In the last few years, there have been numerous developments in the law and practice surrounding appraisal rights under Delaware law. That trend has continued with the Delaware Chancery Court’s opinion in Merlin Partners v AutoInfo, Inc., which provides additional guidance regarding the courts determination of fair value in an appraisal action.
As discussed in our March 2014 and April 2015 newsletters, in the last few years, there have been numerous developments in the law and practice surrounding appraisal rights under Delaware law. That trend has continued with the Delaware Chancery Court’s opinion in Merlin Partners v AutoInfo, Inc., which provides additional guidance regarding the courts determination of fair value in an appraisal action.
In the AutoInfo, the target, with the assistance of its financial advisor, contacted 164 potential strategic and financial buyers, 70 of which entered into non-disclosure agreements. The company eventually signed a letter of intent that provided for an acquisition of the company at $1.30 per share. After that prospective buyer walked away, the company executed a letter of intent with Comvest, which contemplated the sale of the company for $1.26 per share. Comvest’s due diligence then turned up numerous accounting issues, and subsequent, protracted negotiation, resulted in an agreement for Comvest to acquire the company at $1.05 per share.
Merlin Partners filed an appraisal action, arguing that the fair value of the company was $2.60 per share. In support of this valuation, Merlin presented two comparable companies analyses and a discounted cash flow (“DCF”) analysis prepared by Merlin’s financial expert. AutoInfo argued that comparable companies and DCF analyses could not be reliably performed with the available data, and that the fair value should be $0.967 per share based on the merger price paid by an unrelated third party, the synergies the buyer took into account in agreeing to $1.05 per share and the strength of the sales process.
Merlin’s position seemed well-supported by prior Chancery Court decisions. Although the Chancery Court may consider “any techniques or methods which are generally considered acceptable in the financial community and otherwise admissible in court” in an appraisal proceeding, in practice this has generally meant some combination of a DCF analysis, a comparable companies analysis and a comparable transactions analysis. The price actually paid in the merger was not generally viewed as part of this analysis, particularly since the Chancery Court’s 2010 decision in the Golden Telecom case, where it rejected a target company’s argument that the court should defer to the merger price in an appraisal proceeding. In upholding the Golden Telecom ruling on appeal, the Delaware Supreme Court noted that: “Section 262(h) unambiguously calls upon the Court of Chancery to perform an independent evaluation of “fair value” at the time of a transaction. […] Requiring the Court of Chancery to defer—conclusively or presumptively—to the merger price, even in the face of a pristine, unchallenged transactional process, would contravene the unambiguous language of the statute and the reasoned holdings of our precedent.”
However, after evaluating the parties’ competing analyses, the Chancery Court reached a different result in this case.
DCF Analysis—Merlin used the projections prepared by management in its DCF analysis, a position that would seem sound—Delaware has “a long-standing preference for management projections.” That preference, however, is based on the assumption that management’s knowledge of the company’s operations puts it in the best position to prepare meaningful projections. That was not the case with AutoInfo’s management, whose projections were little more than guesswork. The court accordingly found that Merlin failed to carry its burden of proof that the projections could be relied upon, and accordingly disregarded Merlin’s DCF.
Comparable Companies Analyses—The court similarly found that Merlin failed to establish that its comparable companies analyses were reliable, noting that the companies it deemed “comparable” ranged from 2 to 300 times larger than AutoInfo, and that the selection of companies failed to take account of the fact that AutoInfo had a different business model that was perceived as riskier by prospective buyers than any of the “comparable” companies’ models. The comparable companies analyses were therefore disregarded as well.
Merger Price—The Court then noted that if DCF and comparable companies analyses are non-existent or unreliable, the merger price may be the most reliable indicator of value. Here the Court cited Golden Telecom as supporting this view, noting Vice Chancellor Strine’s comment in that case that “it is true that an arm’s-length merger price resulting from an effective market check is entitled to great weight in an appraisal.” In Golden Telecom, in fact, the Court didn’t state that the merger price cannot be taken into account, but instead that it “declined to reform the statute to build in an assumption” that the merger price is the best indicator of value. The court’s deference to the merger price is therefore not necessarily inconsistent with Golden Telecom and its progeny, and was supported by at least two recent decisions in the Ancestry.com and CKx cases.
The Court noted that the evidentiary value of a merger price in an appraisal proceeding is “only as strong as the process by which it was negotiated.” Here there was no indication of any self-interest or disloyalty, and a thorough sales process featuring arms-length negotiations, no compulsion, adequate information, and a competitive process involving a very large number of potential bidders. The court accordingly gave 100% weight to the merger price.
The court then considered the company’s arguments that the fair value should be reduced from $1.05 per share merger consideration to $0.967 per share to account for merger-specific elements of the $1.05 price, namely the savings on public company costs and certain executive compensation costs that the buyer intended to eliminate. While the appraisal statute directs the Court to value a company on an ongoing, stand-alone basis, here it found that AutoInfo did not adequately substantiate the value of these savings to the buyer. Although the numbers AutoInfo used were taken from Comvest’s internal projections, the reliability of these numbers was not tested, and AutoInfo therefore failed to carry its burden of proof. The court therefore settled on $1.05 per share as the fair value of the AutoInfo shares.
Although the AutoInfo case doesn’t break new ground, it is a valuable primer on how the Chancery Court will evaluate appraisal actions. Aside from the rather obvious lesson that valuation methodologies are only as meaningful as their inputs are reliable, the case highlights the importance of process in M&A transactions.
Interestingly, although having generally taken pains to establish that this ruling is not a departure from what may appear to be contrary precedent, in his final paragraph, Vice Chancellor Glasscock states that “where, as here, the market prices a company as the result of a competitive and fair auction, ‘the use of alternative valuations techniques like a DCF analysis is necessarily a second-best method to derive value'” (emphasis added), quoting a case that pre-dates Golden Telecom. Although this was merely dicta, we will be looking out to see whether the Court is tipping its hand and indicating that, in parallel with making it easier to commence appraisal claims (see our March 2014 newsletter), the Court will seek to weed out non-meritorious claims by placing a greater degree of deference on a merger price that results from a robust sales process.