The Delaware Chancery Court relied on the unaffected market price and performed an independent DCF analysis to corroborate the most persuasive market evidence.
In July 2019, the Delaware Court of Chancery (the “court”) issued an opinion In Re: Appraisal of Jarden Corporation. Newell Rubbermaid (“Newell”) acquired Jarden Corp. (“Jarden,” or the “respondent”) for cash and stock totaling $59.21 per share on April 15, 2016 (the “merger date”). The petitioners, a group of Jarden shareholders that acquired 2.4 million shares of Jarden common stock after the announcement of the merger, sought a judicial appraisal of the fair value of their Jarden shares as of the merger date. Two well-credentialed valuation experts were engaged to determine the fair value of Jarden’s stock, and concluded upon widely disparate values. Specifically, Jarden’s expert opined that Jarden’s fair value as of the merger date was $48.01 per share, while the petitioners’ expert concluded that Jarden’s fair value as of the merger date was $71.35 per share. The court declined to rely on either expert, and instead, opined that the fair value of Jarden as of the merger date was $48.31 per share, based on Jarden’s unaffected market price on December 4, 2015, which was the last day of trading before the potential merger leaked in the news. To support this conclusion, the court performed its own discounted cash flow (DCF) analysis.
The Court’s Conclusion That the Merger Price Was Not Reliable
In this dispute, the petitioners claimed that “the sale process leading to the merger was highly flawed because Jarden’s lead negotiator was willing to sell Jarden on the cheap and the Jarden board of directors (the “board”) failed to test the market before agreeing to sell the Company to Newell.” After considering the evidence, the court agreed with the petitioners that “the sale process left much to be desired.”
After hearing the evidence, the court opined that “the ‘sale process’ for Jarden, if one can call it that, raises concerns.” Specifically, the court noted that Jarden’s lead negotiator, CEO Martin Franklin “laid Jarden’s cards on the table before the negotiations began in earnest and before the board and its financial advisors had a chance to formulate a plan.” In addition, the court noted that Franklin’s “approach may well have set an artificial ceiling on what Newell was willing to pay.” These actions, along with “the fact that there was no effort to test the Merger Price through any post-signing market check” caused the court to conclude that the merger price was not a reliable indicator of fair value. Ultimately, the court placed no weight on the merger price, noting that “the sales process was not well-conceived or well-executed.”
Why the Unaffected Market Price Ruled the Day
When, as a result of the flawed sale process, the actual merger price proved to be unreliable, the court analyzed whether the unaffected market price was a reliable indicator of the fair value of Jarden’s stock. After performing an analysis, the court concluded that the unaffected market price was the best indicator of fair value in this case.
The court supported its decision that the unaffected market price was the best indicator of fair value by noting the following:
- Jarden’s stock was traded on the New York Stock Exchange, and Jarden become a member of the Standard & Poor’s (S&P) 400 index in 2012.
- In 2015, Jarden’s shares traded with a daily and weekly average trading volume in the top 25% of the S&P 500. The court noted that high trading volume contributes to the efficiency of the market.
- Jarden’s market capitalization of approximately $10.2 billion placed the company in the top 20% of all publicly traded firms. The court noted that high market capitalization leads to greater interest in the security being analyzed, which increases the likelihood that new information will be quickly incorporated into the stock price.
- Jarden had no controlling stockholder as of the merger date, and the company’s public float was approximately 94%. The court noted that a high public float indicates an efficient market for Jarden’s stock, because the more holders of a security that are not insiders with access to non-public information, the more likely the market will demand that information be released for public consumption.
- Jarden’s stock had a narrow bid-ask spread of only 0.02%. The court noted that a narrow bid-ask spread indicates minimal information asymmetry between insiders and the public markets, and as a result, higher market efficiency.
- Jarden’s stock was well-covered by approximately 20 professional stock analysts.
In light of the above, and the court’s previous findings that the merger price was not reliable, in the decision the court placed weight on only the unaffected market price of Jarden’s stock.
Corroborating the Unaffected Market Price with Independent Valuation
Before concluding that the unaffected market price was the most appropriate indicator of the fair value of Jarden’s stock, to determine the fair value of Jarden’s stock, the court considered common valuation methodologies proffered by two valuation experts.
The court noted that this was a “classic case where … very-well credentialed experts are miles apart.” The respondent’s expert applied a DCF analysis, and opined that Jarden’s fair value as of the merger date was $48.01 per share. The petitioners’ expert applied a comparable company analysis and a DCF analysis, and opined that Jarden’s fair value as of the merger date was $71.35 per share. The court pointed out that “to put the disparity into context, [the petitioners’ expert’s] valuation implies that the market mispriced Jarden by over $5 billion.”
