Dell Buyout Critics Seek New Market For Appraisal Rights

By Liz Hoffman

Law360, New York (June 21, 2013, 7:57 PM ET) -- Unfolding behind the scenes of the battle for Dell Inc. is a first-of-its-kind effort to help disgruntled shareholders make the most of their appraisal rights, and supporters say it could shake up the merger litigation chessboard.

The Shareholder Forum, an independent advocate for investor rights, is preparing to launch a U.S. Securities and Exchange Commission-registered trust that would pool appraisal rights, effectively creating a public market for any upside resulting from an independent valuation of Dell's shares.

If it works, it could make appraisal demands — which are potentially lucrative, but often more trouble than they are worth — a more widely used tool, says Gary Lutin, who heads the forum.

"[Dell founder] Michael Dell says he believes in the long-term value of the company,” Lutin told Law360. “So do other investors. Appraisal rights allow for that, and the idea is to make them a better option for more people.”

Appraisal suits allow shareholders unhappy with a merger price to put the question before a judge, who conducts an independent valuation of the stock. The judge — in this case, likely Delaware Chancellor Leo E. Strine Jr., who is overseeing the Dell class action — hears testimony, looks at financial models and comes up with a number.

Some appraisal valuations have awarded shareholders double, triple or even four times the merger price. It's basic investment logic, Lutin says; buyers are almost always paying less than they think the company is worth.

That risk of big awards prompts many companies to settle, especially ones like Dell, whose buyouts hinge on lots of financing, said Larry Hamermesh, an M&A expert at Delaware's Widener University. A big, uncertain future payment can cut into cash flows needed to pay back debt and send borrowers scrambling.

“The threat of having to come back in a few years and pay 50 million shares three times the merger price … that's a real point of leverage,” Hamermesh said.

The problem is that appraisals are a pain. They are expensive and can take two years or more, tying up cash that could go into other investments. The famous Technicolor case, in which shareholders challenged Ronald Perelman's buyout of the movie production company in 1982, dragged on for 22 years.

And the investments are illiquid, since they are essentially shares of a company that no longer exists. That means most investors don't want them, and some, like money-market funds, can't legally hold very many of them.

That's where Lutin's idea comes in. Shareholders would swap their Dell shares for units of a new trust, which would be listed on an exchange. If they don't like the way the appraisal is going or need to cash out, they can do so.

The setup would also give arbitragers a way in. In the same way that some hedge funds are now investing in future litigation claims, more patient market players could buy the right to any future appraisal award, long after a deal is closed.

“Right now, it's a small group of people willing to take the risk and have their money tied up for two years,” said Eric Andersen, a Delaware lawyer working with the Shareholder Forum. “The idea of the trust is to make that a nonissue.”

There's an added bonus. In class actions, plaintiffs have to show that a board breached its fiduciary duty or that the process was somehow tainted — claims that appear to face a tough road in the pending Dell class action. But appraisal cases don't require plaintiffs to allege anything at all.

“If the Chancery Court approves this, it will change the entire landscape of deal litigation,” Andersen said. “It would make no sense to go the class action route any more. Why put yourself through the racket of trying to prove the board of directors did anything wrong?”

If successful, the effort could create a template for others to follow. Management buyouts, which tend to sound shareholder's alarm bells, are enjoying a comeback. So is merger-related activism, which suggests a deep pool of investors who might be interested in buying appraisal rights.

Still, the Shareholder Forum has a tough road ahead.

First, it must round up investors willing to forgo a guaranteed $13.65 per share. Stockholders must vote against the merger to exercise their appraisal rights and the deal must close to pursue the case.

Andersen said investors with between 50 million and 100 million shares have expressed interest, representing up to about 6 percent of Dell's stock, though Lutin said even 10 million shares would provide enough liquidity to make it workable.

But more importantly, several sources close to the Dell deal questioned the likelihood of a big award. Most of the large payouts have come in deals where a controlling stockholder sought to freeze out minority shareholders. Those deals tend to be done on the cheap, and a judge's independent calculation adds back the takeover premium, Hamermesh said.

But Michael Dell only owns about 16 percent of his company, a stake Chancellor Strine said this week doesn't come “anywhere close” to a controlling position. Michael Dell has already said he will vote his shares in favor of a higher bid, and his votes won't count toward approving the deal.

“The further away a transaction gets from a minority freeze-out and the closer it gets to being arm's-length, the smaller the awards tend to be,” Hamermesh said.

There's always the risk that the judge decides Dell's shares are actually worth less than the merger price. It's happened before — at least seven times in the past two decades. In 2007, hedge fund Highfields Capital turned down a $31-per-share offer for its stock in MONY Group Inc., only to have Vice Chancellor Stephen Lamb decide the shares were only worth $24.97. Even with accrued interest, Highfields lost money.

Plus, there's the issue of pricing. Right now, a Dell investor can vote for the buyout and is guaranteed $13.65 per share. To gain any upside, the trust units would have to trade higher. But an arbitrage fund can buy into the stock anytime before the closing for $13.65, so it has little incentive to wait and pay more down the road.

“This seems like false liquidity,” said one insider. “If no smart investor will buy your [appraisal rights], you don't have a market.”

The Shareholder Forum is being advised by Mark Andersen PA and Fish & Richardson PC on the appraisal rights, Berger Harris LLC on trust issues and Bingham McCutchen LLP on SEC issues.

--Editing by Andrew Park and Jeremy Barker. 

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