most reliable” determinant of fair value. So it appears unlikely the deal price can be written out of the calculus, barring extreme facts. This is also another area that may see an increased use of experts to address the adequacy of the sale process and/or whether an auction was designed appropriately. Interestingly, the Court of Chancery in Aruba reminds that neither Dell nor DFC held “that a deal price would be rendered unreliable in the absence of [bidding] competition” in a sales process, and that the Supreme Court’s reliance on market price as part of adhering to the efficient market theory appears to override sales process concerns.

Convergence of Fiduciary Duty and Appraisal Standards. The Court of Chancery had noted in Dell (and in prior precedents) that a sell-side board’s fulfillment of its fiduciary duties in a sale process does not guarantee the resulting transaction will reflect fair value for appraisal purposes. The court held that, as a process matter, the sales effort there passed muster for fiduciary duty purposes, but when viewed through an appraisal lens, there were issues pointing to the deal price being less reliable as a determinant of fair value.

On the one hand, that view is understandable given the statutory mandate. But from a policy perspective, it creates an incongruity where the exact same deal features can be viewed in one context as exemplary (and so as to deny stockholder plaintiffs relief against director defendants who constructed and ran the process), but yet when scrutinized through the prism of appraisal be found to be so lacking (such that the buyer may need to pay significantly more ($7 billion) as a result of a process it did not design or control). While the distinction is explained by pointing to the statutory mandate as compared to the director-friendly common law standards used to evaluate breaches of the fiduciary duty of care, the asymmetry nonetheless remains as a matter of judicial philosophy and policy. It becomes all the more pronounced when measured against the evolving approach the Delaware judiciary has adopted of late in the fiduciary duty realm as to the advisability of having law-trained judges second-guess the economic decisions of fully informed market actors. The Supreme Court did not address this issue head-on in Dell. But it did emphasize the trial court’s conclusion that the transaction “easily would sail through if reviewed under enhanced scrutiny.” That at least appears to suggest some convergence between fiduciary duty standards and appraisal standards when assessing process elements.

Financial Sponsors. Dell is particularly relevant for sponsors, whether considered in terms of basic take-privates or MBOs. In the aftermath of the lower court rulings in Dell and DFC, as well as another 2016 appraisal action,[7] financial sponsors were seen as having had foisted upon them far greater appraisal risk than strategic buyers, given the lower court’s views on certain aspects of sponsor-led transactions. But as it did in DFC, the Supreme Court in Dell rejected what it described as a “private equity carveout” — the notion that the Court of Chancery could disregard deal price because only private equity bidders who used similar LBO pricing models geared toward achieving desired internal rates of return to formulate their bids were involved in the process. In Dell, the Supreme Court determined it “was error” (at least in this case) for the lower court to determine that the “winner’s curse” theory (and other attributes commonly associated with MBOs) supported disregarding the deal price when determining fair value.

The outcome at the Supreme Court in both Dell and DFC were positive developments for sponsors in terms of eliminating unequal treatment in appraisal settings. But the rulings nevertheless remind that sponsors should place importance on assessing the matrix of variables that are part of any transaction in which they are involved (e.g., market efficiency, sales process features, deal terms) when assessing potential post-closing appraisal risk exposure and capital outlays.

Experts. The concept of the use of experts in appraisal proceedings was raised at oral argument before the Supreme Court in Dell and flows through that ruling as well as Aruba. At one level, Dell cautions that staking out extreme positions on fair value in appraisal proceedings to skew the outcome or create negotiating leverage is a strategically weak move. Both the lower court and the Supreme Court dismissed the petitioners’ valuation as inherently implausible, as it was two times the deal price and three times the pre-announcement market price. But the Supreme Court noted that, when reviewing certain aspects of a DCF analyses, the Court of Chancery may use “a court-appointed expert” to resolve such technical issues. As noted, one outgrowth of Dell, DFC and Aruba may be that both petitioners and respondents will make greater use of market efficiency experts, auction design and sale process experts, and synergy experts to attack or justify deference to the deal price.

DCF Analyses. In Dell, the Supreme Court described DCF as “the best tool for valuing companies when there is no credible market information and no market check.” But it also took DCF analyses down a peg further by acknowledging that “slight differences” in the “many inputs” of a DCF model “can produce large valuation gaps” and result in disputes that a law-trained judge may not be fully equipped to resolve with precision — a view that has been expressed in other Court of Chancery rulings. The court in Dell also noted that “[w]hen an asset has few, or no, buyers at the price selected, that is not a sign that the asset can be shown to be stronger than believed — it is a sign that it is weaker. This fact should give pause to law-trained judges who might attempt to out-guess all of these interested economic players with an actual stake in a company’s future.” While DCF has long been viewed as the gold standard in Delaware for valuation exercises, the court’s comments in Dell, along with the Court of Chancery giving no weight to DCF in Aruba when market-based information is readily available, highlights the de-emphasis of DCF. That also may suggest that other market-based valuation methodologies, such as comparable transactions, gain in influence. But notwithstanding Dell and Aruba, DCF will remain an important valuation metric — especially if market price and deal price are unreliable.

