On February 28, 2018, Cineworld acquired Regal Entertainment Group (“Regal”) in a reverse triangular merger (the “Merger”). Regal shareholders had the right to receive $23 per share in cash. The petitioners filed an appraisal action in the Delaware Chancery Court^[1] and argued at trial in favor of a discounted cash flow (DCF) methodology, which they maintained supported a fair value per share of $33.83 per share. In contrast, Cineworld contended that the court should not consider indications of value from the application of a DCF methodology, but rather that the fair value be determined based on Regal’s unaffected public trading price and based on the deal price less synergies. Cineworld gave equal weight to each indication, resulting in a fair value conclusion of $18.02 per share.

Thus, the plot of this case was a familiar one. It involved the necessity of the court weighing results 1) indicated by a traditional, well-accepted fundamental valuation method applied by a valuation expert at trial, versus 2) indications of value for the subject company (i.e., Regal) based on the actions of contemporaneous market participants outside of the context of litigation.

Definition of Value

The relevant Delaware appraisal statute states that “the Court shall determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation.”^[2] In other words, the basic concept of value under the appraisal statute is that dissenting stockholders are entitled to be paid for that which has been taken from them, their proportionate interest in a going concern. The value of the stockholders’ proportionate interest in the corporate enterprise is meant to be represented by the true or intrinsic value of the subject stock that has been taken by the merger.

In its determination of the fair value of Regal stock as of the Merger date, the court assessed the DCF method put forth by the petitioners’ expert, the unaffected public stock price put forth by Cineworld, and the deal price minus synergies also put forth by Cineworld.

Discounted Cash Flow Method

While admitting that the DCF method is well accepted in the financial community and has been relied upon in numerous previous decisions in appraisal actions, the court explained that a fair value analysis should begin with market-based indicators when available and that a fundamental DCF methodology or a guideline public company methodology should only be used when the subject company was not public or was not sold in an open market process.

The court questioned the reliability of the petitioners’ DCF method given that the indicated value was so divergent from the market-based evidence. Cineworld pointed out that the petitioners’ DCF valuation represents a premium of 47.1% over the deal price and observed that if that valuation were accurate, then Cineworld received a windfall of $1.7 billion.

In addition, the court was critical of the projections relied upon by the petitioners’ expert, stating that the projections were overly optimistic and were much higher than consensus projections of industry analysts following Regal. The court stated that, for many companies, there could be good reasons why management would be in a better position than analysts to project long-term financial results. However, that was unlikely the case with respect to Regal, as its business was easy to understand. The key driver was attendance, which generally depended on the quality of the film slate. The court’s opinion was that the Regal management team did not have any unique insight into the pipeline of future films that was not available to industry analysts.

Finally, in commenting on the suitability of projections, the court cites other Delaware cases to analyze Regal management’s projections, noting that:

• There is a strong preference for management projections prepared in the ordinary course of business and available as of the merger date.

The court viewed the suitability of the Regal management projections positively from the perspective that the projections reflected the management team’s best judgement concerning Regal’s future performance, were prepared as of the date of the Merger, and were prepared outside of the context of litigation. On the negative side, the court noted that the projections were not prepared in the ordinary course of business (but rather were prepared for a sale of the company) and that the management team did not have experience in preparing five-year projections.

• Projections prepared using a “bottom-up” process (i.e., where the process starts with detailed information drawn from business units and then are aggregated) are generally more reliable than projections using a “top-down” process.

The court viewed the reliability of the Regal management projections negatively from the perspective that they were prepared on a “top-down” basis, which differed from the “bottom-up” process management used for the annual budget prepared in the ordinary course of business.

In summary, the court declined to place any weight on the value indicated by the DCF method put forth by the petitioners’ expert given the divergence in value compared with market-based indicators and given the uncertainty as to the reliability of management’s projections.

Unaffected Trading Price

Cineworld contended that the trading price of Regal’s stock provides reliable evidence of fair value; the petitioners rejected this stance.

On this issue, the court noted that the question in an appraisal proceeding is whether the trading market for the security to be valued is “informationally efficient enough, and fundamental-value efficient enough, to warrant considering the trading price as a valuation indicator when determining fair value.”

