On April 23, 2018, the Delaware Supreme Court affirmed (without comment) the Delaware Court of Chancery’s ruling in a statutory appraisal case from July 2017. The case stemmed from a consolidated breach of fiduciary duty and appraisal action following Sprint’s acquisition of Clearwire in 2013.
In the original decision in ACP Master LTD., et al. v. Sprint Corporation, et al. and ACP Master LTD., et al. v. Clearwire Corporation (“Clearwire”), the Chancery found the fair value of Clearwire to be only $2.13 per share, or more than 50% below the $5.00 per share that Sprint (known as Sprint Nextel at the time) had paid in July 2013 to acquire the 49.8% of Clearwire that Sprint did not already own. The court stated a clear preference for the use of financial projections prepared by the management of the seller versus the buyer. In addition, the Chancery reinforced the notion that synergies should not be considered a component of fair value in appraisal proceedings.
The Clearwire decision stands out for several reasons. The most notable is that the Chancery concluded a fair value for the shares that was below the deal price, a rare occurrence for the Chancery up to that time. However, instead of being an outlier (as had other decisions of its ilk), it turned out to be prescient, as the Chancery has issued a string of subsequent rulings in which the court found the fair value was less than the deal price, most notably in the decisions in the Verition Partners Master Fund Ltd. and Verition Multi-strategy Fund Ltd. v. Aruba Networks, Inc. (“Aruba Networks”) appraisal case, as well as in re Appraisal of AOL Inc. (“AOL”).
The decision was notable for the Chancery’s treatment of synergies in the court’s analysis of fair value. In a statutory appraisal proceeding, any amount the buyer had paid for synergies should be excluded from the determination of the fair value, though the Chancery usually has not considered this factor in deliberations. In Clearwire, however, the Chancery made it clear in its opinion that the deal price was significantly inflated due to the buyer’s inclusion of synergy value in the offer. This concept was further reinforced in Aruba Networks and AOL, cases in which the Chancery used the existence of synergies to justify the court’s determination of a fair value below the deal price.
Sprint’s acquisition of Clearwire was the first part of a broader attempt by Softbank to enter the U.S. cellular telephone market. Softbank, the largest player in the cellular telephone market in Japan, wanted to acquire either Sprint or T-Mobile to compete with the two largest players in the U.S. cellular market at the time, AT&T and Verizon. After T-Mobile rejected Softbank’s overtures, Softbank made an offer in September 2012 to acquire 70% of Sprint. However, given Clearwire’s strategic importance to Sprint and Softbank (which coveted the large block of 2.5 GHz spectrum that Clearwire had assembled), the lenders for the deal conditioned their financing on Sprint having the right to appoint the majority of the members of the Clearwire board. To satisfy this condition, Sprint attempted to buy out one of the other strategic investors in Clearwire.
After news of the Sprint/Softbank merger leaked and Sprint received significant pressure from the Clearwire board, Sprint ultimately decided to pursue the purchase of all the Clearwire shares that Sprint did not own. After much back and forth, Sprint initially settled on an offer of $2.97 per share. However, once Clearwire was put into play, another player, DISH Networks (“DISH”), entered the fray. Similar to Softbank, DISH was trying to enter the U.S. cellular market and coveted Clearwire’s 2.5 GHz spectrum. DISH started a bidding war with Sprint for Clearwire, which Sprint eventually won at $5.00 per share. At a special stockholders meeting held in July 2013, the holders of more than 80% of the shares of Clearwire (not held by Sprint) voted in favor of the Sprint/Clearwire merger. On July 9, 2013, the Sprint/Clearwire merger closed, and on July 10, the Sprint/Softbank merger closed.
Following the announcement of the acquisition, a group of Clearwire shareholders led by activist investor Aurelius Capital Management, LP filed an action claiming that Clearwire’s directors had breached their fiduciary duties in considering the merger with Sprint, and submitted their shares for appraisal by the Court of Chancery. The Chancery ultimately rejected the breach of fiduciary duty claim and turned to the appraisal action.
In assessing fair value pursuant to the appraisal action, the Chancery first looked at the final merger price of $5.00 per share. However, for several reasons, the court rejected the deal price as indicative of fair value. First, neither the petitioner nor the respondent argued that the court should give weight to the deal price. At least with respect to the respondents (Sprint and Clearwire), this was not unusual in the Chancery’s view, as the deal involved a controlling stockholder, and it had declined to rely on the deal price in numerous previous instances where this had been the case.
More important, the Chancery determined that the deal price was not determinative of the fair value because the deal price contained a large element of synergy value. According to Delaware’s appraisal statute, the Chancery is required to determine the fair value of shares submitted for appraisal “exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation.” That is to say, fair value should exclude synergies that result from the deal itself and would not have existed had the target company remained a stand-alone entity pursuing its own business plan absent the deal. Previous Chancery decisions have codified this concept, including M.P.M. Enters., Inc. v. Gilbert (fair value is “the value of the company . . . as a going concern, rather than its value to a third party as an acquisition”) and Merion Capital LP v. BMC Software, Inc. (the “appraisal statute requires that the court exclude any synergies present in the deal price – that is, value arising solely from the deal”).
