June 3, 2016
On May 31, 2016, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery issued his much-anticipated merits opinion in In re: Appraisal of Dell Inc., C.A. No. 9322-VCL, a statutory appraisal action arising from the 2013 management-led buyout of Dell Inc. In the opinion, Vice Chancellor Laster determined that Dell Inc.’s fair value as of the date of the transaction was $17.62 per share–approximately 28% higher than the $13.75 per share transaction price approved by Dell Inc.’s stockholders. In contrast to several recent appraisal decisions by the Court of Chancery, Vice Chancellor Laster declined to give significant weight to the transaction price in his determination of Dell Inc.’s fair value.
Although Vice Chancellor Laster recognized that the transaction price can be a relevant factor when determining fair value, he determined that, under the facts of this case, "a combination of factors undercut the relationship between the [transaction price] and fair value, undermining the persuasiveness of the former as evidence of the latter." These factors included, in the Court’s view, (i) the use of a leveraged buyout pricing model to determine the transaction price, "which had the effect in this case of undervaluing the Company," (ii) the evidence of a "valuation gap" between the trading price of Dell Inc.’s stock and the Company’s operative reality, "driven by the market’s short-term focus," and (iii) the lack of meaningful competition among bidders before the merger agreement was signed.
Vice Chancellor Laster further noted that, although Dell Inc. conducted a go-shop after the merger agreement was signed, it was not sufficient to ensure that the transaction price provided fair value. In particular, Vice Chancellor Laster observed that although the go-shop generated two higher indications of interest for the Company, it ultimately resulted in only a 2% price increase for Dell Inc.’s stockholders. Additionally, Dell’s large size–approximately 25 times larger than any other "jumped" deal–made a topping bid unlikely. Finally, the Court expressed its view that Michael Dell’s superior knowledge of and unique value to the Company created information asymmetries and other potential impediments to competing bidders.
In view of these factors, Vice Chancellor Laster concluded that Dell Inc. "did not establish that the outcome of the sale process offers the most reliable evidence of the Company’s value as a going-concern." The market data was sufficient, however, "to exclude the possibility, advocated by the petitioners’ expert, that the Merger undervalued the company by $23 billion." Accordingly, based on the results of a discounted cash flow analysis, Vice Chancellor Laster determined that Dell Inc.’s fair value was $17.62 per share, or approximately $31 billion. For comparison, the $13.75 per share transaction price valued Dell Inc. at approximately $25 billion. The petitioners’ expert opined that Dell Inc. was worth approximately $48 billion.
This decision should not be read as a rejection of judicial consideration of–or even deference to–the transaction price in appraisal proceedings. Indeed, Vice Chancellor Laster acknowledged that the Court of Chancery repeatedly "has found the deal price to be the most reliable indicator of the company’s fair value, particularly when other evidence of fair value was weak." However, Vice Chancellor Laster went to great lengths to distinguish the Dell Inc. transaction from those in which the Court of Chancery deferred to the deal price in subsequent appraisal proceedings. In the Court’s view, distinguishing factors included the transaction’s status as a management-led buyout, rather than an arm’s-length, third-party merger; the Special Committee’s decision not to contact any potential strategic bidders; and the size of the transaction.
This decision has conflicting implications for the growing appraisal arbitrage trend. On one hand, the decision will probably further encourage appraisal arbitrage in the context of management-led buyouts, which are more likely to involve the circumstances Vice Chancellor Laster concluded undercut the reliability of the transaction price as an indicator of fair value. On the other hand, the decision should serve as a warning to appraisal petitioners who–as Vice Chancellor Laster recognized in his opinion–frequently submit expert testimony that the subject company is worth more than double the transaction price. Vice Chancellor Laster agreed with Dell Inc. that it was "counterintuitive and illogical–to the point of being incredible–to think that another party would not have topped [the buyout group] if the Company was actually worth" $28.61 per share, the valuation petitioners’ expert advanced. Rather, where a transaction results from a credible process free from any fiduciary breaches, the evidence likely will not support a valuation gap of the magnitude typically proffered by petitioners in appraisal proceedings.
The decision has implications for dealmakers, as well. In view of Vice Chancellor Laster’s conclusion that the use of a leveraged buyout pricing model to determine the transaction price "had the effect of undervaluing the company," boards, special committees, and their advisors faced with bids from financial sponsors should take care to consider multiple valuation methodologies and determine the fairness of the proposed transaction independent of any leveraged buyout analysis. Additionally, the decision serves as a reminder that go-shops will not necessarily provide a sufficient market check to justify deference to the transaction price in a subsequent appraisal proceeding. Even though Vice Chancellor Laster noted that Dell Inc.’s go-shop was "relatively open" and "flexible," he nonetheless concluded that other factors precluded a finding that the go-shop "in fact generated a price that persuasively established the Company’s fair value."
The following Gibson Dunn lawyers assisted in preparing this client update: Stephen Glover, Eduardo Gallardo, Meryl Young, Adam Offenhartz, Aric Wu and Colin Davis.
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