Emphasizes, But Does Not Require, Deference to Deal Price in Appropriate Circumstances
On December 14, the Delaware Supreme Court reversed a Chancery Court decision that had found the “fair value” of Dell shares in the 2013 MBO by Michael Dell and Silver Lake to be about 28% more than the final negotiated deal price. The Supreme Court found instead that, based on the facts in the record with respect to the company and the transaction process, the deal price “deserved heavy, if not dispositive weight.”
Dell is the second recent reversal of a Chancery Court appraisal ruling for failure to give sufficient weight to a deal price resulting from a fair process. In Dell, the Supreme Court declined (again) to establish a rule requiring deference to the deal price in an appraisal contest. However, the Supreme Court emphasized the “long endorsed” efficient market hypothesis which, as described by the Supreme Court, “teaches that the price produced by an efficient market is generally a more reliable assessment of fair value than the view of a single analyst, especially an expert witness who caters her valuation to the litigation imperatives of a well-heeled client.”
The Chancery Court and Supreme Court opinions describe the market status of Dell and the chronology of the transaction and appraisal contest. Following are highlights from the Supreme Court opinion relating to the deal process.
Mr. Dell owned about 15% of Dell. After two PE firms discussed with him the potential for a MBO, he reached out to a third PE firm and, after getting positive feedback, informed the Board. The Board created a Special Committee of independent directors, with power to hire its own legal and financial advisors, and determined not to recommend that stockholders approve a transaction without a prior favorable recommendation from the Special Committee. Mr. Dell signed a confidentiality agreement that required him to “explore in good faith the possibility of working with any such potential counterparty or financing source” if requested by the Special Committee.
The Special Committee initially focused its efforts on two PE firms. Ultimately, the Special Committee recommended an offer by Mr. Dell and Silver Lake (the “Buyout Group”) that would cash out existing stockholders and result in a company owned 74.9% by Mr. Dell, 25.1% by Silver Lake. Mr. Dell agreed to vote his shares in proportion to the number of unaffiliated shares that voted for either a superior proposal or adoption of a merger agreement if the Board changed its recommendation.
The merger agreement provided an active go-shop period of 45 days, with a one-time match right for the buyer. One of the Special Committee’s financial advisors (who was to receive a contingency fee if a deal arose during the go-shop) led the process, contacting 67 companies, including 20 strategic buyers. Several potential buyers responded. One PE firm demanded as a condition to proceeding with due diligence that Dell reimburse it for its diligence costs, which Dell agreed to do, to a maximum of $25 million, and Dell also agreed to do so for another bidder as well as the Buyout Group.
Ultimately, one other bidder made and pursued a proposal. The Buyout Group in turn raised its price, but also required the Special Committee to agree to lower the shareholder approval threshold to a majority of the unaffiliated shares voting, rather than a majority of the unaffiliated shares outstanding. The merger agreement was approved by 57% of all shares (70% of those present).
The Chancery Court, in its decision, generally commended the Special Committee’s process, concluding that it “easily would sail through … enhanced scrutiny review” of the directors’ fiduciary duties. However, after reviewing potential issues with using the deal price to indicate “fair value” in an appraisal, the Chancery Court elected to give no weight to the deal price and relied instead entirely on its own valuation (by discounted cash flow analysis).
Supreme Court Analysis
The Supreme Court noted that the Delaware corporate statute requires the court in an appraisal proceeding to consider “all relevant factors,” and accordingly prevents the adoption of a presumption that, under some circumstances, deal price reflects fair value. However, the Supreme Court rejected the Chancery Court’s reasons in the instant case for giving no weight to the deal price.
1. “Investor Myopia” and a “Valuation Gap”. The Chancery Court had concluded that “investor myopia” and focus on short-term profit had created a “valuation gap” between the market price for Dell shares and its intrinsic value. The Supreme Court found no indication of such a gap, pointing to lack of indication that Dell “lacked a vast and diffuse base of public stockholders, that information … was sparse or restricted, that there was not an active trading market …, or that Dell had a controlling stockholder,” that “the market … lacked any of the hallmarks of an efficient market,” or that “information failed to flow freely or that management purposefully tempered investors’ expectations….” The Supreme Court found instead that investors “understood” Dell’s long-range plans, but “weren’t buying Mr. Dell’s story.”
2. Lack of Strategic Bidders and the LBO Pricing Model. The Chancery Court believed that the PE firms that participated in the process were focused on their internal rate of return and ability to pay, as reflected in a LBO pricing model, rather than on Dell’s intrinsic value. The Supreme Court noted that the Special Committee’s financial advisor concluded initially that no strategic bidder was likely to make an offer and later, given leaks, that any serious strategic bidders could have approached Dell. The Supreme Court also noted that the Special Committee had reached out to strategic bidders as part of the go-shop, even though none had pursued the company, and had used its “power to say no” to force increases from the initial PE firm several times. The Supreme Court also found that the 45-day go-shop afforded potential bidders “enough” time to decide whether to submit a proposal that would allow them to continue in the process.
3. MBO Features. The Supreme Court found that several potential aspects of an MBO that could undermine the probative value of a deal price were not present in the Dell MBO.
- The “size and complexity” that the Chancery Court had identified as the source of the “main structural problem” with the go-shop was a characteristic of Dell, rather than of the MBO structure. Rival bidders had participated in the go-shop and had a “realistic pathway to succeeding.” There was no evidence that Dell management was critical to the potential rival bidders, given the bidders’ doubts about Mr. Dell’s leadership and willingness to consider transactions without him.
- The threat of a “winner’s curse” reflecting an information disparity that discouraged rival bidders from trying to outbid management was mitigated through a due diligence process where potential buyers had access to all necessary information, with cooperation from Mr. Dell.
- Evidence did not support management’s inherent value to the company, given that the market did not give weight to Mr. Dell’s “lengthy efforts to convince it of [Dell’s] bright future” and that there was no evidence he would have stopped serving if another bidder had prevailed. Mr. Dell also had agreed to explore alternative deals with other parties if requested by the Special Committee, and showed such good faith during the go-shop.
Supreme Court Order
The Supreme Court declined to order the Chancery Court to use the deal price in subsequent proceedings, but gave the Chancery Court “discretion” to do so, with no further proceedings, and required that any weighing of factors be explained based on reasoning “consistent with the record and with relevant, accepted financial principles.”
The Supreme Court concluded that “when the evidence of market efficiency, fair play, low barriers to entry, outreach to all logical buyers, and the chance for any topping bidder to have the support of Mr. Dell’s own votes is so compelling, then failure to give the resulting price heavy weight because the trial judge believes there was mispricing missed by all the Dell stockholders, analysts, and potential buyers abuses even the wide discretion afforded the Court of Chancery in these difficult cases.”
The Supreme Court’s ruling is not likely to eliminate, but may temper, the current level of appraisal demands. Plaintiffs have been pursuing appraisal claims aggressively, and still may argue for consideration of factors beyond the deal price, particularly in situations where the efficiency of the target company’s trading market or the deal process can be challenged. In particular, plaintiffs may look for transactions that do not have the aspects cited by the Supreme Court, such as an active trading market, the lack of a controlling stockholder or the level of cooperation by Mr. Dell, but they will need to consider all relevant factors in context. In any event, they will need to be able to provide the court with a reasoned explanation for departing from the market result.