But while the starting deal price is clear in HFF, more nuance is required to determine the adjustments
On July 1, 2019, Jones Lang LaSalle (“JLL”) acquired HFF, Inc. (“HFF”) through a reverse triangular merger. Under the terms of the merger agreement, each share of HFF’s stock was converted into the right to receive $24.63 in cash and 0.1505 shares of common stock of JLL. At the time the merger was announced on March 19, 2019, the deal consideration equated to $49.46 per share. However, based on the stock price of JLL at the time of closing, the implied value per share of the deal consideration had declined to $45.87 per share.
A shareholder of HFF, BCIM Strategic Value Master Fund, LP (“Petitioner”), pursued its appraisal rights under Section 262 of Delaware Corporation Law. The Petitioner’s expert opined to a fair value per share of $56.44 (using principally a discounted cash flow [DCF] method, and secondarily an adjusted trading price), while the expert engaged by JLL (in the role of “Respondent” for this case, as it was the buyer of HFF) opined to a fair value per share of $44.29 per share (considering the deal price at the time of signing, adjusted for net synergies).
The Delaware Chancery Court (“Court”) ultimately concluded on a value of $46.59 per share.1 In doing so, it relied on an adjusted deal price methodology, noting that “the Delaware Supreme Court’s recent appraisal jurisprudence treats the adjusted deal price methodology as first among equals, so long as the transaction process exhibits sufficient objective indicia of reliability.” To arrive at this conclusion, the Court first presented a detailed analysis of the sale process to conclude that the transaction process was reliable. Having established this, it concluded that the adjusted deal price methodology was appropriate. To utilize this method, however, the Court first needed to estimate a reasonable deduction for synergies. Secondly, the Court made appropriate adjustments to account for the fact that the relevant date of value under Section 262 was the closing date, not the date on which the merger agreement was reached. Specifically, between the date of the merger agreement and the closing date, HFF reported unexpectedly high earnings, which in lieu of an announced merger agreement would likely have increased the share price (based on market evidence presented by each of the Petitioner’s and Respondent’s valuation experts). Therefore, since a shareholder of HFF would have benefited from its unexpectedly strong performance, the Court needed to measure this value in determining fair value per share of HFF at the time of closing.
Reliability of Sales Process
The Court first evaluated the reliability of the deal price as setting a ceiling on fair value. Specifically, it considered the following six objective indicia as evidence that the deal process was sufficiently effective:
- Affiliation with the Acquirer
- Conflicts of Interest
- Access to Information
- Bidder Due Diligence
- Negotiations over the Merger Price
- Post-Signing Phase
The Court concluded that most of these indicia clearly indicated that the deal process was effective. The Court did scrutinize in more detail the conflicts of interest criteria given the significant role played by HFF’s Chief Executive Officer, Mark Gibson, and HFF’s President, Joe Thornton, in the sale process. Of note, negotiations with JLL focused entirely on governance criteria initially, including the cultural fit of JLL and HFF. Other items negotiated included retention bonuses to key employees of HFF and a restructuring of the combined business to remove JLL employees seen by HFF as a less-than-ideal fit for the combined company. While Gibson and Thornton were significant shareholders of HFF, the Court emphasized that other incentives could be important to Gibson and Thornton as well:
“In this case, Gibson and Thornton had significant personal incentives that aligned imperfectly with the interests of [HFF]’s stockholders. Together, they had built [HFF] as an entity, taken it public, and established an industry-leading capital markets franchise. They were justifiably proud of what they had accomplished. They wanted to preserve the business they had created and the culture they believed was essential to its success.”
Ultimately, the Court acknowledges that “Gibson and Thornton faced real conflicts,” but such conflicts were not sufficient to reject the adjusted deal price as a valuation metric. The Court’s analysis emphasized the dependence of HFF’s business on its people. As a real estate financial intermediary that generated 90% of its revenue from service fees associated with real estate lending transactions, HFF was highly dependent on its employees, with the Court noting that compensation and other employee-related costs comprised about 82% of HFF’s total operating expenses in 2018. Therefore, the value of HFF was heavily impacted by its ability to retain its key employees:
“Those employees easily could have left if they perceived that a deal would lead to changes in how the business was operated. Changes to the senior management team, the managerial structure, or the compensation system would lead to an exodus.”
By negotiating initially on governance and retention payments, “Gibson and Thornton ensured that JLL had confidence in what it was getting. They therefore set themselves up to bargain for a better price.”
Since the negotiations with JLL essentially represented a single-bidder process, the Petitioner also questioned whether a sufficiently open post-signing market check took place. Specifically, the Petitioner drew attention to the potentially chilling effect of the retention agreements provisionally in place with JLL on competing bids, and that, since such retention agreements would be applicable only upon the consummation of the merger with JLL, a potential buyer may need to make an even more generous offer to retain HFF’s key personnel. However, the Court observes that if the retention payouts are considered in the context of deal consideration in its entirety, an increase in payouts would not be cost prohibitive (i.e., a 10% increase in retention payments would only effectively increase merger consideration by 0.6%). While HFF did not actively pursue other bidders, they did not seek to dissuade potential suitors during the post-signing period (such as Collins and CBRE, both of whom initially expressed interest in an acquisition but did not press the matter).
