In Koehler v. Netspend Holdings Inc., CA No. 8373-VCG (Del. Ch. May 21, 2013), Vice Chancellor Glasscock reviewed the sales process for an acquisition of Netspend by Total System Services, Inc., a strategic buyer, scheduled to close May 31, 2013. An eight-person board, with each member an independent director other than the CEO, approved the merger transaction; four of the directors were affiliated with Netspend‟s two largest stockholders. The record shows that the board was actively involved in the negotiation and strategy relating to the merger transaction, as well as earlier expressions of interest by potential buyers. The board had recent active interest from two private equity firms offering to purchase substantial blocks of stock from the two largest stockholders at a price significantly below the merger price. Those two private equity firms signed "don‟t ask, don‟t waive" standstills of one- and two-year durations in connection with their diligence relating to their potential investment, although the shareholders did not sell their stock to these firms in light of the merger discussions with Total Systems that commenced at about the same time as the private equity firms‟ indication of interest at the lower price. Earlier in 2012, the board had declined to pursue a merger of equals with another strategic buyer due to the board‟s view that Netspend‟s stock was undervalued and the strategic buyer‟s stock was overvalued, as well as a variety of other business risks. Thus, the board was aware of current market interest relating to the company and sophisticated in developing a strategy to maximize value.
In October 2012, Netspend was contacted by Total Systems about a possible change-of-control transaction. The board determined to pursue the opportunity while maintaining that the company was not for sale. The board contacted one strategic buyer who had a contractual right to notice, and who the board thought could be a credible buyer due to its size, financial capacity and strategic interest. That strategic buyer did not indicate any interest in a possible transaction with Netspend, and the board took that buyer‟s lack of interest as indicative of the marketplace‟s general lack of interest in Netspend. The board declined to grant exclusivity to Total Systems, but did not contact any other potential acquirors because of the risk of leaks and rumors regarding a potential sale of the company. The board tried for a go-shop provision in the draft merger agreement it prepared for Total Systems, but eventually gave this up in return for a significant increase in purchase price and a reduction in the termination fee. One condition of the transaction was the extension of an important commercial contract with a subsidiary controlled by one of the two large stockholders.
The board properly considered that special interest of that shareholder in approving the transaction. The board also reviewed the deal protection provisions, including a 3.9 percent termination fee, matching rights, a no-shop provision with a fiduciary out for a superior proposal, and voting agreements by the two major
holders covering 40 percent of the voting stock, with such agreements permitted to be terminated if the board terminated the merger agreement to accept a superior proposal. The merger agreement included a covenant not to waive existing standstill agreements. The board‟s negotiations had increased the purchase price from $14.50 per share to $16 per share, a 45 percent premium to the stock price one week before the announcement.
Vice Chancellor Glasscock initially reviewed the Revlon standard applicable to this transaction, noting that directors "need not follow a particular path to maximize stockholder value, but the directors‟ path must be a reasonable exercise toward accomplishing that end." He explained that enhanced scrutiny under Revlon is a test of reasonableness, "which requires that the board be informed and that it construct a sales process to maximize value in light of that information." He noted that the directors have the burden of proving they were fully informed and acted reasonably. The Vice Chancellor observed that under Revlon, the court is also required "to scrutinize the board‟s true intentions to determine if the board is acting with the best interests of the stockholders in mind."
Enhanced scrutiny under Revlon is a test of reasonableness, "which requires that the board be informed and that it construct a sales process to maximize value in light of that information."
The Vice Chancellor noted that the stock ownership attributed to four of the directors was not a conflict in this case, but rather an indication that those directors were aligned with the interests of stockholders generally. This is an interesting perspective in light of a few recent cases in which directors representing large stockholders were viewed with suspicion. See e.g.
In re Answers Corp. S‟holder Litig., C.A. No. 6170-VCN (Del. Ch. Apr. 11, 2012). The Vice Chancellor noted that the facts in this case demonstrated that one of the major stockholders had abandoned the sale of its stock to the private equity buyers in favor of a higher price in the merger, despite the fact that the merger transaction would be at a higher tax rate, and the other stockholder had engaged in a distribution of stock to its investors, and therefore he found that neither director had conflicts due to the stockholders‟ ownership or interests. Similarly, the Vice Chancellor found that the CEO‟s interests were aligned in achieving the highest price for stockholders, and that even if he were conflicted, the majority of directors were motivated by achieving the highest price reasonably available.
The Vice Chancellor nevertheless expressed significant criticism over a few aspects of the board‟s process, derived from the fact that this transaction was a "single bidder" transaction without a pre-signing market check of other likely bidders. He found that "in forgoing a pre- Agreement market check, and relying on an ambiguous fairness opinion, the Board had to be particularly scrupulous in ensuring a process to adequately inform itself that it had achieved the best price." He initially expressed concern over the lack of a go-shop clause, although he eventually found that the board had acted reasonably in giving up the go-shop provision in exchange for more value. He also criticized a weak banker opinion and the "don‟t ask, don‟t waive" provisions in the standstill and merger agreement. The "don‟t ask don‟t waive" provisions seemed particularly troublesome to the Vice Chancellor, as he observed that the private equity firms had just completed diligence and had expressed an interest in buying substantial blocks at $12 per share. The board never unilaterally waived these provisions and did not inquire as to the private equity firms‟ potential interest in an acquisition of the entire company despite their recently expressed interest. The Vice Chancellor concluded in light of these two process defects, the weak fairness opinion and these "don‟t ask, don‟t waive" provisions, that he could not find that the board was sufficiently informed to create a process to ensure the best price.
