In a recent appraisal decision, Verition Partners Master Fund Ltd. v. Aruba Networks, Inc. (Aruba Networks),1 the Delaware Court of Chancery awarded 30% less to the shareholders than they would have received had they not sought an appraisal. In Aruba Networks, the Court of Chancery followed recent Delaware Supreme Court guidance and held that the market price of the company’s stock prior to the announcement of the merger (the “unaffected market price”) was the “best evidence” of the value of the entity as a going concern.2 Although the Vice Chancellor noted that unaffected market price was not the only relevant consideration, this opinion ought to give stockholders pause in their decision to seek appraisal for shares of widely traded, public company stock.
Overview of Delaware Appraisal Law
Under Delaware’s appraisal statute, stockholders who perfect their appraisal rights are “entitled to an appraisal . . . of the fair value of the stockholder's shares” as of the merger date.3 In determining fair value, the Court of Chancery is required to “take into account all relevant factors.”4 The Delaware Supreme Court recently emphasized that the purpose of appraisal is to make sure that dissenting stockholders get “fair value” or “fair compensation for their shares in the sense that it reflects what they deserve to receive based on what would fairly be given to them in an arm’s-length transaction.”5 Importantly, the Court noted that appraisal is not intended to make sure that dissenters get the “highest conceivable value” for their shares.6 The Court also explained that fair value should exclude “any synergies or other value expected from the merger giving rise to the appraisal proceeding itself.”7
The Delaware Supreme Court Emphasizes the Importance of Market Prices in Appraisal Proceedings
In DFC Global Corporation v. Muirfield Value Partners, L.P. (DFC),8 the Delaware Supreme Court reversed and remanded the Court of Chancery’s appraisal decision, which had estimated fair value based upon an equal weighting of: (1) an estimate of DFC Global’s discounted cash flows; (2) the value of comparable companies; and (3) the deal price. Although the Court declined to adopt a judicial presumption that the deal price is the best evidence of fair value, the Court made clear that deal price is most reflective of fair value in an arm’s-length transaction that is subject to a robust market check.9 The Court rejected the notion that the deal price was depressed because the buyers were all financial buyers, rather than strategic buyers.10 The Court also rejected the argument that the deal price was unreliable because the unaffected market price was itself artificially depressed in light of regulatory concerns, explaining that any such risk would have been incorporated into the unaffected market price for DFC stock.11
Subsequently, in Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd. (Dell),12 the Delaware Supreme Court reaffirmed the importance of the unaffected stock price and deal price where there is compelling evidence of “market efficiency, fair play, low barriers to entry, [and] outreach to all logical buyers. . . .”13 The Dell Court determined that the Court of Chancery abused its discretion in relying on its own discounted cash flow analysis and in giving unaffected market price and deal price no weight. The Court cautioned that its holding does not mean that "the market is always the best indicator of value, or that it should always be granted some weight.”14 Rather, the Court explained that, when there has been a robust sales process and no reason to doubt the efficiency of the market, the unaffected market price and deal price should be given weight.15
Aruba Networks: The Court of Chancery Concludes that Unaffected Market Price is Paramount
After Hewlett-Packard (HP) acquired Aruba for US$24.67 per share, two large shareholders commenced an appraisal proceeding in the Delaware Court of Chancery.16 Vice Chancellor Laster analyzed the three methods of valuation raised by the parties: (1) Aruba’s unaffected market price; (2) the deal price; and (3) discounted cash flow analyses. After discussing each of these three methods at length, the Court concluded that Aruba’s unaffected market price of US$17.13 per share represented fair value.17
In addressing the unaffected market price, the Court explained that the Delaware Supreme Court’s decisions in Dell and DFC endorse the efficient capital markets hypothesis, concluding 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-heeded client.”18 As in Dell and DFC, no expert in Aruba Networks offered an opinion on whether Aruba’s shares traded in an efficient market. However, the Court found, based upon publicly available information, including the reaction of Aruba’s stock price to news, that Aruba’s common stock traded in an efficient market.19 As a result, the Court concluded that Aruba’s 30-day average unaffected market price of US$17.13 per share was a reliable indicator of the going concern value of the Company.20
The Court also found that the deal price “carries heavy weight” in fair value determinations when a publicly traded company is traded in an arm’s-length transaction, negotiated fairly.21 The Court, however, held that fair value in the appraisal setting must exclude any value generated by the merger itself, such as synergies or the reduction of agency costs.22 Although a “deal-price-less-synergies” metric has been used by Delaware courts, the Court reasoned that this metric is inherently flawed because of the difficulty in determining synergies with precision.23 After considering the synergy opinions of HP’s and Aruba’s experts, the Court determined the deal-price-less-synergies value to be US$18.20 per share.24
The third methodology that the Court considered was the discounted cash flow (DCF) analyses conducted by the parties’ experts. Although DCF analysis is a generally-accepted valuation method in Delaware appraisal proceedings, the Court followed Dell and DFC and declined to use this method because credible market information was available.25 The Court noted that the discounted cash flow analysis methodology should generally be used only in appraisal proceedings when the “company was not public or was not sold in an open market check.”26
After addressing the three methods of valuation, the Court concluded that the unaffected market price of US$17.13 per share was the fair value.27 In reaching this conclusion, the Court rejected various attacks on the unaffected market price. Specifically, in light of the Delaware Supreme Court’s endorsement of the efficient market hypothesis, the Court:
- Held that the market price was not unreliable, even if the merger was timed to take advantage of a downturn in the market for Aruba stock.
- Discounted evidence that the buyers believed that they were getting a good deal because the view of the market, and not specific insiders, was most important.
- Rejected the argument that the market price was not reliable because Aruba had waited to disclose positive earnings news until the same day the merger was announced.
The Court also chose not to rely on the deal-price-less-synergies method. The Court held that this method is probative of fair value, especially where the deal was an arm’s-length transaction. Nevertheless, the Court did not rely upon this method because of the difficulty in determining the adjustments that would need to be made to the deal price to account for synergies.28 Moreover, the Court explained that the unaffected market price “provides a direct route to the same endpoint, at least for a company that is widely traded and lacks a controlling stockholder. Adjusting down from the deal price [through the use of the deal-price-less-synergies method] reaches, indirectly, the result that the market price already provides.”29
The recent Delaware court decisions in DFC, Dell, and Aruba Networks make clear that market-driven indications of value will be the most important drivers of “fair value” when the company’s stock traded in an efficient market. Aruba Networks goes so far as to treat the unaffected market price as the most important indicator of value. While it remains to be seen whether other courts will follow Aruba Networks, it seems clear that, in light of these cases, it will be more difficult for Delaware appraisal petitioners to obtain a recovery that exceeds the deal price when the company’s stock traded in an efficient market and the deal was negotiated via an arm’s-length process. As evidenced by Aruba Networks, attacks on the market price will likely fail and expert calculations of value will likely be discounted (or even ignored entirely) when there is no reason to doubt the efficiency of the market price or that the deal was arm’s-length. As such, it will be important for parties on both sides to develop expert testimony regarding market efficiency and the fairness of the deal process. By contrast, in the case of private companies, or when market efficiency and/or the arm’s-length nature of the transaction has been successfully questioned, expert-driven calculations of value should remain relevant.