In this case, the Chancery explicitly stated, “The deal price … provided an exaggerated picture of Clearwire’s value because the transaction generated considerable synergies.” Specifically, Sprint put the synergy value at somewhere between $1.5 billion and $2.0 billion, or roughly $2.00 to $2.50 per share. Moreover, the Chancery felt that other evidence of fair value existed upon which the court could rely.
Interestingly, the Chancery’s ultimate fair value conclusion of $2.13 per share is also below Sprint’s original offer of $2.97 per share. When evaluating the fair price portion of the breach of fiduciary duty claim, the Chancery noted that the initial merger consideration of $2.97 “is fair when judged against this price and is consistent with the Special Committee having successfully extracted a portion of the synergies that Sprint hoped to achieve.” This statement suggests that the Chancery considered even the initial offer of $2.97 to be ladened with a certain amount of synergy value.
Having rejected the deal price as suggestive of fair value, the Chancery turned its attention to the valuations prepared by the experts for the petitioner and the respondent. In doing so, the court focused mostly on the financial projections used by the experts in their respective application of the discounted cash flow (DCF) approach to valuation. The Chancery had relied on DCF analysis in assessing fair value numerous times in the past, stating that such an analysis “is an established method of determining the going concern value of a corporation.” Thus, the court was comfortable with this approach. In this case, the DCF model prepared by the petitioner’s expert determined that Clearwire had a value of $16.08 per share, while the respondent’s expert felt that Clearwire was worth only $2.13 per share.
The Chancery pointed out in its analysis that the projections used by each expert drove 90% of the difference in the valuations. The respondent’s expert used what were termed single-customer case projections, while the petitioner relied on a set of projections deemed full-build projections. The most obvious difference between the two sets of projections was who prepared them. The single-customer case projections were prepared by Clearwire management, while the full-build projections were developed by the Sprint corporate development and finance team.
In the opinion, the Chancery took pains to point out its preferences for this key input, stating, “The first key to a reliable DCF analysis is the availability of reliable projections of future expected cash flows, preferably derived from contemporaneous management projections prepared in the ordinary course of business,” and “Delaware law clearly prefers valuations based on contemporaneously prepared management projections because management ordinarily has the best first-hand knowledge of the company’s operations.”
The single-customer case projections were prepared by Clearwire’s management in the ordinary course of business and were updated regularly, while the full-build projections were a hypothetical exercise prepared by Sprint in the context of the merger. Moreover, the full-build projections relied on numerous assumptions that the Chancery found were unrealistic, most notably that they assumed that Sprint would use the same quantity of Clearwire’s spectrum as Sprint would have if it owned the spectrum itself (despite the considerable differences in marginal cost in a lease-versus-own scenario) and that Sprint assumed that its payments to Clearwire would massively increase over the historical amounts Sprint had paid Clearwire (despite this being significantly detrimental to Sprint’s own financial well-being and there being other, less expensive options that they could pursue if the merger did not close). As a result, the Chancery determined the full-build projections were “not a plausible business plan.”
In addition, the Chancery felt that Sprint created the full-build projections only “to convince Softbank to top DISH’s tender offer.” The court stated, “Sprint management created the full-build projections to convince Softbank to increase the merger consideration by showing what Sprint’s business would look like if the merger failed and Sprint nevertheless decided – contrary to the evidence – to use Clearwire’s spectrum as Sprint would have if the merger had closed. Sprint and Softbank would not have done that.”
On the contrary, in assessing the single-customer case projections, the court pointed out that “Clearwire’s management had significant experience preparing long-term financial projections, and they regularly updated the single-customer case to reflect changes to Clearwire’s operative reality.” Moreover, the Chancery felt that the single-customer case projections more closely matched Clearwire’s reality at that time, given that Clearwater assumed that Sprint would remain Clearwire’s only customer (Clearwire had tried unsuccessfully on numerous occasions to obtain additional customers) and that Sprint’s payments to Clearwire would increase significantly, but not exorbitantly, in the future (consistent with Sprint’s actual usage of the Clearwire network based on trends in customer demand).
Thus, the Chancery determined that the single-customer case projections reflected Clearwire’s operative reality on the date of the merger, while the full-build projections did not.
For this and several other, less significant, reasons, the Chancery ultimately adopted the respondent’s valuation model in whole in the court’s analysis of the merger (and correspondingly, rejected the petitioner’s model in its entirety) and the respondent’s conclusion that the fair value of Clearwire on the date of the merger was $2.13 per share. This decision, along with subsequent Chancery decisions in the past year, provides companies, boards, and their advisors with additional guidance regarding the factors that the Delaware courts will consider in assessing fair value pursuant to an appraisal proceeding in the context of a merger transaction.