In In re Appraisal of Dell, Inc., the Court of Chancery awarded an appraisal value of $17.62 after Dell Inc. completed a merger related to a management buyout (“MBO”). The awarded appraisal exceeded the agreed merger price by more than 25%.
Background. In late 2012, Dell explored the possibility of taking the company private by way of an MBO. Of three interested sponsors, two dropped out during negotiations, concluding that the PC business was too risky. After pushing the remaining sponsor to increase its price twice—and after the Dell CEO agreed to roll over his shares at a lower valuation than the public would receive—the Board agreed to a deal for $13.65 per share. Dell’s financial consultants contemporaneously agreed that the $13.65 price was fair to unaffiliated stockholders. After a go-shop period and early indications of stockholder opposition, the buyout group ultimately agreed to pay $13.96 per share.
The court explained at great length that, despite the fairly pristine process by which the Board achieved the merger price, the merger price was “not the best evidence of the Company’s fair value.” Instead, the court relied exclusively on a discounted cash flow (“DCF”) analysis, settling on the $17.62 price after first rejecting the plaintiff’s expert recommendation of $28.61 on the idea that a valuation of two times the Buyout Group’s price was implausible, and then averaging the two DCF models proposed by Dell’s expert after determining that one ($16.43) was “likely somewhat conservative” and the other ($18.81) was “likely somewhat optimistic.”
Significance. In the future, companies undergoing an MBO should expect to see this opinion cited heavily in appraisal actions. The court in Dell granted a premium over the merger price despite going out of its way to highlight the virtues of the Company’s negotiation process. The opinion suggests that, no matter the procedures followed, prices generated in the MBO context will be inherently suspicious and will lead to premiums in appraisal proceedings.
The court repeatedly explained that Dell acted properly, even commendably, in generating the merger price it did, noting that “the Company’s process would sail through if reviewed under enhanced scrutiny.” The Company “did many praiseworthy things” and the court “could not hold that the directors breached their fiduciary duties.”
Despite the notable care exercised by Dell in this merger, the court would not accept that the merger price was fair to unaffiliated shareholders precisely because it was negotiated as an MBO, which “present different concerns than true arms’ length transactions,” such that prices generated in MBO mergers would “be evaluated with greater thoroughness” than mergers stemming from unaffiliated strategic buyers.
Three factors informed the court’s view. First, the court found that the LBO pricing model used by all interested financial sponsors did not calculate “fair value” as a going concern. This was so despite the fact that no non-financial sponsors expressed interest in purchasing Dell.
Second, there was evidence of a substantial gap “between the market’s perception and the Company’s operative reality,” which apparently was not sufficiently explained by the premium paid over the market price of Dell stock. The court was concerned that, theoretically, management teams would be able to strategically time MBOs so as to deny unaffiliated shareholders as-yet unrealized returns on long-term investments. Yet, the court noted that there was no evidence that Dell here sought to create a valuation disconnect so they could take advantage of it. To the contrary, the court recognized that Dell “tried to convince the market that the Company was worth more” and only “[w]hen the gap persisted despite their efforts” did they consider an MBO.
Finally, the court found that a lack of pre-signing competition undercut the merger price as an indication of “fair value.” This was so despite the fact that the lack of competition was due to two financial sponsors dropping out during negotiations and despite the court noting that the merger agreement included an unusually flexible and open go-shop provision.
Going forward, this case suggests that even the most extensive procedures designed to insulate interested officers from negotiations and obtain the best value for a firm contemplating an MBO will not prevent courts from ordering a premium in appraisal proceedings. That, combined with the current interest rate environment, should encourage those considering appraisal litigation. In turn, one would expect the decision to increase the incentive for shareholders to object to MBO-related mergers.
In re Appraisal of Dell, Inc., C.A. No. 9322-VCL, in the Court of Chancery of the State of Delaware.