The court summarized the following about Regal in assessing whether the unaffected trading price of Regal could be relied upon:

• Public Information: Regal had been a public company since 2002 and had generated an extensive body of public information by making filings required by the federal securities laws.
• Stock Exchange Listing: Regal was listed on a major stock exchange. Accordingly, it was “unlikely that the market would somehow miss out” on information about the company’s value.
• Active Trading: The average daily and weekly trading volumes for Regal’s stock were significantly higher than the average company in indices of similarly sized companies.
• Followed by Equity and Credit Analysts: The existence of equity and credit specialists who covered Regal strengthens the inference that the market’s “digestion and assessment of all publicly available information” about Regal “was quickly impounded” into its trading price.
• Bid-Ask Spread: Regal’s stock exhibited a bid-ask spread of 0.05% of the price of its shares, which is narrower than the bid-ask spread of 0.08% that was cited with approval in recent prior cases (e.g., Dell^[3]).
• Market Capitalization: Regal’s market capitalization was approximately $2.85 billion, more than double the market capitalization of the company in Stillwater.^[4] a case in which the court found that the company’s market capitalization provided evidence that its stock traded in an efficient market.

The court noted that the above attributes suggest as an initial matter that Regal’s common stock had sufficient attributes of market efficiency to warrant considering it as an indicator of fair value. However, despite these high-level indicators, the court concluded that Cineworld failed to carry its burden to prove that the trading price for Regal’s stock was sufficiently reliable to use in this case. The court cited three reasons that weaken the reliability of Regal’s unaffected stock price relative to other available market evidence:

• Regal had a controlling stockholder.
• The controlling stockholder of Regal engaged in block sales that created an overhang that capped the price of Regal stock.
• The petitioners introduced evidence that Regal’s stock price was in a “trough” due to the disastrous film slate just prior to the Merger.

Ultimately, the court did not opine that the trading price for Regal’s stock was inefficient, but that Cineworld failed to carry its burden to show that the market for Regal’s common stock was sufficiently efficient to be used as an indicator of fair value when another market-based indicator is available.

Deal Price Minus Synergies

Step One: The Reliability of the Sales Process

The court’s decision notes that the first step in considering the reliance on the deal-price metric is to determine whether the process that led to the deal is sufficiently reliable. If that process is determined to be sufficiently reliable, then the deal price establishes an upper bound for fair value because “it is widely assumed that the sales price in any M&A deals includes a portion of the buyer’s expected synergy gains, which is part of the premium the winning buyer must pay to prevail and obtain control.” However, under the appraisal statute, fair value must be determined “irrespective of the synergies involved in a merger.”

In evaluating the reliability of the deal process, the court considered the following:

• Cineworld was an unaffiliated acquiror with no prior ownership interest in Regal.
• Eight of Regal’s nine board members were disinterested, outside directors, and had the statutory authority under applicable Delaware law to reject any proposed merger.
• There was a robust level of public information about Regal.
• Cineworld conducted extensive diligence to obtain non-public information about Regal’s value as demonstrated by its signed confidentiality agreement and evidence presented at trial.
• The parties engaged in active negotiations before ultimately reaching an agreement on price.
• Although the Regal board pursued a single bidder strategy, the merger agreement permitted Regal to conduct an active post-signing market check during which its financial advisor contacted 47 potential buyers.

Based on the foregoing analysis, the court concluded that the sale process that led to the merger agreement was sufficiently reliable to make it probable that the deal price establishes a ceiling for the determination of fair value as of the date the merger agreement was signed and a deal price was finalized.

Step Two: The Deduction for Synergies

The court then determined whether any synergies were allocated to the seller that should be deducted to arrive at fair value. The evidence presented at trial showed that Cineworld identified two types of synergies: operational synergies and financial synergies.

Operational Synergies
The court’s decision describes a synergy report conducted by a Big Four accounting firm hired by Cineworld and assesses: 1) whether or not the planned operational synergies arose from the accomplishment or expectation of the Merger and therefore must be excluded from the fair value determination; or 2) whether the synergy initiatives were already part of Regal’s operative reality at the time of the Merger and therefore would not be deducted from the deal price. The court then reduced the former category of synergies for the confidence level Cineworld had in the realization of these synergies. The court’s analysis suggested that when negotiating the Merger, Cineworld expected to achieve operational synergies of $4.26 per share that both qualified for potential exclusion from the deal price under the appraisal statute and which Cineworld was prepared to allocate to Regal as part of the price negotiations.

