Delaware law has long made clear that the price established for a company in a market transaction, while a relevant factor, does not necessarily equate to the fair value that shareholder claimants are entitled to receive in an appraisal proceeding. But a series of more recent decisions in the Delaware Court of Chancery reinforced the view that the market value for a company set in an arm's-length transaction, achieved by a thorough sale process, usually represents the best evidence of fair value. Vice Chancellor J. Travis Laster's May 31 decision, In re Appraisal of Dell, C.A. No. 9522-VCL (Del.Ch. May 31, 2016), provides a sharp reminder of the limits of market price as an indicator of fair value when the transaction involves a leveraged management buyout (MBO), even one resulting from a careful sales effort free of any fiduciary breach.
As Dell makes clear, appraisal claimants in transactions involving inherent conflicts of interest (including an MBO) or an unreliable sales process, or both, will have an excellent opportunity to persuade the court that fair value exceeds the transaction price. The Dell decision affirms the primacy of the court's role in making such determinations in MBO and other conflict transactions. Left unresolved is what effect this will have on the structuring of such transactions and the criteria to which deal participants and their fiduciaries may turn to be confident they have captured fair value.
On Oct. 29, 2013, Dell effected a going-private merger resulting in a management buyout group led by Silver Lake and Michael Dell, the company's founder, chairman and CEO, acquiring the shares held by Dell's public shareholders. Dell was a difficult company to value as it was in the midst of executing a business plan that would transform it from a primarily personal computer company selling to end-users into an integrated company with substantial additional business lines selling software and services to enterprise customers. During the first half of 2012, Dell's stock declined from a high of $18/share to $12/share, as the market doubted Dell's plan or its ability to execute it successfully. The merger followed a lengthy process begun in August 2012 when Michael Dell was invited to participate in an MBO and so advised Dell's board. The appointment of a strong independent committee, well-advised by sophisticated legal and financial advisers followed. The committee led a sales-negotiation process which the court acknowledged "easily would sail through if reviewed under enhanced scrutiny." The sale process attracted interest from leading financial buyers and sought to garner the interest of strategic buyers. The merger agreement initially reached with the Silver Lake buyout group at $13.65/share included a 45-day go-shop provision and modest deal protections. During the go-shop period, the committee solicited the interest of HP and other strategics; Blackstone invested substantial resources analyzing the deal; and Carl Icahn ultimately surfaced to oppose the merger and to propose an alternate leveraged recapitalization. HP chose not to pursue a transaction, and Blackstone dropped out of the bidding process citing a rapidly eroding financial profile for Dell inconsistent with management's projections. Icahn eventually withdrew his opposition to the merger and plan to seek appraisal after his and other shareholder opposition led to a 2 percent price bump.
As the best evidence of the company's fair value, the company relied heavily on the sale process and the final merger consideration of $13.75 (plus a dividend of $0.13), which was corroborated by its expert's use of a DCF model indicating fair value of $12.68/share. The petitioner contended the MBO sale process was flawed and relied on an expert's DCF model to contend the company had a fair value of $28.61.
The court appraised the company at $17.62/share, an increase of approximately 28 percent above the final merger price. The court arrived at the value by relying primarily on modifications to the company's DCF model. Acknowledging that the final merger price was a relevant factor, the court nonetheless found that it was not the best evidence of the company's fair value for several reasons.
First, the mere fact that the process followed by Dell met fiduciary standards did not equate to fair value. Second, the court determined that a number of factors undermined the reliability of the merger price as evidence of fair value:
• The pre-signing phase had limited competition when the presence of a realistic threat of competition during this period is most important in driving up the price.
• The bidders relied on an LBO pricing model that is designed to set a price based on the buyer achieving a minimum internal rate of return on its invested equity rather than a price based on the present value of the firm as a going concern.
• There existed a valuation gap between the market's perception of Dell and the company's operative reality.
• Even when the company's stock was trading at $9 to $10/share in October 2012 and Dell was out of favor with analysts, Dell's management projections and financial advisers generated valuations ranging from $14 to $27/share.
• The post-signing go-shop phase failed to cure the lack of pre-signing competition and this, along with other structural limitations in the go-shop process, failed to achieve fair value even with the 2 percent price increase that resulted.
Finally, the court rejected the company's argument that another party would have topped the management bid if the company was actually worth more. The court agreed that a topping bid would likely have emerged had the disparity been as great as the petitioner alleged. Implicitly the court concluded that an underpricing of 28 percent, representing almost $6 billion, was not a sufficient disparity to generate a topping bid given the economic and structural constraints of the go-shop provisions.
In the near term pending further appraisal decisions, advisers to parties in conflict transactions will struggle to structure such transactions in a way that will achieve fair value with some measure of confidence, and not result in an unexpected additional transaction expense. "Appraisal-out" conditions giving the buyer an out if appraisal demands exceed a certain percentage is one course, although such conditions threaten deal certainty and are disfavored by sellers.
In cases like Dell, where a process not susceptible to attack for breach of fiduciary duty fails to produce strategic bidders or sufficient competition at critical phases of the sales process, and where the financial bidders relied on an LBO pricing model, the independent committee may need to give greater consideration to just saying "no" and staying the course. The vice chancellor suggested as much when he noted that "as a practical matter, the committee negotiated without determining the value of its best alternative to a negotiated transaction."