Vice Chancellor Strine’s May 13, 2010 decision in Maric Capital Master Fund, Ltd. is likely to be controversial because the court’s holding (consistent with its prior holding in Netsmart) that cash flow projections are material and required to be disclosed appears inconsistent with the Delaware Supreme Court’s decision in Skeen and Chancellor Chandler’s decision in CheckFree.
- Maric: “[I]n my view, management’s best estimate of the future cash flow of a corporation that is proposed to be sold in a cash merger is clearly material information.”
- Netsmart (2007, also VC Strine): “It would therefore seem to be a genuinely foolish (and arguably unprincipled and unfair) inconsistency to hold that the best estimate of the company’s future returns, as generated by management and the Special Committee’s investment bank, need not be disclosed when stockholders are being advised to cash out. . . . Indeed, projections of this sort are probably among the most highly prized disclosures by investors. Investors can come up with their own estimates of discount rates or (as already discussed) market multiples. What they cannot hope to do is to replicate management’s inside view of the company’s prospects.”
- Skeen (an opinion published in 2000 in which the Delaware Supreme Court considered and rejected a claim that the board of House of Fabrics breached its fiduciary duties by failing to disclose (i) management’s projections and (ii) a summary of the methodologies used and the ranges of values generated by the financial analyses performed by its financial advisor):
“Appellants are advocating a new disclosure standard in cases where appraisal is an option. They suggest that stockholders should be given all the financial data they would need if they were making an independent determination of fair value. Appellants offer no authority for their position and we see no reason to depart from our traditional standards.”
“[Appellants] say, in essence, that the settled law governing disclosure requirements for mergers does not apply, and that far more valuation data must be disclosed where, as here, the merger decision has been made and the only decision for the minority is whether to seek appraisal. We hold that there is no different standard for appraisal decisions.”
- CheckFree (2007, Chancellor Chandler): “Although the Netsmart Court did indeed require additional disclosure of certain management projections . . ., the proxy in that case affirmatively disclosed an early version of some of management’s projections. Because management must give materially complete information ‘[o]nce a board broaches a topic in its disclosures,’ the Court held that further disclosure was required. . . . Because [the CheckFree] plaintiffs have failed to establish that management’s projections constitute material omitted information, they have failed to demonstrate a likelihood of success on the merits of their claim and, therefore, I deny their motion for a preliminary injunction on this ground.” (emphasis in original)
There also seems to be a disconnect between the Maric court’s view that the court can determine whether the valuation methodology used by a financial advisor in preparing a fairness opinion is appropriate (e.g., based on analogy to the methodologies approved in connection with appraisals) and Chancellor Chandler’s views regarding the limits on the court’s ability to assess a financial advisor’s chosen valuation approach as expressed in his December 2009 decision in 3Com.
In Maric, the financial advisor used a discount rate determined by adding additional premia (illiquidity and micro cap premia) to the calculated cost of capital of the company. The proxy disclosed the range of discount rates used, as did the discussion materials provided to the special committee, but the special committee was apparently not told why the financial advisor was using a discount rate higher than the company’s calculated cost of capital.
“In the proxy statement, it says that Craig-Hallum selected discount rates ‘based upon an analysis of PLATO Learning’s weighted average cost of capital.’ The proxy statement then indicates that Craig-Hallum used a range of 23% to 27% in conducting its DCF. In that respect, it is the literal case that the DCF analysis presented to the Special Committee used a range of 23% to 27%. But that range was not the result of the analysis of the WACC simultaneously given to the Special Committee. In reality, Craig-Hallum calculated two estimates of a so-called WACC, one using a very loose variation of the capital asset pricing model and one using a comparable companies analysis. These generated discounts [sic] rates of 22.6% and 22.5%, both very hefty but both below the 23% bottom disclosed in the proxy statement. These analyses were given to the Special Committee.”
Rather than simply requiring disclosure of the additional premia to bridge the gap between the cost of capital calculation and the discount rates the financial advisor deemed appropriate and used in its financial analysis, the Maric court required the disclosure of the valuation ranges that would have resulted from using discount rates equal to the calculated cost of capital. The Maric court wrote: “Unless the proxy statement is supplemented by a corrective disclosure indicating the value that would be obtained by using the discount rates Craig-Hallum actually calculated, the merger will be enjoined.”
- Maric: “The idea that Craig-Hallum subjectively added a further liquidity discount on top of PLATO’s healthy beta of 1.12 and the other subjective discounts is itself dubious as a valuation practice.”
Footnote 11: “Obviously, this approach has the risk of counting identical risks multiple times - e.g., heaping a liquidity discount based on a small market capitalization on top of a small stock premium. Indeed, the use of a liquidity discount by a sell-side banker is strange for many reasons, including the legal one that such discounts cannot be considered in appraisal . . . .” (emphasis in original)
- 3Com (2009, Chancellor Chandler): “Under Delaware law, the valuation work performed by an investment banker must be accurately described and appropriately qualified. So long as that is done, there is no need to disclose any discrepancy between the financial advisor’s methodology and the Delaware fair value standard under Section 262 (or any other standard for that matter). If shareholders believe the financial advisor undervalued the company after reading a summary of its work, they are free to exercise their appraisal rights under Section 262. Indeed, an appraisal action addresses this concern by subjecting the financial advisor’s fairness opinion to scrutiny. Valuing a company as a going concern is a subjective and uncertain enterprise. There are limitless opportunities for disagreement on the appropriate valuation methodologies to employ, as well as the appropriate inputs to deploy within those methodologies. Considering this reality, quibbles with a financial advisor’s work simply cannot be the basis of a disclosure claim.”