Financial Synergies
The financial synergies expected by Cineworld were estimated by the court to be equivalent to $7.10 per share based on financial restructuring benefits, tax savings related to transfer pricing savings, and tax savings expected to result by moving revenue out of the United States and into lower tax jurisdictions. At the time that the deal price was finalized and the merger agreement was signed, all of these savings were unique to Cineworld and could not be effectuated by Regal on its own. However, the passage of the Tax Cuts and Jobs Act (the “Tax Act”), which reduced the corporate tax rate from 35% to 21% (and which was passed subsequent to the signing of the merger agreement, but before the deal closed), made the latter category of saving related to shifting income out of the United States a moot issue for Cineworld. The court concluded that as of the closing date of the Merger, this category of tax savings, equating to $4.37 per share, was realizable by Regal on its own without the Merger and therefore should not be excluded from the deal price under the appraisal statute. In summary, the court concluded that when negotiating the Merger, Cineworld anticipated financial synergies of $2.73 per share that both qualified for potential exclusion from the deal price under the appraisal statute and a portion of which Cineworld was prepared to allocate to Regal as part of the price negotiations.

After determining that the Merger generated operational synergies of $4.26 per share and financial synergies of $2.73 per share, that potentially were available for allocation to Regal’s stockholders, the court’s next task was to estimate how much of the $6.99 in total synergies was in fact allocated to Regal’s stockholders in the purchase price. The court admitted that determining what amount of the available synergies created by the Merger were paid by the buyer to the seller is imprecise, but pointed out that the strongest evidence that Regal extracted at least a portion of the anticipated synergies comes from the fact that the deal price of $23 per share reflected a premium of 46.1% over Regal’s unaffected market price. Relying on a study published by Boston Consulting Group as well as a recent Delaware Supreme Court decision (Aruba^[5]), the court concluded that 54% of the $6.99 per share (i.e., $3.77 per share) of synergies available for sharing were paid to the seller and thus should be excluded from fair value.

Thus, at this point in the court’s analysis, the fair value per share was equal to $19.23 per share (i.e., $23 per share deal price less the court’s $3.77 per share estimated value of synergies that Regal’s stockholders captured in the deal).

Step Three: The Change in Value between Signing and Closing

Cineworld made various arguments in support of its viewpoint that that passage of the Tax Act did not increase the fair value of Regal between the signing of the merger agreement and the closing of the deal, including the fact that it was anticipating a reduction in corporate taxes as of the signing of the merger agreement. The court rejected each of these arguments and concluded that the value of Regal after passage of the Tax Act was higher by $4.73 per share, based largely on the quantification of these savings in presentations Cineworld made to its lenders after the Tax Act passed and before the deal closed.

Roll the Credits

Applying recent Delaware court precedent to the facts of the case, the court’s decision looks to the deal price as the most reliable evidence of Regal’s value at the time of signing. To adjust the deal price to eliminate value arising from the accomplishment or expectation of the Merger, the decision then subtracts $3.77 per share, representing the portion of Cineworld’s anticipated synergies that the deal price allocated to Regal’s stockholders. The resulting value of $19.23 per share reflects the fair value of Regal when the merger agreement was signed. However, the appraisal statute obligates the court to determine the fair value of Regal when the Merger closed.

The parties agreed that some adjustment was necessary because, after signing but before closing, Regal’s value increased when the Tax Act reduced the corporate tax rate from 35% to 21%. To reflect the valuation increase in Regal caused by the lower tax rates reflected in the Tax Act, the court then added $4.37 per share, resulting in a conclusion as to the fair value of Regal’s common stock at the closing date of the Merger of $23.60 per share, which was a slight premium to the deal price of $23 per share.

1. In re Appraisal of Regal Entertainment Group, 051321 DECH, 2018-0266-JTL (Del. 2021)
2. 8 Del. C.36 § 262(h)
3. Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd., 177 A.3d 1, 21 (Del. 2017)
4. Brigade Leveraged Cap. Structures Fund Ltd. v. Stillwater Mining Co., 240 A.3d 3, 17 (Del. 2020)
5. Verition P’rs Master Fund Ltd. v. Aruba Networks, Inc., 210 A.3d 128, 132–33 (Del. 2019)