Investors who think that
the price is inadequate have surely been disappointed that a higher bid
never emerged. One big Dell investor, Southeastern Asset Management,
has estimated that the company is worth almost $24 a share.
But many shareholders may
not realize that they have an intriguing alternative that could generate
more money than Mr. Dell is offering: requesting that a court appraise
the company’s long-term value.
Because Dell is
incorporated in Delaware, such an appraisal process would go through
that state’s Court of Chancery. Upon the case’s conclusion,
Delaware law would require Mr. Dell to pay the shareholders bringing
the litigation whatever value the court determined was fair.
Going the appraisal route
has its risks. One big one is that the court could award shareholders
less than the $13.65 a share that Mr. Dell is offering. The cases also
take time, during which investors’ stock is tied up.
But in the Dell case, an
innovative trust has been set up by an outside group allowing Dell
shareholders to pursue appraisal-rights litigation while also allowing
them to sell their shares. More on that later.
Shareholders making legal
challenges to buyouts typically base them on a supposed breach of duty
by company directors overseeing the process. No such breach is required
in appraisal litigation. Investors simply agree to disagree on the
proposed purchase price and ask a court to assess the company’s value.
Nevertheless, because of procedural complexities, appraisal litigation
in takeovers is not that common.
Often purchasers limit
shareholder participation in appraisals to minimize their financial
exposure should a judge rule that a higher price is in order. But Mr.
Dell’s offer did not limit how many shareholders could mount an
appraisal case.
In the Dell transaction,
said
Lawrence A. Hamermesh, a professor of corporate and business law at
Widener Law School in Wilmington, Del., appraisal litigation could be “a
safety valve on doubts about whether a valuation process worked
appropriately.”
“No matter how effective
you think special committees are, some people genuinely believe the
result isn’t fair,” he said. “So this is a way of giving people access
to a court to make that determination.”
For appraisal litigation to
proceed in the Dell case, a majority of the company’s shareholders — not
counting Mr. Dell — must first approve his offer. Only then can
investors who chose not to tender their shares bring an appraisal case.
“What makes this an
interesting case for appraisal is you rarely see going-private deals of
this size,” said
Jeffrey Gordon, a professor at Columbia Law School. “If you’re a 3
percent or 5 percent owner, the litigation cost of an appraisal case for
Dell is a tiny fraction of the potential upside.”
The outcomes in past
appraisal cases suggest that such litigation can pay off handsomely.
Some 40 appraisal cases from 1984 through 2004 that culminated in court
decisions were cited in an unpublished paper by Charles Korsmo,
assistant professor at the Case Western Reserve School of Law, and Minor
Myers, associate professor at Brooklyn Law School.
The professors found that
in the 40 cases where both the merger premium and the court’s finding
were disclosed, appraisal litigation generated a median award of 50.2
percent over the buyout price. Mr. Myers noted in an interview, however,
that some of the cases involved small, private companies where a large
premium did not amount to all that much in dollars.
Eric M. Andersen, a lawyer
specializing in appraisal litigation at the law firm of Mark Andersen in
Wilmington, Del., has also studied cases that went to trial. His
analysis identified 46 since 1985; among those, the court assigned a
lower price in only seven of them. The median premium paid in cases
analyzed by Mr. Andersen was approximately 72 percent.
Another benefit to joining
an appraisal case, lawyers say, is that Delaware law gives participating
shareholders 60 days after a shareholder vote to change their minds and
tender their shares. So why haven’t there been more appraisal cases in
recent years? Operational hurdles and costs have made it hard for both
institutional and individual investors to participate in such
litigation.
But some of the main
hurdles are being eliminated in the Dell case
by the Shareholder Forum, an independent creator of programs devised
to provide the kind of information investors need to make astute
decisions.
The forum, overseen by Gary
Lutin, a former investment banker at Lutin & Company, has created a
trust registered in Delaware to which shareholders seeking to exercise
their appraisal rights can assign their stock and pursue the case as a
group. The Dell Valuation Trust, as it is known, will oversee the
process, hiring lawyers to represent the shareholders in Chancery Court.
This will allow individual investors, who would find it too onerous to
hire their own lawyers, to demand appraisal rights as well.
The trust will also provide
another benefit to investors: freedom to trade their rights. Ordinarily,
shares of investors seeking appraisal rights in a deal are frozen until
the court comes to a decision, which can take as long as two years. But
the securities held in the Dell trust will continue to trade as the case
proceeds.
Shares deposited by
investors into the Dell Valuation Trust will be exchanged, one to one,
for a security representing the appraisal rights. Investors will be able
to buy and sell these instruments throughout the legal process with
their price reflecting the market’s view of a potential outcome. As
such, investors, like mutual funds, who can’t or don’t want to hold
illiquid securities will be able to participate in the appraisal
litigation. The Shareholder Forum charges one penny per share
represented.
“Most investors had viewed
appraisal rights as a perfect theoretical solution for underpriced
buyouts, but impractical because of administrative burdens and lack of
marketability,” Mr. Lutin said. “The analytical view of professional
investors is fairly consistent — assuming appraisal rights are
marketable, processing a demand essentially reserves a no-risk option.”
“Most investors look
at this the same way Michael Dell does, and reach the same conclusion,”
Mr. Lutin added. “They want the long term value of the company, not the
short term value of the stock price."
Mr. Dell’s deal might be
approved, or it might not. But providing a low-cost tool for investors
to exercise appraisal rights means that they may occur more often. And
that’s a good thing.
