By: Marc Casarino and Lori Smith
On December 14th, the Delaware Supreme Court provided some welcome news to dealmakers by reversing the lower court decision in Dell v. Magnetar Global in which the lower court ignored the deal price in determining fair value of stock in an appraisal action brought by investors who opposed a management led buyout to Michael Dell and a large private equity firm. In doing so, the Court furthered its recognition of the deal price as indication of fair value when the transaction is the result of an arm’s length, robust process. The Court’s march toward deal price deference arguably began with its August 1st decision in DFC Global v. Muirfield Value Partners. Although the DFC Global decision declined to establish an absolute presumption of deal price fairness in an arm’s length transaction, it clarified that the deal price is likely the best indicator of value in such circumstances. As such, absent evidence cogently weighted by the trial court to justify divergence from the deal price, in the face of a valid transaction process, the deal price should control.
These concepts were put to the test in Dell, where the trial court was presented wildly divergent valuations from the parties’ appraisal experts, and ultimately determined to follow its own discounted cash flow analysis. Despite starting from the premise that the transaction process was fair, the trial court entirely disregarded the deal price because of its perception of a “valuation gap” between the stock price and the company’s intrinsic value which it attributed to the involvement of only financial acquirers which it believed suppressed the deal price to accommodate their internal rates of return, and the “winner’s curse” inherent in management led buyouts, which anchored the price artificially low. Rejecting the trial court’s logic as unfounded in the record, and stating that it ignored the long endorsed “efficient market hypothesis,” the Supreme Court ruled that the trial court abused its discretion in not giving weight to the deal price and cautioned to “be chary about imposing the hazards that always come when a law-trained judge is forced” to rely upon its own analysis in the face of “divergent partisan expert testimony.” Rather, the Supreme Court reminded us once again that when faced with an arm’s length, robust process, “the market-based indicators of value – both [the company’s] stock price and deal price – have substantial probative value” and “deserved heavy, if not dispositive, weight.”
The Supreme Court’s rejection of a bright-line adoption of the deal price as fair value is premised upon the Delaware appraisal statute language requiring the trial court to weigh “all relevant factors.” Thus, absent a statutory revision, no absolute presumption of fairness of the deal price is likely, and it will accordingly remain impossible to fully insulate a transaction from a dissenting stockholder’s appraisal action.
Nevertheless, the Supreme Court’s guidance in DFC Global and Dell puts parties on notice that the deal price will likely reflect fair value in arm’s length transactions absent sound reasons grounded in the record to deviate from this principle. This decision is good news for private equity sponsors who were surprised by the Court of Chancery’s opinion which had created an increased risk of appraisal actions on transactions involving financial buyers.
Dealmakers have cited concerns in the past that appraisal actions challenging fair value have become an investment strategy for some sophisticated hedge funds and other investors who seek to buy shares before a deal closes simply to profit from ownership of shares through such actions. Deal counsel should take comfort from these decisions that if transactions are structured so as to follow a fair transaction process, substantial weight will be given to deal price under the DFC Global and Dell standards.
