In In Re Appraisal of Dell, C.A. No. 9322-VCL, (Del. Ch. May 31, 2016), stockholders of Dell Inc. (“Dell”) sought appraisal of their shares in connection with Dell’s 2013 “go-private” merger. Vice Chancellor Laster of the Delaware Court of Chancery held that the fair value of the Dell’s common stock at the effective time of the merger was $17.62, approximately a 28% premium over the final merger consideration of $13.75 per share. In making its determination, the court rejected Dell’s contention that the negotiated merger consideration was the best evidence of Dell’s fair value and held that the Dell was sold for too little and that the concept of fair value under Delaware law is not equivalent to the economic concept of fair market value.
In 2013, Dell completed a merger that was structured as a management buyout (“MBO”) and sponsored by Michael Dell, the founder and CEO of Dell, and Silver Lake Partners, a private equity firm. Dissenting stockholders brought an appraisal action. Dell contended that deal price was the best evidence of its fair value. Noting that Delaware courts have long considered deal price in appraisal proceedings, the court found that it was a relevant factor, but not the best evidence of Dell’s fair value in this case. Rejecting the argument that the value of a target company in an M&A deal could always be readily be ascertained by reference to the actual purchase price in the transaction, the court identified three factors that could cause the agreed-upon merger consideration to differ from the intrinsic value of the target company’s stock, even when the target is a public company. First, the merger consideration is typically determined at signing, while the fair value analysis takes place at closing. Significant changes in intrinsic value could take place between the signing and closing dates, particularly if there is a long gap to accommodate stockholder votes or regulatory approvals. Second, unlike the market for public securities, the deal market for M&A transactions involves very few buyers and only one seller, and involves disclosure of non-public information. Thus, the M&A market is not as well-informed or as efficient as the public stock market. Third, the merger consideration may be based in part upon synergies between the buyer and the target company, not upon the true value per share to the stockholders of the target company. The court noted that synergy value should therefore be excluded from the fair value analysis. The court also distinguished between the determination of whether directors satisfied their fiduciary duties in an M&A setting and the determination of fair value for purposes of appraisal: “it is entirely possible that the decisions made during a sale process could fall within Revlon’s range of reasonableness,” and “yet still generate a sub-optimal process for purposes of an appraisal.”
Despite stating that Dell’s sale process would easily pass an enhanced scrutiny review, because the Dell directors sought to obtain the best value reasonably available for the company’s stockholders, the court found that the sale process functioned imperfectly as a retroactive value discovery tool, both during the pre-signing and post-signing phases. Historically, courts have closely examined transaction fairness in the context of MBOs, because they inherently involve buyers inside the target company with access to material non-public information and the ability to arrange transactions with advantageous timing. Here, the court acknowledged that a careful review of the board’s actions was necessary, and praised the board’s efforts during the sale process, but stressed that a procedural fairness test is entirely distinct from the outcome-based test of fair value in an appraisal proceeding. The fact that the directors sought to obtain the best possible price per share, and took procedural steps that would shield them from liability for breaches of fiduciary duty even in the MBO context, did not have any bearing on whether the per-share merger consideration in the deal actually reflected the true value of the shares at the time of the merger. In the pre-signing phase, three factors undermined Dell’s argument that the final merger consideration was the evidence of fair value.
The first factor was the use of a leveraged buyout (“LBO”) pricing model. “The fact that a board has extracted the most that a particular buyer (or type of buyer) will pay does not mean that the result constitutes fair value.” In this case, the special committee only engaged with financial sponsors in the pre-signing phase. The court found that the factual record demonstrated that the price negotiations during the pre-signing phase were driven by the financial sponsors’ willingness to pay based on their LBO pricing models, rather than Dell’s fair value. Financial sponsors using an LBO model were constrained by their internal rate of return requirements and Dell’s inability to support the necessary levels of leverage.
The second factor was the “widespread and compelling evidence of a valuation gap between the market’s perception and [Dell’s] operative reality.” Specifically, the court stated that proposing a MBO when the stock price is low has the effect of using the depressed stock price to anchor price negotiations, and when combined with market myopia, makes the process intuitively more likely to generate an undervalued bid. Thus, the court found that the evidence established the existence of a significant valuation gap between the market price of Dell’s common stock and its intrinsic value.
The third factor undermining Dell’s argument was the lack of meaningful price competition, despite the inclusion of a 45-day go-shop provision (in addition to other structural features that made it possible to achieve excluded party status) in the merger agreement. The court noted that go-shop provisions in MBO transactions rarely produce topping bids, so the bulk of any price competition occurs before the deal is signed. In this particular case, expert testimony revealed that there was literally no precedent of topping bids having occurred during a go-shop period for a company as large and complex as Dell. The record established that the special committee did not contact any strategic buyers and only engaged with two financial sponsors, with one of them dropping out after providing its initial expression of interest. Without a meaningful source of competition, the court reasoned, the special committee “lacked the most powerful tool that a seller can use to extract a portion of the bidder’s anticipated surplus.”
The court also found that the post-signing phase of the sale process functioned inadequately for purposes of price discovery. Here, the special committee’s second financial advisor conducted a go-shop bid solicitation process. The court stated that although this resulted in an increase in the amount of consideration that stockholders received, this did not establish that the stockholders received fair value. Rather, it only demonstrated “that the stockholders received an amount closer to the highest price that a bidder whose valuation was derived from and dependent on an LBO model was willing to pay.” The court concluded that, given the evidence that the pre-signing phase did not generate a price equal to fair value, and in light of the nature of the competition that took place during the go-shop phase, a “2% [increase] was not sufficient to prove that the final merger consideration was the best evidence of fair value.”
Finding that Dell did not establish that the outcome of the sale process offered the most reliable evidence of its value as a going concern, the court instead used the discounted cash flow (“DCF”) method to derive the fair value of Dell. Because the mandate to determine fair value rests with the court, each party to the transaction has an equal burden of proof to show that their valuation, and the methodology used to achieve it, is correct. The court has discretion to select a valuation methodology of its choosing, either from the options presented by the parties or in its own discretion. Here, the court stated that “[t]he DCF . . . methodology has featured prominently in this Court because it is the approach that merits the greatest confidence within the financial community.” Although the DCF methodology is well established, the court noted that the parties’ respective DCF analyses, offered by expert testimony, differed wildly in their conclusions. The petitioners’ DCF valuation came in at $28.61 per share, while the Company’s was only $12.68 per share — an aggregate difference of approximately $28 billion. After adjusting each party’s valuation analysis for certain tax liabilities, costs, debt to equity ratio, and other factors, the court arrived at revised DCF valuations of $18.81 and $16.43, respectively. Because each party bears an equal burden of proof for determination of fair value, the court averaged these two figures to conclude that the Dell’s fair value on the closing date was $17.62 per share, approximately 28% higher than the $13.75 final merger consideration received by non-dissenting stockholders. The court reiterated that it declined to take into account the actual merger consideration, and relied solely on the DCF valuation methodology to arrive at its conclusion.