The Vice Chancellor carefully reviewed the case law regarding single-bidder situations in assessing the process here, and relied on distinctions between the information available to the boards in the prior cases versus the situation faced by the Netspend board. He noted that reliance on investment bankers has been deemed a "pale substitute" for a market check. The question was "whether the board had sufficient knowledge of the relevant markets and a body of reliable evidence to agree to the transaction without any market check." He noted that other cases involving single-bidder situations had reasonably long post-signing periods, and relatively mild deal protection. The Vice Chancellor found favorable facts here regarding the process, noting that the directors were "sophisticated professionals with extensive business and financial expertise," and "well informed about the process of selling the company and had engaged in prolonged negotiations" with other merger partners. He outlined the board‟s strategy to tell "would be acquirors that it was not for sale while intimating that it could be for sale for a high enough offer," and called it "a deliberate strategy to maximize value." The Vice Chancellor found this strategy to be within the range of actions a reasonable board could undertake to maximize shareholder value. He concluded that the initial decision to engage in a single-bidder process was reasonable.
Vice Chancellor Glasscock then explained that this conclusion that the decision to enter into the single-bidder process was reasonable did not end his analysis and that the board must produce a process reasonably designed to maximize price. He then reviewed the
banker‟s fairness opinion, and criticized the "weak" opinion in several important respects – first, although two of the five valuations were based on the price of Netspend‟s stock, the board had acknowledged that the stock price was not a good indicator of its value, as the board believed the stock to be undervalued. Second, the comparable companies used in the analysis were dissimilar to Netspend and the comparable transactions were quite old, so therefore neither the comparable companies analysis nor the comparable transactions were strong indications of Netspend‟s value. Thus he found four of the five valuation analyses flawed or unreliable, and the final valuation metric, the discounted cash flow valuation (DCF) analysis showed the Total Systems offer to be inadequate. The board argued that this analysis was based on five-year projections, and was therefore outside the range of management‟s customary three-year projections, making the analysis unreliable. The banker opinion was therefore not a strong substitute for valuation compared to the preferable market check, which the board had decided to forgo. Vice Chancellor Glasscock held that the directors‟ reliance on the fairness opinion was not a breach of their fiduciary duty, noting that directors relying on experts in good faith are fully protected. However, he observed that the board‟s reliance on a weak fairness opinion provided context for their other process decisions, and he noted that the fact that the fairness opinion was a poor substitute for a market check for value was available to the board when it approved the merger. He seemed to be suggesting that the board, faced with a weak fairness opinion, should have realized that it needed more current information about value in assessing whether the deal at hand was the best available price and terms.
The Vice Chancellor also reviewed the deal protection devices. The plaintiff conceded that the package of devices was "relatively mild and could be considered reasonable under different circumstances." Importantly, Vice Chancellor Glasscock concluded that the voting agreements, which were 40 percent of the outstanding stock, but which were terminable on a termination for a superior offer, posed no credible barrier to the emergence of a superior offer. He further held that the 3.9 percent termination fee ($53 million on a $1.4 billion deal) was within the range of termination fees held to be reasonable in the past and would not deter a serious bidder.
The Vice Chancellor discussed the board‟s decision to forgo the go-shop and to agree to the no-shop after extracting further consideration from the buyer in an increased purchase price and lower termination fee. He noted that this decision was not unreasonable. However, he also pointed out that the board expected a short period before the deal‟s consummation and therefore was not counting on a leisurely post-signing market check, so important in earlier single-bidder deals. The Vice Chancellor also noted that the "don‟t ask, don‟t waive" provisions prevented the private equity buyers from bidding. It is particularly noteworthy that the Vice Chancellor was troubled by the fact that the record does not show that the board even considered whether the standstills should remain in place once it started negotiating with Total Systems, which he observed "would have been the ideal time to waive" those clauses. Whether or not the proper time to waive these standstills was during the ongoing negotiation with Total Systems, or rather only after an agreement had been signed, the ultimate and defining issue in this case is that the board never considered the matter as part of its value-maximizing strategy. The Vice Chancellor observed: "[t]he record suggests that the Board did not consider, or did not understand, the import of the ["don‟t ask, don‟t waive"] clauses..." As one would expect, Netspend argued that it did not believe that either private equity firm was interested in bidding for Netspend, but the Vice Chancellor rejected this argument completely, stating that "Netspend cannot have known with certainty that those entities are uninterested in Netspend." Interestingly, the Vice Chancellor enjoined those clauses for each of the private equity firms at oral argument, and neither private equity firm expressed any indication of interest through the date of his opinion.
