In two recent post-trial opinions in appraisal cases under 8 Del. C. § 262, the Court of Chancery addressed the importance of merger price and process as well as the reliability of discounted cash flow (DCF) analyses in determining fair value. In Merlin Partners LP v. AutoInfo, Inc., 2015 WL 2069417 (Del. Ch. Apr. 30, 2015), Vice Chancellor Noble found that, where there was an adequate sale and negotiation process conducted at arm’s length and there were no reliable cash flow projections from which to make a DCF analysis nor available alternate valuations, the price received in the merger, $1.05 per share, was the best indication of fair value at the time of the merger. Two months later, in In re LongPath Capital, LLC v. Ramtron International Corporation, 2015 WL 4540443 (Del. Ch. June 30, 2015), Vice Chancellor Parsons similarly determined that there were no reliable means of appraisal valuation other than the merger price, but also found that the fair value at the time of the merger was $0.03 below the deal price of $3.10 per share after accounting for synergies.
Under Section 262, stockholders who choose not to participate in certain merger transactions may petition the Court to determine the fair value of their stock. “Fair value” represents “the value to a stockholder of the firm as a going concern, as opposed to the firm's value in the context of an acquisition or other transaction.” To determine fair value, the Court independently evaluates the evidence and may consider techniques or methods that are generally considered acceptable in the financial community and otherwise admissible in court. Depending on the case, the Court may rely upon a DCF analysis, a comparable transactions analysis, a comparable companies analysis, or the merger price itself. Delaware courts tend to favor a DCF model over other available methodologies in an appraisal proceeding. However, a DCF analysis has “much less utility” in cases where the transaction was an arm’s-length merger or where the data inputs used in the model are not reliable.
After struggling financially, AutoInfo began a sale process. As part of the process, Stephens Inc., AutoInfo’s financial advisor retained to assist with the sale process, asked management to prepare five-year financial projections that were “aggressively optimistic” for use in marketing AutoInfo. AutoInfo’s management had never prepared multi-year projections before, and the company’s CEO described the process as "a bit of a chuckle and a joke." Despite this, AutoInfo engaged in an extensive sales process, with Stephens contacting 164 potential strategic and financial buyers, 70 of which entered into non-disclosure agreements. Several bidders submitted letters of intent, including Comvest, which signed a letter of intent at $1.26 per share but eventually reduced its price to $1.05 per share after discovering problems with the reliability of AutoInfo’s financial information.
Merlin Partners filed an appraisal action and, relying on two comparable companies analyses and a DCF analysis prepared by its financial expert, argued that the fair value of the company was $2.60 per share. The Court first found that Merlin’s DCF analysis deserved little deference because Merlin had failed to establish the credibility of the management projections upon which it relied. Not only were they AutoInfo’s first attempt at such projections, they had also been specifically prepared to “paint the most optimistic and bright current and future condition of the company” possible in connection with the sales process. The Court also gave no weight to Merlin’s comparable companies analyses because the companies used for comparison differed significantly in size from AutoInfo (from more than twice to 300 times its size) and also used store-based business models rather than AutoInfo’s riskier agent-based model. Conversely, AutoInfo’s expert relied on merger price, and the Court found that it could place “heavy weight” on a merger price in the absence of any other reliable valuation analysis. Finding that fair value was the deal price, the Court noted that the merger was the result of a competitive and fair auction because AutoInfo: (1) retained an investment bank experienced in the transportation industry using an incentive-based fee structure; (2) contacted numerous companies in the sales process; (3) formed a special committee; (4) was sold at a premium to market; and (5) had no other topping bid emerge between announcement and closing of the merger.
In Ramtron, after rejecting Cypress Semiconductor Corporation’s bear hug letter to acquire all of its shares, as well as engaging in a subsequent sales process that involved its advisor contacting twenty-four potential buyers and executing nondisclosure agreements with six of those potential buyers, Ramtron engaged in negotiations with Cypress. After rejecting two more offers from Cypress, Ramtron agreed with Cypress on a final transaction price of $3.10 per share. LongPath, which acquired its shares after announcement of the merger, demanded appraisal and argued that fair value was $4.96 per share. The Court determined that LongPath’s DCF analysis was not appropriate because it relied on management projections prepared by newer employees who were creating multi-year projections for the first time, which also utilized a point-of-sale revenue recognition methodology rather than Ramtron’s historic point-of-purchase method. As further evidence of the unreliability of the projections, the Court noted that they were created after Cypress’s bear hug letter, in anticipation of potential litigation or a hostile takeover bid, and that Ramtron, which already had a questionable track record at forecasting, prepared separate projections to provide to its bank. The Court also afforded no weight to LongPath’s comparable transactions analysis, as the petitioner’s expert had a “dearth of data points” and could only point to two comparable transactions with vastly different multiples. Instead, the Court found it could give “one-hundred percent weight” to merger price as evidence of fair value when the merger resulted from a proper process. Here, only one company, Cypress, ever made a bid even after an active solicitation process, and Ramtron could and did repeatedly (and publicly) reject Cypress’s overtures, after which Cypress raised its price. In addition, the Court determined that it was appropriate to subtract LongPath’s estimate of net synergies of $0.03 per share (which was reached by netting negative revenue synergies and transaction costs from Ramtron’s estimate of positive synergies) from the merger price to reach a fair value determination of $3.07 per share.
As these decisions illustrate, even though Delaware courts “tend to favor a DCF model in appraisal proceedings,” they will be willing to rely entirely upon or afford substantial weight to the merger price to determine fair value where there is reason to question the reliability of the underlying management projections and where no other viable alternate valuation technique exists.