Law360, New York (September 10,
2013, 3:48 PM ET) -- A review of all Delaware appraisal cases in
the last 20 years shows that the court has consistently
established a “fair value” greater than the amount a buyer
offered to pay for a stand-alone business. The only cases in
which appraised value was less than the merger price — fewer
than 20 percent of the decisions — were those in which the buyer
was paying for something more than the value of the stand-alone
business, such as synergies of a combination with the buyer’s
existing operations or a resolution of disputes.
These results reflect the Delaware law’s definition of “fair
value” as the long-term intrinsic value of a company, considered
as a stand-alone “going concern,” and the state’s Supreme Court
has recently made it clear in Golden Telecom Inc. v. Global GT
LP, 11 A.3d 214, 217-28 (Del. 2010) that the court must make its
appraisal independently of current market pricing or auction
bids. In this context, it is reasonable to assume that a
stand-alone buyer would not have offered to pay more for a
company than what it was worth, and that a judge will reach the
same conclusion. This logic is especially compelling when the
buyer is a well-informed management insider partnering with
professional private equity investors.
Management Buyouts are Likely Priced Below Intrinsic
Value
In a management buyout, one or more individuals responsible for
a company’s management purchase the stand-alone going concern
with funding from professional equity and debt investors. With
full access to the company’s inside information, the manager and
partnering investors price the offer to profit from the
difference between market pricing and the intrinsic value of the
company.
Viewing a management buyout as a pure “stand-alone buyout” —
which, for purposes of this article means a buyout in which the
purchaser pays only for the value of the company as a going
concern (and not for any additional value resulting from the
transaction such as synergies of combination with another
company, or for the “resolution of disputes”) — it is highly
unlikely that management (together with the professional
investor) could present a credible argument to the court that
they knowingly overpaid for a company. Indeed, court opinions
from the Delaware Courts show that there has not been a single
case during the past 20 years in which a stand-alone buyout’s
“fair value” was appraised at less than the offer price.
The Only Appraisal Cases Over the Last 20 Years That
Have Been Appraised at Less than Merger Price are Not
Stand-Alone Buyouts
Over the last 20 years, 45 appraisal actions have gone to trial
and resulted in a post-trial opinion (some appraisal actions,
including Cede v.
Technicolor have resulted in more than one post-trial
opinion). Of those 45 cases, only eight (17.8 percent) resulted
in an appraisal of fair value by the court that was less than
the merger price.
Significantly, none of those eight cases was a stand-alone
buyout. Rather, six of them — Gerreald v. JustCare; Highfields
Capital v.
AXA Financial; Union Illinois 1995 Inv. Ltd. Partnership v.
Union Financial Group; In re Grimes v. Vitalink Communications
Corporation; Kleinwort Benson v.
Silgan Corporation; and Cooper v. Pabst Brewing Company —
involved a competitively bid acquisition as part of a strategic
business combination. The other two — Andaloro v. PFPC Worldwide
Inc. and Finkelstein v.
Liberty Digital Inc. — involved the resolution of disputes
with affiliates.
It appears that the acquiring company in each of those eight
cases paid for value beyond that of the stand-alone going
concern, whereas it is well established that the court’s
analysis must be based exclusively on the company’s value as a
stand-alone going concern. Because the buyer’s valuation in
those cases was based on benefits beyond the stand-alone
enterprise value, the price they were willing to offer was more
than the fair value of the company.
Foundations of Delaware Appraisal of Fair Value
Under Delaware law, stockholders who properly perfect their
appraisal rights are entitled to have the Court of Chancery
determine the “fair value” of their shares of stock as of the
merger date. The basic concept of fair value is simple, as
stated in a frequently cited Delaware Supreme Court case from
1950: stockholders are entitled to be paid for their
“proportionate interest in a going concern,” which means they
are entitled to be paid “the true or intrinsic value of [their]
stock which has been taken by the merger.” Tri-Cont’l Corp. v.
Battye, 74A.2d 71, 72 (Del. 1950).
