On August 1, 2017, the Delaware Supreme Court, in an opinion by Chief Justice Leo E. Strine, Jr., reversed and remanded an appraisal ruling that had determined the buyout of DFC Global Corporation (“DFC”) by private equity investor Lone Star at $9.50 per share significantly undervalued the stock of DFC. DFC Global Corp. v. Muirfield Value Partners, L.P., No. 518, 2016 (Del. Aug. 1, 2017). The Court of Chancery had calculated a fair value of $10.30 per share, 8.4% higher than the deal price of $9.50 per share, by giving equal weight to: (1) the deal price, (2) a comparable companies analysis, and (3) a discounted cash flow analysis. The Delaware Supreme Court found that the Court of Chancery’s valuation methods were unsupported by the record, which revealed (a) a fair, non-conflicted sale process with a robust market check, (b) debt markets expressing bearish views of DFC’s prospects, and (c) that DFC failed to meet its projections before the deal closed, all of which suggested that the deal price was likely the “most reliable indication of fair value.” The Court, however, expressly rejected the approach urged by DFC: a blanket presumption in favor of the deal price for arm’s-length transactions that were subjected to a robust market check.
According to the Court, before agreeing to the Lone Star transaction, payday lender DFC faced increased regulatory scrutiny and spent two years exploring a sale, reaching out to over 30 potential buyers, none of which decided to move forward. The company also tried to raise money through a $600 million refinancing, which was cancelled because DFC’s “uncertain financial condition” discouraged potential investors. Eventually, after other potential buyers dropped out due to regulatory uncertainty and DFC’s downward revisions of its own financial projections, DFC agreed to be acquired by Lone Star on April 1, 2014 for $9.50 per share. Between that date and closing on June 13, 2014, DFC failed to meet its already-lowered financial projections.
The Court of Chancery, in a decision by Chancellor Andre G. Bouchard, acknowledged that the deal price resulted from a fair, “arms-length” sale process, but found that the inherent difficulty in pricing DFC’s regulatory risk and Lone Star’s position as a private equity investor indicated that the deal price did not adequately reflect the fair value. The Court of Chancery instead calculated fair value by taking the average of (1) a modified version of the discounted cash flow analysis offered by petitioners’ expert ($13.10 per share), (2) the comparable companies analysis offered by DFC’s expert ($7.81 per share), and (3) the deal price of $9.50 per share. Giving each of these values equal weight, the Court of Chancery determined fair value to be $10.30 per share.
Reversing the Court of Chancery, the Delaware Supreme Court criticized courts’ tendency, “[w]hen faced with briefs and expert reports written by highly-skilled litigators in concert with [valuation experts] that often come to ridiculously varying positions,” to “take[ ] every valuation method put in the record, give[ ] each equal weight, and then divide[ ] by the number of them,” as the Court of Chancery did here. Instead, courts must “explain[ ], with reference to the economic facts before it and corporate finance principles, why it is according a certain weight to a certain indicator of value.” Here, “economic principles suggest that the best evidence of fair value was the deal price, as it resulted from an open process, informed by robust public information, and easy access to deeper, non-public information, in which many parties with an incentive to profit had a chance to bid.” As for the supposed difficulty in pricing regulatory uncertainty and Lone Star’s status as a private equity investor, which the Court of Chancery cited as grounds for questioning the deal price, the Court found that “the collective judgment” of investors and prospective buyers regarding regulatory risk “is more likely to be accurate than any individual’s guess,” and rejected the notion that a private equity buyer’s price does not reliably represent fair value (the so-called “private equity carve out”) as “not . . . grounded in economic literature or this record.”
At the same time, the Court rejected DFC’s suggestion that the Court craft a rule that presumes the deal price reflects fair value whenever it is the product of an arm’s-length deal subject to a market check. The Court explained that such a bright-line rule is incompatible with the statutory text, which requires courts to consider “all relevant factors” when determining fair value. 8 Del. C. § 262(h). Nonetheless, the Court emphasized that its “refusal to craft a statutory presumption in favor of the deal price when certain conditions pertain does not in any way signal our ignorance to the economic reality 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.” Applying these principles to this case, the Court directed that:
On remand, the Chancellor should reassess the weight he chooses to afford various factors potentially relevant to fair value, and he may conclude that his findings regarding the competitive process leading to the transaction, when considered in light of other relevant factors, such as the views of the debt markets regarding the company’s expected performance and the failure of the company to meet its revised projections, suggest that the deal price was the most reliable indication of fair value.
Thus, even though the Court declined to adopt a general presumption in favor of the deal price in appraisal matters, the Court’s decision signals that, going forward, Delaware courts are likely to give greater consideration to the deal price where the record shows that the transaction resulted from an arm’s-length, competitive, and fair sale process.
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