Measurement of Synergies
Having established that the deal price set a ceiling on value, the Court then sought to “determine what adjustments are necessary to exclude sources of value (positive or negative) arising from the accomplishment or expectation of the merger.” The Respondent’s expert began with an initial estimate of net revenue and cost synergies of $60 million per year (estimated by JLL management at the time of the merger negotiations and reviewed by JLL’s Board), which also included “dis-synergies” such as retention payments that JLL would need to pay to its own employees and the costs of integrating JLL employees into HFF’s compensation platform. Next, the Respondent’s expert subtracted from the synergy estimate retention payments totaling $112 million that would need to be made by JLL to key management and employees of HFF as part of the merger (since such costs would not need to be incurred by HFF on a stand-alone basis but would need to be incurred by JLL to realize the above-mentioned synergy benefits associated with the transaction).2 Further, the Respondent’s expert subtracted upfront transaction expenses of $66 million, together with $50 million in retention payments made to JLL employees. The Petitioner’s expert thus determined a net present value of net synergies of $371.2 million. The Respondent’s Expert also assumed that 54% of net synergies would be captured by shareholders of HFF, based on a 2018 Boston Consulting Group Study (which represented a similar percentage as estimated by JLL’s banker, JP Morgan, at the time of the deal negotiations). Ultimately, the Court approved the methodology and analysis of net synergies employed by the Respondent’s expert, resulting in net synergies per share allocable to the seller of $4.87. Subtracting this amount from the unadjusted deal price of $49.16 per share results in a value indication for HFF at $44.29 at the time the merger agreement was signed.
Subsequent to the signing of the merger agreement, HFF reported its results for the first quarter of 2019. It reported year-over-year increases of 20.9% in revenue; 80.6% in earnings before interest, taxes, depreciation, and amortization (EBITDA); and 62.9% in net income, a performance that greatly exceeded analyst expectations (as the Court notes, HFF’s “results beat the analyst consensus for earnings per share by 68%”). Since the fair value per share under Section 262 is based on the closing date, but the deal price was based on the time the merger was agreed to, the Court needed to account for the incremental benefit from HFF’s surprisingly strong performance before the deal closing date that would have enhanced the value of the stock to an investor at the time but would not have been accounted for in the deal price. Naturally, since the merger had already been announced, the stock price subsequent to the time of the merger announcement would principally be driven by the expected likelihood that the deal would close (and the amount of consideration received from the deal closing) and would not have been as impacted by the earnings announcement as would be the case in lieu of a merger agreement.
The Court considered separate analyses prepared by the Petitioner’s expert and the Respondent’s expert. The Petitioner’s expert prepared a regression analysis measuring the abnormal change in HFF’s stock price (relative to changes in the S&P 500 Index and the Dow Jones U.S. Real Estate Index) caused by the extent to which HFF’s earnings per share historically exceeded or trailed the consensus of analysts covering HFF. The model prepared by the Petitioner’s expert concluded that HFF’s stock price would have increased 20.2% (in lieu of the merger announcement) in response to the earnings announcement. In contrast, the Respondent’s expert used a larger data set and incorporated a comparison of peer group companies to HFF (such as other real estate service businesses) rather than the Dow Jones U.S. Real Estate Index (comprised to a large extent of real estate investment trusts) in his analysis. The Respondent’s expert ultimately concluded that HFF’s stock price would have increased 5.2% (in lieu of the merger announcement) in response to the earnings announcement. The Court adopted the approach used by the Respondent’s expert.
The Court gave clear precedence to the Adjusted Deal Price approach in its final analysis, noting at the outset that the “Delaware Supreme Court’s recent appraisal jurisprudence treats the adjusted deal price methodology as first among equals, so long as the transaction process exhibits sufficient objective indicia of reliability.” The Court dismissed the use of HFF’s unaffected trading price, acknowledging JLL’s argument that “the unaffected stock price of $46.51 per share on March 16, 2019, contained some takeover speculation, constituting value arising from the expectation of the Merger.” Since the stock price just before the Merger announcement was higher than the adjusted deal price of $44.29 per share, the Court effectively considers that “the unaffected market price was not wholly unaffected.”
The Court similarly dismisses the use of the DCF method, which was employed by the Petitioner’s expert. Notwithstanding that, according to the Court, the Petitioner’s expert “followed a careful process, made reasonable assumptions and produced a credible set of projections,” the usefulness of the expert’s analysis was impaired by the lack of reliable management projections (with the expert needing to prepare projections specifically for use in litigation). The Court concluded:
“In a different case and on a different record, the court might well rely on a DCF analysis based on (the Petitioner’s expert’s) projections. In this case, there is no reason to take that step…If market-based metrics were lacking, then an adjusted version of [the Petitioner’s expert’s] DCF model could provide reliable evidence of the fair value of [HFF]. Because market-based metrics are available, this decision does not consider it.”
Relying entirely on an Adjusted Deal Price methodology, the Court found that the fair value per share at the time of the deal’s agreement should not exceed $49.16 per share (the value of the merger consideration at the time of the deal’s agreement). The Court then subtracted $4.87 in net synergies per share (which were effectively net of retention payments made by JLL to key HFF employees) to calculate a value indication of $44.29 per share for HFF at the time of the merger agreement. To determine the value per share at the time of close, the Court adjusted this price upward by 5.2% (or $2.30 per share) to account for the pre-close earnings surprise, resulting in a concluded value of $46.59 per share. This amount slightly exceeded the deal consideration that would have been received at closing (or $45.87 per share) due to the decline in value of JLL’s stock between the date of merger agreement and closing.
- BCIM Strategic Value Master Fund, LP, v. HFF, Inc., The Court of Chancery of the State of Delaware, February 2, 2022. C.A. No. 2019-0558-JTL
- While the Petitioner advocated that the retention payments should be simply added to the deal price in calculating, the Court sided with the Respondent.