In DFC Global Corp. v Muirfield Value Partners, L.P. et al, the Delaware Supreme Court declined to adopt a presumption that in an arm’s length merger the deal price is the best estimate of fair value for purposes of an appraisal rights action. The Supreme Court also found the Chancery Court erred by not giving appropriate weight to the price paid by a private equity buyer because a sponsor focuses on achieving certain internal rates of return and on reaching a deal within its financing constraints.
DFC was a NASDAQ listed company in the pay day loan business. It had experienced rapid growth in the past and was relatively heavily leveraged. In more recent years, it faced a period of regulatory uncertainty resulting from the financial crisis.
Given the regulatory headwinds, the DFC Board hired a financial advisor to explore a sale. Initially the advisor contacted six private equity sponsors. None of the six sponsors, together with another party, decided to proceed with the transaction. Over the next year, the advisor reached out to 35 more private equity sponsors and three strategic buyers. Financial projections provided to the sponsors were revised and lowered during the sales process. Loan Star ultimately agreed to acquire the Company at $9.50 per share.
In determining fair value, the Court of Chancery, without appropriate supporting rational, gave equal weight to the deal price, a comparable companies analysis and a discounted cash flow analysis. The fair value determine by the Court of Chancery was $10.21 per share.
The Supreme Court declined to adopt a presumption that the transaction price was the best estimate of fair value because it would be contrary to the Delaware appraisal statute. Simply put, the appraisal statute requires the court to consider “all relevant factors” and a presumption would be contrary to the statutory command. It would also be contrary to controlling precedent, as established in Golden Telecom, Inc. v. Glob. GT LP and elsewhere. The Supreme Court noted however that the sale value resulting from a robust market check “will often be the most reliable evidence of fair value and that second-guessing the value arrived upon by the collective views of many sophisticated parties with a real stake in the matter is hazardous.”
The Supreme Court also rejected the Chancery Court’s finding that the deal price was unreliable because Lone Star, a private equity firm, required a specific rate of return on its transaction with DFC. The Supreme Court found that was illogical because all disciplined buyers, both strategic and financial, have internal rates of return that they expect in exchange for taking on the large risk of a merger, or for that matter, any sizeable investment of its capital. That a buyer focuses on hitting its internal rate of return has no rational connection to whether the price it pays as a result of a competitive process is a fair one. According to the Supreme Court, that was especially true here when there were no conflicts of interest and when there were objective factors that support the fairness of the price paid, including:
- the failure of other buyers to pursue the company when they had a free chance to do so;
- the unwillingness of lenders to lend to the buyers because of fears of being paid back;
- a credit rating agency putting the company’s long-term debt on negative credit watch; and
- the company’s failure to meet its own projections.
The Supreme Court also found untenable the idea that the deal price cannot be relied upon as a reliable indicia of fair value because lenders would not finance the acquisition by Lone Star at a higher price. Lenders get paid before equity. If lenders fear getting paid back, then that is not a reason to think that the equity is being undervalued.