In its decision, the court discussed at length numerous discrepancies between the valuation inputs used by the two experts, including, but not limited to, the following:
- the reliability of the comparable companies analysis
- appropriate inputs in a DCF analysis, including the terminal investment rate, the terminal growth rate, and many components of the weighted average cost of capital (WACC)
Comparable Companies Analysis
In the beginning of the court’s discussion, the court stated that “as a threshold matter, before a comparable companies multiples analysis can be undertaken with any measure of reliability, it is necessary to establish a suitable peer group through appropriate empirical analysis.” After this step is achieved, the court noted that “the next step in the comparable companies analysis is to select an appropriate multiple and then determine where on the distribution of peers the target company falls.” The court stated, “Enterprise Value to [earnings before interest, taxes, depreciation, and amortization] EBITDA multiples … is widely accepted as the most reliable data set for a comparable companies analysis,” and “the preference is to use forward-looking projections instead of a firm’s historical earnings data.”
When preparing valuation analyses, valuation experts testifying in the court should be well-aware of these court statements. However, in this case, the court decided that the comparable companies utilized were not comparable enough to be meaningful. In its opinion, the court pointed to the respondent’s expert’s testimony, which emphasized that “Jarden’s unique and highly diversified portfolio of businesses, its aggressively acquisitive growth strategy and its holding company structure made the selection of a valid peer set for a comparable companies analysis a fundamentally flawed exercise.” The court agreed, noting that “[a]fter carefully reviewing the evidence, I am convinced that … Jarden had no comparable peers.” As a result, the court placed zero weight on the comparable companies analysis.
As noted, the opposing valuation experts developed DCF analyses that produced widely disparate conclusions. As a result, the court did not accept either expert’s DCF analysis. Instead, the court “adopted some of both expert’s inputs to construct” its own DCF model. The court’s DCF model concluded that the fair value of Jarden’s common stock was $48.13 per share, which corroborated the reasonableness of the unaffected market price of $48.31 per share.
The key differences between the two experts’ DCF inputs upon which the court commented in detail are discussed in the remainder of this article.
Terminal Investment Rate
Based on the court’s analysis, the divergent terminal investment rates utilized by the two experts accounted for 87% of the disparity in their DCF valuations. After reviewing the experts’ analyses, and finding flaws in both, the court concluded its own terminal investment rate, which was an average of Jarden’s historic average investment rate and the terminal investment rate used by the respondent’s expert. The court found the terminal investment rate used by the petitioners’ expert to be too low, as it unreasonably assumed that Jarden’s return on invested capital would continue to increase for more than 40 years into the terminal period, and unreasonably assumed that all new investment during the terminal period would be comprised entirely of working capital.
Terminal Growth Rate
At the outset of its discussion, the court noted that “of all the inputs into a discounted cash flow valuation model, none creates as much angst as estimating the [terminal] growth rate.” Both experts measured Jarden’s terminal growth rate based on estimates of U.S. nominal gross domestic product (GDP) growth and long-term economic inflation. This practice is common within the valuation industry. However, the experts disagreed as to what forecast sources should be relied upon.
The petitioners’ expert derived a 2.1% projected long-term inflation rate based on four estimates of U.S. economic outlooks, and an expected nominal GDP growth rate of 4.3% from three projections of U.S. GDP growth. Based on these data points, the petitioners’ expert utilized the midpoint, or 3.2%, as a reasonable long-term growth rate for Jarden. The respondent’s expert applied a 2.5% long-term growth rate based on several inflation and nominal GDP growth forecasts for the U.S. economy and the eurozone. Furthermore, the respondent’s expert noted that his 2.5% long-term growth rate fell in between his estimated range of inflation and the nominal GDP.
The court ultimately concluded that a 3.1% long-term growth rate was appropriate to apply in its DCF analysis. In reaching this conclusion, the court noted the following:
- The experts calculated historical organic growth rates for Jarden of 3.1% and 3.2%.
- Jarden was considered a GDP growth business.
- The midpoint of each experts’ inflation and GDP estimates is approximately 3.1%.
The court’s conclusion with respect to the long-term growth rate falls between inflation as a lower-bound and the nominal GDP as an upper bound, which is consistent with many previous decisions rendered by the court.