In determining the price that represents fair or intrinsic
value, the Court of Chancery is required to perform an
independent evaluation. In doing so, the court must take into
consideration all relevant factors that “reasonably might enter
into the fixing of value,” including (i) market value, (ii)
asset value, (iii) dividends, (iv) earning prospects, (v) the
nature of the enterprise subject to the appraisal proceeding,
and (vi) any other facts (such as the value of intellectual
property, including patents, trademarks, trade secrets and other
proprietary data) that were known or could have been known as of
the date of the merger and which shed light on future prospects
of the merged corporation.
Factors Not Relevant to the Court’s Determination of
“Fair Value”
While the court must consider all relevant factors to determine
fair value, those factors do not include merger price, or
whether the merger price resulted from a fair process. The
merger price is not the same thing as a company’s “fair value”
as a going concern. As noted above, the Delaware Supreme Court
made this point unambiguously clear in its 2010 Golden Telecom
decision by refusing to “establish a rule requiring the Court of
Chancery to defer to the merger price in any appraisal
proceeding.”
Subsequent to Golden Telecom, Chancellor Leo Strine refused to
give any weight to the merger price in valuing a company at
$4.67 per share, which was more than double the $2.05 merger
price. In re Orchard Enters. Inc. (Del. Ch. July 18, 2012). And
Vice Chancellor Parsons found the merger price irrelevant in
concluding that the fair value of a company was $10.87 per
share, in excess of the $10.50 merger price. Merion Capital LP
v.
3M Cogent Inc. (July 8, 2013). Accordingly, not only is it
well settled law that the court need not rely on merger price in
an appraisal action, the court does not even have to consider
merger price.
Moreover, the court need not consider whether the merger price
was a product of a “fair process” in an appraisal action. In
Orchard, the company attempted to justify the merger price by
“mak[ing] some rhetorical hay out of its search for other
buyers.” But the court appropriately pointed out that it “[w]as
an appraisal action, not a fiduciary duty case, and although I
have little reason to doubt Orchard’s assertion that no buyer
was willing to pay Dimensional $25 million for the preferred
stock and an attractive price for Orchard's common stock in
2009, an appraisal must be focused on Orchard's going concern
value.” Id. In other words, the court recognized its statutory
obligation to independently analyze Orchard’s “fair value”
regardless of whether the company conducted an auction or
performed a market check.
Similarly, the Court of Chancery recently explained that “the
determination that no breach of duty occurred because the Merger
price was fair does not necessarily moot the companion appraisal
proceeding.” In re Trados Incorporated Shareholders Litig. (Del.
Ch. Aug. 16, 2013). For example, the court stated that while the
merger price may not support a fiduciary liability claim if it
fell within a certain range of reasonableness, an appraisal
analysis could still yield an award in excess of the merger
price. By way of example, the court cited Cinerama v.
Technicolor, 663 A.2d at 1156, 1176-77 (Del. 1995) and Cede &
Co. v. Technicolor Inc., 884 A.2d 26, 30 (Del. 2005), in which
the Delaware Supreme Court affirmed the determination that the
merger consideration of $23 per share was “entirely fair” in the
context of that company’s breach of duty case, but also awarded
“fair value” of $28.41 per share in the company’s appraisal
case.
Conclusion
The Delaware Courts have made clear that fair value in the
context of an appraisal of a corporation’s going concern is
distinct from a market-based merger price for the stock of that
corporation. Given that all the factors the courts must consider
in determining fair value in an appraisal proceeding are based
on long-term business fundamentals rather than the current
market fluctuations that determine a merger price, appraisal
actions have resulted in court determinations of fair value
(often far) in excess of the merger price in more than 80
percent of the cases that went to trial.
Applied to stand-alone buyouts, appraisal offers a practical and
very reliable process for unlocking a company’s intrinsic value
above the merger price, and such an action is even more likely
to unlock value when the stand-alone buyer is a corporate
insider. Management buyers, after all, can be expected to know
their company’s intrinsic value best and are not likely to
convince the court that they knowingly offered to pay more than
the company was worth.
—By Jeremy D. Anderson and José P. Sierra,
Fish & Richardson PC
Jeremy Anderson is of counsel in Fish & Richardson’s
Wilmington, Del., office.
José Sierra is a principal in Fish’s Boston and Wilmington
offices.
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.