In summary, Vice Chancellor Glasscock concluded that it was reasonably likely that the Netspend board would fail to meet their burden at trial in proving that they acted reasonably to maximize share price in light of the following:
- the lack of a market check
- the board‟s reliance on a weak fairness opinion
- the "don‟t ask, don‟t waive" provisions, and the remainder of the deal lockup provisions
- the lack of an anticipated leisurely post-agreement process giving other suitors the opportunity to appear
As noted above, and instructively for boards engaged in processes in the future, the Vice Chancellor focused particularly on the failure to waive the "don‟t ask, don‟t waive" provisions and the board‟s seeming lack of understanding as to the effect these provisions would have on those potential bidders‟ ability to make any expression of interest post-signing. He concluded that the board simply did not satisfy its burden of showing that it acted reasonably in developing a process in this single-bidder setting to show that it was maximizing value.
The Vice Chancellor focused particularly on the failure to waive the "don‟t ask, don‟t waive" provisions and the board‟s seeming lack of understanding as to the effect these provisions would have on those potential bidders‟ ability to make any expression of interest post-signing.
Although the Vice Chancellor also concluded that the plaintiff faced irreparable harm in the absence of an injunction, he nevertheless declined to enjoin the transaction. He explained that the plaintiff "bears the burden of showing that the magnitude of the harm absent an injunction exceeds the potential harm of an injunction" and noted that the court is generally reluctant to enjoin a transaction that affords stockholders a premium in the absence of a competing offer. He observed that the merger parties had also postponed the deal twice, making a further delay less of an apparent burden, and thus weighed the marginal benefit of an injunction against the marginal harm caused by an injunction (given the parties‟ seeming lack of urgency to close). Ultimately, he properly noted the deal risk from a delay in the form of a possible material change that could result in a failure of condition. He also noted that the "glaring flaw in the Board‟s process, the thoughtless incorporation of the ["don‟t ask, don‟t waive"] provisions in the Merger Agreement" posed little risk of irreparable harm because the affected entities showed no interest in acquiring Netspend once the offending provisions were withdrawn. Thus the transaction is set to close later on May 31, 2013.
This decision is somewhat surprising, given the unconflicted board‟s careful and thoughtful process, ably described by the Vice Chancellor, showing every intention to maximize value. Single-bidder cases are always fraught with potential missteps, given the lack of a market check to provide information to the board about the company‟s value. Clearly one takeaway here is that single-bidder transactions will continue to be subjected to significant scrutiny under
Revlon. From our vantage point, one could question the board‟s decision to forgo a soft market check, but we must keep in mind that we do not know the competitive dynamics in this industry and the risk to business from leaks, or the potential disruption in the company management or workforce from a leak, and the board must weigh these matters against the benefits of a market check. It may be that the board weighed these matters carefully and came to a reasonable conclusion given their existing knowledge of the market, and one practice pointer is to reflect such discussions in the minutes.
Further, while one can understand the board‟s desire to avoid leaks, it is worth noting that the court here wasn‟t expecting a full auction, and that a limited and soft market check could have gone a long way in satisfying the court that the board was well-informed. The key lesson here is that in a single bidder situation the board must keep top of mind the information it has available to assess the single bidder‟s terms, and to take steps to obtain all reasonably available information.
The key process flaws identified by the court were the fairness opinion and the "don‟t ask, don‟t waive" provision. As to the fairness opinion, we do not know the thought process behind the choices for the comparable transactions and companies analyses, but this case demonstrates the importance of vetting those metrics carefully with the board. Moreover, the bankers should discuss early on the length of the period for projections and the pros and cons of three-year versus five-year projections early in the process, and should also consider the significance of stock-based valuations in light of the board‟s view of the stock valuation. The board may conclude that a fairness opinion is not reliable, and this will suggest that further information may be helpful to the board‟s decision as to whether the deal at hand offers the best value for stockholders.
As to the "don‟t ask, don‟t waive" provisions, recent case law makes clear that these provisions will be part of every Revlon analysis going forward. The board should be briefed on the standstill provisions and the reasons for them, and should be consulted regarding a possible waiver in light of "don‟t ask, don‟t waive" provisions in the merger agreement. The board should understand the impact of these provisions on the bidding process both before and after the merger agreement is signed. In a single-bidder situation, any other limitations on the information about alternative bidders should be removed to the extent possible.
As to the „don‟t ask, don‟t tell‟ provisions, recent case law makes clear that these provisions will be part of every Revlon analysis going forward. The board should be briefed on the standstill provisions and the reasons for them, and should be consulted regarding a possible waiver in light of? don‟t ask, don‟t waive? provisions in the merger agreement.
The bottom line is that the board‟s role is to maximize value. Here the board took those responsibilities very seriously and nonetheless is criticized for the banker‟s opinion and the standstill provisions. This case points out the importance of experienced and thoughtful advisors who can advise the board about the impact of various decisions on the process.