Weighted Average Cost of Capital
In addition to the terminal investment rate and the terminal growth rate, the court analyzed several key inputs in the WACC, which is the overall rate of return to discount the projected cash flows in a DCF analysis. The WACC is calculated based on three components: cost of equity (in this case, both experts used the capital asset pricing model (CAPM)), cost of debt, and capital structure. The most significant discrepancies in the experts’ WACC calculations related to selecting an appropriate capital structure and various inputs in the CAPM (including beta, equity risk premium, and size premium).
The petitioners’ expert calculated Jarden’s capital structure to be 69% equity and 31% debt, which was based on Jarden’s median capital structure ratios in the last four quarters before December 4, 2015. The respondent’s expert concluded that Jarden’s capital structure should be 63.9% equity and 36.1% debt, which was equal to Jarden’s one-year average capital structure ratio. The respondent’s expert noted that “in order to capture Jarden’s value as a going concern, the capital structure ratio used in the WACC analysis should reflect Jarden’s long-run target capital structure.” The respondent’s expert also considered that Jarden had a target of lowering its debt-to-EBITDA level, which the court appreciated. The court noted that the “cost of capital analysis should be based on target debt-to-equity ratios instead of current ratios.” Because the respondent’s expert analyzed Jarden’s target debt levels, the court sided with his capital structure conclusion.
CAPM – Beta
Beta is generally defined as the volatility of an individual stock (i.e., Jarden stock) relative to the overall market (i.e., the S&P 500 index). In the beginning of the court’s discussion, the court noted that “from the evidence, it appears the most appropriate (and commonly used) parameters are two- or five-year time periods and weekly or monthly return intervals” with respect to estimating beta.
The petitioners’ expert estimated a beta of 1.24 based on Jarden’s actual beta, using five years of weekly returns ending on the merger date. The respondent’s expert, however, estimated that a beta of 1.18 was appropriate for Jarden based on daily returns for the one-year period ended on December 4, 2015.
The court ultimately concluded that because Jarden’s beta was very consistent whether one-, two-, or five-years of data is used, and whether daily, weekly, or monthly data is used, the company had a low error rate across different time and interval measurements. Therefore, despite disagreeing on the proper inputs in the beta analysis, the difference between the experts was not material. The court ultimately relied on the respondent’s expert’s beta of 1.18, however, which was based on one year of daily returns, because the respondent’s expert’s beta mitigated the potential confounding effects of several large acquisitions Jarden completed during the five years before the merger.
CAPM – Equity Risk Premium
The equity risk premium is generally defined as the return investors require over the risk-free rate of return when investing in equity securities (e.g., publicly traded stock). The petitioners’ expert used an equity risk premium of 6.03% based on the supply-side equity risk premium. The respondent’s expert determined that an appropriate equity risk premium was 6.47%, which was based on the average of the supply-side equity risk premium and the long-term historical equity risk premium. Ultimately, the court sided with the petitioners’ expert with respect to the equity risk premium by determining that the supply-side equity risk premium is most appropriate. Use of the supply-side equity risk premium is consistent with many previous decisions rendered by the court.
CAPM – Size Premium
The size premium is generally applied in the CAPM to account for the relative size of the subject company, and the publicly traded companies utilized in the underlying equity risk premium. The petitioners’ expert applied a size premium of 0.57% in his WACC calculation, which was based on a study by Duff & Phelps that placed Jarden within the second size decile of publicly traded stocks based on market capitalization. The respondent’s expert argued that a size premium was not necessary, but provided no credible explanation for that position.
The court concluded that although Jarden is a large public company, applying a size premium was appropriate, stating that “the valuation texts in the record make the point that beta captures some, but not all of a company’s size premium and that a size premium is an empirically observed correction to CAPM.” Use of a size premium is consistent with previous court decisions, and general practice within the valuation industry.
The Court Gets Technical
Despite relying exclusively on the unaffected market price to determine fair value in this case, the court still spent a considerable amount of time analyzing valuation inputs and assumptions in this decision. Although every case is fact-specific, and dependent on the company that is being valued and the current situation, experts who prepare valuations in the context of litigation should be aware of the court’s thought process for technical aspects of valuation, such as those detailed in this decision.
- These shareholders included Verition Partners Master Fund, Verition Multi-Strategy Master Fund, Fir Tree Value Master Fund, and Fir Tree Capital Opportunity Master Fund.
- Note that we address only a subset of the differences outlined in the decision. Refer to the decision for a full analysis of all of the differences between the two valuation experts’ analyses.