Recent rulings issued by the Delaware Chancery Court in two appraisal cases handed wins to the defendant companies, reflecting at least some degree of temperance within the Delaware Chancery and potentially stemming the tide of decisions that favored appraisal petitioners. These decisions, issued while the Dell and DFC Global appraisal decisions (in which the Chancery Court found that the statutory “fair value” of the stocks significantly exceeded the deal price) are before the Delaware Supreme Court, represent significant victories for the defendant companies and a warning to stockholders willing to gamble on a costly appraisal action.
On May 26, 2017, Vice Chancellor Joseph R. Slights III “deferred” to the deal price as the fair value of PetSmart, Inc. (“PetSmart”) stock in an appraisal action brought challenging the company’s acquisition by private equity sponsor BC Partners, Inc. (“BCP”). In re Appraisal of PetSmart, Inc., No. 10782-VCS (Del. Ch. May 27, 2017). Citing “a robust pre-signing auction among informed and motivated bidders,” the Court rejected petitioners’ discounted cash flow (“DCF”) analysis because it failed to provide “a reliable measure of fair value.” Days later, on May 30, Vice Chancellor Sam Glasscock III issued an unusual decision in an appraisal action against SWS Group Inc. (“SWS”), finding that the fair value of the stock was approximately 7.8 percent below the merger price. In re Appraisal of SWS Group, Inc., C.A. No. 12717-VCG (Del. Ch. May 30, 2017) (“SWS”). The Court emphasized that, even though merger price is typically the best indicator of fair value, the synergistic values accounted for in SWS’s merger with a Hilltop Holdings, Inc. affiliate (“Hilltop”) had to be omitted from a fair value calculation.
In PetSmart, large stockholders pressured the company to pursue strategic alternatives after disappointing financial results caused a stock drop. PetSmart engaged a financial advisor to conduct an auction process involving 27 potential bidders and ultimately agreed to a leveraged buyout with BCP for $83 per share in cash, which was overwhelmingly approved by stockholders. Petitioners, holding approximately 11 percent of PetSmart’s outstanding stock, invoked their appraisal rights and argued at trial that the fair value of PetSmart was $129 per share, relying on a DCF analysis that used PetSmart management’s long-term performance projections. Petitioners claimed that the deal price was unreliable because (i) bids were restricted by a seized credit market, (ii) the models used by the acquirers were inappropriate, (iii) a lack of strategic bidders undermined the reliability of the deal price, and (iv) the advisor’s relationships with certain bidders created a conflict. PetSmart argued that deal price, which was derived from a well-run active auction that produced an arm’s-length sale to a third-party bidder, offered the best approximation of PetSmart’s fair value (and proffered a DCF analysis based on its financial advisor’s projections that aligned closely with the deal price).
The PetSmart court acknowledged that the two “most reliable means by which to determine fair value—deal price [and] a discounted cash flow analysis”—yielded vastly different valuations. After finding that PetSmart met its burden of demonstrating that the deal price was the result of a reasonably designed and properly implemented process to attain fair value, the Court examined the experts’ competing DCF valuations. VC Slights rejected as unreliable the projections used in petitioners’ DCF because PetSmart’s management had never made long-term projections until the board insisted that management provide optimistic forecasts with an eye towards sale. The Court found that PetSmart’s financial advisor’s projections, by contrast, fairly reflected management’s sales growth plan and were the most reliable projections in the record. Seeing no need for adjustments to the DCF inputs, the Court deemed the deal price to be fair value as of the time of closing.
The PetSmart decision’s deference to deal price was not replicated in SWS, however. In SWS, both sides argued that the merger price differed substantially from the fair value of the company’s stock. Both sides’ experts relied almost exclusively on DCF analyses to assert “fair values” of $9.61 per share (by petitioners) and $5.17 per share (by respondents). The Court observed that the merger price was, in part, driven by certain expected synergies that were “properly removed from the calculation of fair value.” The Court also noted that structural limitations unique to SWS and a “problematic [sale] process—including the probable effect on deal price of the existence of [a] Credit Agreement under which the acquirer exercised a partial veto power over competing offers”—rendered the deal price an inaccurate measure of fair value.
The Court performed an independent DCF analysis, using management’s projections, combining aspects of each party’s expert DCF analyses, and making several independent adjustments. Consistent with recent Chancery Court precedent, VC Glasscock used the supply-side equity risk premium endorsed by petitioners’ expert, rather than the historical equity risk premium proffered by respondents; the Court also deemed respondents’ beta inappropriate because it was calculated during a time when SWS’s stock price was impacted by volatility resulting from “merger froth.” The Court then calculated SWS’s size premium by considering both the public and private company traits. Ultimately, the Court concluded that SWS’s fair value was 7.8 percent lower than the merger price.
The PetSmart ruling reflects a departure from recent rulings in which the Delaware Chancery Court has rejected deal price as a poor indicator of fair value. The decision is particularly notable because it concerned a leveraged buyout by a private equity sponsor, a transaction structure that is often heavily scrutinized in appraisal actions (as compared to, for example, a strategic acquisition). The Court emphasized the robust auction process in PetSmart as a significant justification for its ruling. By contrast, in SWS, the Court cited the deal process as undercutting the deal price as an accurate measure of fair value. That decision serves as a cautionary tale to would-be appraisal petitioners, suggesting two important considerations in future appraisal actions: (i) where a stockholder challenges the adequacy of the deal process, such claims may not bolster a petitioner-friendly outcome in an appraisal action; and (ii) suits over transactions that place significant value on anticipated synergies present significant risk that the statutory fair value may well be less than the agreed-upon deal price.
Click here to view In re Appraisal of Petsmart, Inc.
Click here to view In re Appraisal of SWS Group, Inc.