Future Statutory Changes. In 2016, the Delaware Legislature amended the appraisal statute to address perceived shortcomings and criticisms as to how appraisal had been evolving. Those modifications were well-reported at the time. It remains to be seen whether, in the aftermath of Dell, DFC, Aruba and other recent Court of Chancery appraisal rulings, the Delaware Legislature will seek to make further statutory changes in response to those rulings or concerns arising from the earlier amendments.

Synergies. Delaware’s appraisal statute provides that, in determining fair value, the court is to value the company as a going concern, “exclusive of any element of value arising from the accomplishment or expectation of the merger ….” As a result, expected synergies arising from the transaction are to be excluded from a fair-value determination. Historically, the courts in Delaware have acknowledged that an adjustment for synergies may be appropriate in certain instances. They have similarly recognized the difficulty in quantifying and valuing those synergies. Dell did not involve the treatment of synergies. Aruba did involve synergies, but the parties agreed that it was not possible to determine what portion of the final deal price reflected synergy value.

The court in Aruba, using various reports and literature, derived a range of synergy values, and then took the mid-point figure. The court acknowledged, however, that while a deal-price-minus-synergies approach provided an indirect measure of fair value, there were two significant sources of uncertainty. One was potential measurement error at multiple levels involved in trying to assess such complex matters as revenue and cost synergies. The other is that a deal-price-minus-synergies figure may nevertheless continue to incorporate another element of value resulting from the merger, which is reduced agency costs resulting from gaining control of the target. Given these difficulties, which will be present in future appraisal actions just as they were in Aruba, the court determined that using Aruba’s unaffected market price provided the more straightforward and reliable method for estimating the fair value of the entity as a going concern. Notwithstanding these difficulties, the synergies area will likely receive greater focus going forward, even if the pace of appraisals slows.

M&A Litigation Landscape Generally. No area of M&A has evolved as much or as quickly during the past three years as has the standards of judicial review that Delaware courts will apply when evaluating transactions in certain deal settings. There has been significant evolution in the courts’ jurisprudence in an effort to streamline judicial doctrine as well as to address the tsunami-like rise in M&A litigation that occurred during the decade 2005-2015, where the percentage of transactions that experienced fiduciary duty litigation rose to more than 95 percent, and where the incidence of appraisal litigation also rose sharply. This recent evolution largely has focused on fiduciary duty-based litigation and the use of disclosure-only settlements commonly used to resolve much of that litigation. Developments in these areas have been well-reported in these pages and elsewhere. With the Supreme Court’s rulings in Dell and DFC, the Supreme Court appears to have largely completed a realignment of the geography of M&A litigation in Delaware that was begun several years ago — although in the appraisal area, there may be a few more rounds to go.

The Supreme Court’s rulings in Dell and DFC narrowed the target zone of potential transactions where appraisal may be successfully prosecuted. Asset managers focused on appraisal arbitrage as an investment theme were already facing an altered landscape and a different risk profile in the aftermath of those rulings. The Court of Chancery’s ruling in Aruba reconfigures still further a new world order for those parties to navigate or abandon, and further implicates a number of the observations raised above around the look of appraisal in a post-Dell — and now a post-Aruba — world. That is, until the Supreme Court may be asked to speak on it all again, which may be soon, and take observers to still other points unknown. But as with most things in the M&A ecosystem, one thing observers can be sure of is that there will likely continue to be more change.

 

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John K. Hughes is a partner in the M&A group at Sidley Austin LLP, based in Washington, D.C.

Jack B. Jacobs is a senior counsel at Sidley Austin in Wilmington, Delaware. He is a former justice of the Delaware Supreme Court and a former vice chancellor on Delaware’s Court of Chancery.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] -- A.3d ---, 2017, WL 6375829 (Del. Dec. 14, 2017).

[2] C.A. No. 11448-VCL (Del. Ch. Feb. 15, 2018).

[3] 8 Del. C.§ 262.

[4] In re Appraisal of Dell, Inc., 2016 WL 3186538 (Del. Ch. May 31, 2016).

[5] DFC Global Corp. v. Muirfield Value Partners, 2017 WL 3261190 (Del. Aug. 1, 2017).

[6] In re Appraisal of DFC Glob. Corp.,2016 WL 3753123(Del. Ch. July 8, 2016).

[7] Merion Capital LP v. Lender Processing Services Inc., 2016 WL 7324170 (Del. Ch. Dec. 16, 2016).