Chancery Relies on Merger Price to Determine Fair Value
In appraisal actions brought pursuant to 8 Del. C. § 262, the Court of Chancery usually relies on experts performing discounted cash flow and comparable company analyses to determine the fair value of a company. The court may not accept the analysis of either side's expert or experts in toto, but will generally use the analysis of at least one expert as a launching point for determining fair value. But what happens if the court decides that none of the expert analyses are a reliable indicator of fair value? The court confronted this situation in Huff Fund Investment Partnership v. CKx, C.A. No. 6844-VCG (Del. Ch. Nov. 1, 2013). After concluding that neither side's expert offered a reliable basis for determining the fair value of CKx Inc., the court instead relied upon the merger price to determine fair value.
Petitioners Huff Fund Investment Partnership and Bryan Bloom were CKx stockholders. CKx was a Nasdaq-traded company that owned rights to certain entertainment properties. CKx's primary asset was 19 Entertainment, which owned the rights to the number-one-rated television show "American Idol." In 2007, CKx's founder and largest stockholder, Robert Sillerman, sought to buy out the public stockholders for $13.75 per share. This buyout bid failed due to deteriorating credit conditions. Although the Sillerman bid failed, CKx still executed eight confidentiality agreements with strategic and private equity bidders that were interested in acquiring some interest in the company. In October 2010, CKx publicly announced that it was no longer discussing a potential sale and pursued potential acquisitions. Following the public announcement that CKx was no longer for sale, several private equity funds, including Apollo Global Management, Gores Group and Prometheus/Guggenheim expressed interest in CKx. In March 2011, Gores offered $4.75 per share, Guggenheim offered $4.50 per share and Apollo offered $5 per share.
The CKx board of directors decided to pursue a sale of the company again, but to do so expeditiously in order to avoid sending negative signals to the market or to distract management. The board retained Gleacher as its financial adviser. Gleacher ran an auction among interested buyers and solicited interest from third parties. Interested bidders would have three weeks to conduct due diligence and negotiate a transaction. Gleacher contacted other potential bidders, including three financial buyers and nine strategic buyers. The auction process came down to Apollo and one other bidder with Apollo submitting a bid of $5.50 per share and the other bidder submitting a bid of $5.60 per share. Although the Apollo bid was lower, the CKx board decided to accept it because the other bidder's financing was uncertain and Apollo's bid granted CKx the right to seek specific performance under certain circumstances. Class action litigation challenging the Apollo transaction ensued, but was settled for some additional disclosures and a slight modification to the termination fee. Petitioners sought appraisal of their CKx shares and the court held a three-day trial in March.
Petitioners' expert Robert Reilly utilized a discounted cash flow (DCF) analysis, a guideline publicly traded company method and a guideline merged and acquired company method to opine that the fair value of CKx was $11.50 per share. The respondent's expert, Jeffrey Cohen, utilized a DCF analysis to opine that the fair value of CKx was $4.41 per share. The primary difference between the two experts' analyses was their use of five-year cash flow projections prepared by management. The management projections included an assumption that the "American Idol" contract, which was in the process of being negotiated with Fox, would increase by approximately $20 million per year. Several CKx witnesses testified that the $20 million annual increase was an optimistic assessment of the likely outcome of the negotiations since the ratings for "American Idol" had been slipping since 2006. Fox had also indicated that it intended to negotiate reduced licensing payments. Cohen disregarded the forecasted $20 million increase in licensing fees, while Reilly relied on that forecasted increase of $20 million.
As in all appraisal actions, the court focused on the analyses performed by the parties' experts to determine the fair value of CKx. In determining fair value, a court must limit valuation of a company to its going concern and exclude speculative elements of value arising from accomplishment or expectation of the merger. The court may select one of the parties' valuation models or fashion its own valuation model to determine fair value. Delaware courts have relied on several techniques to determine fair value including the DCF approach and the comparable companies approach.
The court refused to rely on either of Reilly's guideline analyses. According to the court, none of the guideline companies used by Reilly were comparable to CKx. In fact, Reilly testified that he had found no companies he could describe as comparable to CKx. As far as the DCF analyses, the court concluded that both analyses were unreliable. The court noted that the reliability of a DCF analysis depends upon the reliability of the five-year cash flow projections used in the analysis. The court concluded that the management projections, which included a $20 million increase in licensing fees paid by Fox, were not reliable. In reaching this conclusion, the court emphasized that CKx witnesses had testified that the $20 million increase was a very optimistic assumption. The court also decided that Cohen's prediction that CKx would receive only marginal additional value from a new Fox contract was not reliable. It was possible the new contract could include variable fees tied to the show's financial performance or that there would be reimbursements to CKx for its contracts with Ryan Seacrest and others. The outcome of the contract negotiations with Fox was simply too uncertain for the court to use a DCF analysis in determining the fair value of CKx.
In the absence of comparable companies or transactions and without reliable projections for a DCF analysis, the court held that the merger price was the most reliable indicator of CKx's value. According to the court, the record reflected that the merger process was thorough, effective and free from self-interest or disloyalty. Thus, the court was comfortable in relying on the merger price as the primary factor determining fair value. The court recognized that the court had previously relied on merger price as the 100 percent indicator of fair value in Union Illinois 1995 Investment LP v. Union Financial Group Ltd., 847 A.2d 340 (Del. Ch. 2004). The court also noted that while there was Supreme Court precedent holding the Court of Chancery is not required to defer to merger price in an appraisal proceeding, there are no cases holding that the Court of Chancery can never rely on merger price. Because fair value under Section 262 cannot include synergies resulting from a merger, the court gave the parties the opportunity to supplement the record (if they wished to do so) with any evidence of synergies in the merger price.
As this case reflects, expert analyses are usually critical to the court's determination of fair value in the appraisal context. The significance and uncertainty of CKx's "American Idol" negotiations with Fox made this one of the unusual appraisal actions where typically used appraisal methods were not reliable. The lack of a controlling CKx stockholder and the auction process made the merger price a more reliable indicator of fair value than it might be under other circumstances. While practitioners cannot depend on this decision to argue that merger price is always a reliable indicator of fair value in the appraisal context, they may be able to use it in the unusual situation where other valuation methodologies are unreliable and the merger process appears effective.